You may think the only time you'd pay taxes on an IRA or a retirement account would be when you take withdrawals or distributions, but it is possible before then for certain income received in retirement accounts to be taxed.
What is UBTI?
When a retirement account earns active business income, this is considered unrelated business income under federal tax law and is subject to its own tax.
Let's say, for example, you own an oil drilling Partnership in your IRA, and the drilling equipment owned by the Partnership is leased to another company to use. This rental income would be considered UBTI.
UBTI tends to be generated by the following types of investment vehicles:
- Limited partnerships (LPs) – businesses owned by more than one person, with limited liability to the owners for business debt
- Master limited partnerships (MLPs) – a type of LP that is publicly traded and often found in the energy sector
An IRA or retirement account may be invested in a business that generates UBTI.
If unrelated business income is $1,000 or more per year, the IRS requires reporting of the UBTI on Form 990-T and the payment of excise tax.
Given how LPs, and MLPs, are structured, they're required to pay out most of their profits to investors.
If, for example, your retirement account is invested in an MLP that generates UBTI and the MLP distributes business profits to your retirement account, and UBTI of $1,000 or more is generated then:
- As custodian, Fidelity will complete and file Form 990-T on behalf of your retirement account.
- We will pay any resulting taxes, penalties, and interest from available assets in your account
Any amounts remitted from the account to pay this tax will not be reported as a tax reportable distribution on IRS Form 1099-R.
Review any carry forward losses for MLPs or LPs with your tax advisor. This information (i.e. loss schedule, prior-year K-1 forms) may reduce your tