The 15 Minute Unrelated Business Income Tax (UBIT) Guide

Transcription

1 The 15 Minute Unrelated Business Income Tax (UBIT) Guide Learn how to Harvest IRA MLP Tax Losses, Offset Taxes and Ensure Compliance with the IRA Mystery Tax Called UBIT.

2 WHY WE WROTE THIS GUIDE This guide is designed to provide an overview of Unrelated Business Income Tax (UBIT). You will also learn how to harvest IRA MLP tax losses, offset taxes and ensure compliance with the IRA mystery tax called UBIT. 1. What is UBTI, UDFI and UBIT? 2. When does UBIT apply to my IRA/401k? 3. Isn t UBIT a Double Taxation? 4. Understanding the Process 5. How Losses may Actually Help you Minimize, or even Eliminate, your UBIT Tax Bill 6. Three Options for UBIT Compliance 7. Facts about UBIT Professional to Compare with Your Current CPA or Tax Professional 2

3 1. What is UBTI, UDFI and UBIT? These three acronyms relate to tax implications within an otherwise tax-exempt account or entity. UBTI and UBIT are often used interchangeably. The first represents the type of income that is taxable; the other is the actual tax owed based on the income received within the tax-exempt account or entity. UBIT Unrelated Business Income Tax, is the tax liability paid to the IRS on certain investments that meet the guidelines within the IRS rules for accounts that would otherwise be tax exempt. The UBIT liability is calculated based on the total UBTI in the tax-exempt account each year. UBTI Unrelated Business Taxable Income, is the actual income subject to the UBIT tax. UBTI will relate to the business income received from an entity or investment which is deemed by the IRS to meet the criteria outlined below. UDFI Unrelated Debt-Financed Income, is primarily used in the context of IRA investments with income that is derived from debt-financed real estate or other property. The UDFI is subject to Unrelated Business Income Tax (UBIT). The amount of the loan on the property is what triggers the investment to incur UBIT, not the rents received or the gains from the sale. This can also be a factor if debt is incurred in the purchase of a business that is contained within an IRA. The following criteria must be met in order to classify income as UBTI 1. Is it a trade or business? 2. Is it regularly carried on? 3. Is it substantially unrelated to the exempt purpose* * Any trade or business conducted inside an IRA or other tax-exempt account is considered unrelated to its purpose Why Do I Have to Pay Taxes on an IRA/401k Investment? Unrelated business income tax/taxable income (UBIT/UBTI) is a provision that was added to the Internal Revenue Code by Congress in the Revenue Act of 1950 to eliminate an unfair competitive advantage enjoyed by exempt organizations and entities over their taxpaying counterparts in the non-exempt world. This provision was later amended to also include IRAs and other tax-exempt retirement accounts. Note: UBIT applies to the business income or debt-financed real estate income earned by the IRA. Distributions classified as investment income are not subject to UBIT, such as interest, dividends, royalties, and rental income/capital gains (when no financing is involved). 3

4 2. When Does UBIT apply to my IRA/401k? Generally speaking, there are two main investment categories that would generate UBTI or UDFI in IRAs: MLPs, LPs & LLCs (UBTI) Master Limited Partnerships (MLPs), Limited Partnerships (LPs), Limited Liability Companies (LLCs) and similar pass-through entities (such as partnerships, limited liability partnerships (LLPs), etc.) that generate business and/or real estate income and issue K-1 tax forms to their investors. Debt Financing & Leveraged Investments (UDFI) Debt financing and leveraged investments, most commonly found through real estate investments utilizing non-recourse financing rather than paying 100% cash from the retirement account. Note: 401(k) plans are exempt from UDFI, pursuant to Internal Revenue Code Section 514(c)(9) How do I know if I am required to file? If the total income subject to UBIT exceeds $1,000, Form 990-T is required to be filed. To determine your filing requirement, calculate the business and/or debt-financed real estate income for each of the UBIT generating assets and aggregate. The filing requirement is determined at the account level, not per asset. LPs & LLCs If prepared correctly, each of your K-1 tax forms should provide a UBTI amount to help determine your filing requirement. This amount should be stated in Box 20, Code V. If there is not a Box 20, Code V amount stated does that mean I have no UBIT? Maybe, but not always. It is also possible for the K-1 preparer to provide a supplemental schedule over UBTI. The schedule will either state a UBTI amount, or provide you with a formula to use based on the numbers on the face of your K-1 tax form. What if Box 20, Code V is blank and there are not any supplement schedules, does that mean I have no UBIT? Once again, maybe, but not always. Unfortunately not all K-1 preparers have a strong grasp of UBTI/UBIT, and therefore might incorrectly omit the information. A good rule of thumb is to look at Box 1, 2, 8 and 9. If any of these boxes show an amount, there is the potential you have UBTI. You will need to contact the investment sponsor and ask them to provide you with a UBTI amount, or a formula to be able to calculate it for calculating UBIT. Debt Financing & Leveraged Investments The UDFI calculation is more complex, and involves a handful of steps in order to determine your filing requirement. If you have multiple debt-financed properties, perform the following steps for each property and aggregate UDFI amounts together. 1. Calculate the average cost basis of each property with debtfinancing. To do so, add the beginning cost basis to the ending cost basis, and divide by two. 2. Calculate the average acquisition indebtedness. Add the outstanding loan balance at the end of each month and divide by the number of months in question. 3. Calculate the percentage of leverage used on each property. Use the average acquisition indebtedness amount calculated above and divide by the average cost basis. 4. Apply the percentage of leverage to all income received and expenses incurred during the current the year to come up with a net UDFI amount. Note: Some allowable expenses include depreciation, interest, insurance, taxes, and repairs. 4

5 3. Isn t UBIT a Double Taxation? One of the primary benefits of IRAs is the tax-free or tax-deferred savings, so when confronted with UBIT many ask, why do I have to pay this tax? and isn t it a double taxation? Almost all publicly-traded stocks are incorporated into what is known as a C-Corporation. This means the earnings are first taxed at the corporate level before distributions flow down to its investors (thus affecting the overall return on your IRA earnings). UBTI and Pass-Through Entities Explained One of the two primary categories of investments that trigger UBIT are pass-through entities, such as Master Limited Partnerships (MLP), Limited Partnerships (LP) and Limited Liability Companies (LLC). When you invest in a pass-through entity, the tax structure allows for the partnership to pass all income/expenses down to its partners, and thus the associated tax consequences. The partnership itself does not pay a corporate level tax, rather each partner is charged with paying taxes on the income they receive on their K-1 (based on their position in the investment). If there were no UBIT rules, an IRA or other tax-exempt entity would be able to invest in a pass-through entity and not pay any tax at the corporate level or the partner level. Without having to pay any taxes, these pass-through entities would have access to more capital and cash flow, providing an unfair advantage over their corporate-tax-paying counterparts. UDFI and Debt-Financed Real Estate Explained The other primary category of investment that triggers UBIT is debt-financed real estate transactions. Although rental and capital gains income from real estate transactions are normally considered passive income and not subject to UBIT, when debtfinancing is introduced into the equation that quickly changes. Consider the following scenarios to better understand the power of leveraging your IRA A. Buy a $50,000 house with 100% funds from the IRA and receive $6,000/year in rental income. The transaction is funded with 100% IRA monies so there is no UDFI or Form 990-T to worry about. Net rental income received $6,000 B. Buy a $100,000 house with 50% funds from the IRA and 50% funds from a non-recourse loan and receive $12,000/year in rental income. The transaction is funded with 50% debt so $6,000 of the rental income is subject to UBIT. Total rental income received $12,000 Total UBIT on $6,000 of UDFI ($1,000) UBIT Professional fees ($700) Net rental Income received $10,300 Which scenario makes more sense to you? Don t forget It is possible to generate UBTI with real estate transactions even if 100% of the funds are from the IRA. Multiple real estate transactions in a given year could be considered a trade or business that is regularly carried on (meeting the criteria discussed above). 5

6 4. Understanding the Process 1. Determine if the investment is subject to UBIT Is the IRA or other tax-exempt account invested in real estate or other property with debt financing/non-recourse loans? Is the IRA or other tax-exempt account invested in a LP or LLC (or similar pass-through entity) for which you receive a K-1 tax form? If either of these conditions apply, the account is likely subject to UBIT and may need to address the IRS rules regarding the tax. 2. Determine how much UBTI/UDFI was generated for the current tax year Calculate the business and/or debt-financed real estate income for each of the UBIT generating assets and aggregate together. The filing requirement is determined at the account level, not per asset. If the total income subject to UBIT exceeds $1,000, the account owner is required to file Form 990-T. If the account has UBTI/UDFI losses and you wish to use them to offset gains in the future, Form 990-T is required to be filed (see next page). 3. If Form 990-T filing is required, the IRA must obtain an Employment Identification Number (EIN) The retirement account is a completely separate entity from the account owner, therefore an Employment Identification Number (EIN) is required to file and pay UBIT, rather than using the account owner s SSN. 4. Prepare and file Form 990-T, and facilitate payments electronically to the IRS Form 990-T for IRAs is due April 15th and tax payments are required to be made electronically using the EFTPS system. Any taxes due must be paid from the IRA. If your UBIT payment is expected to be $500 or more, quarterly estimated payments are required. 5. Determine if your state requires UBIT to be filed in addition to the federal tax State reporting requirements for UBIT vary from state to state. There are currently 10 states that do not require UBIT filings. It is also important to note that some states do not require state income tax filings but do require UBIT. Some states also have minimum UBIT payments regardless of a gain or loss. 4 Prepare and file Form 990-T with the Internal Revenue Service. 5 1 Limited partnerships, limited liability companies or similar entities involved in an unrelated business. Determine if the investment is subject to UBIT: and/or Real estate or other property with debt financing/non-recourse loans. 3 Obtain an employee identification number (EIN) from the Internal Revenue Service. Determine if your state has UBIT in addition to federal tax and file the applicable state form with the state taxing authority. Currently, 10 states do not require UBIT, including: Delaware, Kentucky, Nevada, New Jersey, Ohio, Pennsylvania, South Dakota, Texas, Washington, and Wyoming. A State Return must be filed in the remaining 40 states. This information is subject to change, please check with your state taxing authority or contact UBIT Professional directly. 2 Determine if you are required to file for UBIT: You are required to file Form 990-T if there is over $1,000 in income subject to UBIT. A specific deduction is applied to the first $1,000 of UBTI. and/or You are required to file Form 990-T in the year of the loss if you wish to carry the loss forward or backward to take against possible future or prior gains. Let UBIT Professional Focus on the Process so You Can Focus on Success We specialize in Unrelated Business Income Tax and Form 990-T preparation and have a process in place to provide a Done-For-You Solution. Let us take the complexity out of the process by contacting us today: UBIT Professional LLC. All Rights Reserved. ET

7 5. How Losses may Actually Help you Minimize, or even Eliminate, your UBIT Tax Bill There is a little known tax deduction that can, in many cases, transform a loss into a gain. This critical tax deduction is something many investors with UBTI miss. If your revenue-producing property or entity investment experiences a loss in a given tax year, the amount of the loss may often be carried back up to two tax years or carried forward up to 20 years. This may nullify a good portion, if not all, of the taxes you may have otherwise had to pay in years when you experience positive UBTI amounts. Consider the two scenarios below, which outline a real-life situation with one of our clients: Scenario #1 No Losses Filed IRA investor entered into an LP in 2008 and received a K-1 tax form each year IRA investor was unaware of the ability to use losses, which totaled $98k from 2008 to 2014 In 2015, IRA investor incurred UBTI of $120k (net of the $1k specific deduction) UBTI of $120k applied against the trust tax rate table = $45,828 in UBIT liability Paid $500 (1 year) in tax preparation fees for 2015 $500 + $45,828 = $46,328 in total expenses Scenario #2 Losses Filed IRA investor entered into an LP in 2008 and received a K-1 tax form each year IRA investor enlisted UBIT Professional to file and take advantage of losses, which totaled $98k from 2008 to 2014 In 2015, IRA investor incurred UBTI of $120k (net of the $1k specific deduction) Carryforward losses resulted in total UBTI of $22k ($120k - $98K) UBTI of $22k applied against the trust tax rate table = $7,020 UBIT liability Paid $4,000 ($500 x 8 years) in tax preparation fees for $4,000 + $7,020 = $11,020 in total expenses Total Savings by Filing Losses = $35,308! Important to Know 1. Form 990-T must be filed for each year there was a loss that you wish to use against future gains 2. Intervening years do not need to be filed to preserve losses filed from previous years 3. Multiple investments that incur UBIT within a single IRA have the potential to use a loss from one investment to offset gains from another 7

8 6. Three Options for UBIT Compliance UBIT Professional specializes in Unrelated Business Income Tax and Form 990-T preparation. Quite simply, our sole focus and specialty is to provide solutions for UBIT compliance, prepare Form 990-T and any additional documentation required. We work with individual investors, CPAs, financial advisors, fund managers, investment sponsors and tax professionals to provide a seamless process for maintaining records and preparing IRS filings. Let us focus on UBIT so you can focus on success. Do it Yourself 67 Hours* Record-keeping per year 27 Hours* Learning the law and forms per year 43 Hours* Preparing the forms per year 4 Hours* Copying, assembling, and sending to IRS per year No Experience with Form 990-T Opportunity cost: Inability to focus on your investing, your other responsibilities, or your personal time while completing Form 990-T. *According to estimates provided in the IRS Instructions for Form 990-T, which does not factor in applicable state reporting. UBIT Professional Specialized focus on UBIT and Form 990-T Our UBIT Pro Team has a combined 25 years of experience with thousands of 990-T Forms completed Opportunity cost: NONE - we allow you to focus on what s most important, while we take care of your UBIT needs. Trust your Form 990-T preparation with the experts at UBIT Professional. Our knowledge and experience in UBIT saves you time and money. CPA/Tax Professional Few UBIT Specialists Limited Experience May File T per Year Opportunity cost: The rarity and complexity of the tax cause many to refer business to UBIT Professional for a streamlined solution Many tax professionals may be unfamiliar with UBIT or Form 990-T preparation. There s a difference between experience as a CPA and experience preparing the 990-T in order to pay UBIT. 8

9 7. Facts about UBIT Professional to Compare with Your Current CPA or Tax Professional UBIT Professional Your CPA/Tax Professional Specialized focus on UBIT, with Form 990-T preparation for retirement accounts making up 100% of our business.? Our UBIT Team has a combined 25 years of experience with thousands of 990-T Forms completed and counting.? Helps IRA investors minimize, or even eliminate, UBIT tax bill by using our expertise in this area of the tax code.? Compiled all-inclusive list of state reporting requirements for UBIT over the past 10+ years, including which states don t require filings and those that require minimum payments.? Website fully devoted to UBIT, with FREE videos and other educational resources for IRA investors.? Provides services to obtain EIN and establish EFTPS profile so you can file properly and pay the tax electronically, as required by the IRS.? Highest level of customer service that is with you every step of the way through filing and payment to the IRS.? UBIT PROFESSIONAL DISCLAIMER: This material is presented with the understanding that UBIT Professional LLC, its representatives, officers, affiliates and clients have not been engaged in rendering specific planning, investing, or professional services. Questions relevant to your specific tax, investment, accounting, legal, estate or planning needs should be addressed to practicing members of those professions only after fully disclosing all relevant and material facts regarding your specific situation. Because of the technical nature of the material and the fact that the laws are ever changing, the assistance of a competent, qualified professional is recommended when implementing any ideas disclosed herein. UBIT Professional LLC and all its representatives specifically disclaim any liability, loss, or risk, personal or otherwise, incurred as a consequence directly or indirectly of the use and application of any of the techniques or contents of this material. UBIT Professional LLC, all its affiliates, representatives, officers do not provide any legal or tax advice. We provide education on topics related to unrelated business income tax (UBIT), and recommend that you work with a professional as to your specific tax needs. 9

10 Phone: ( UBIT) Fax: ( UBIT) UB Copyright 2017 UBIT Professional LLC. All Rights Reserved.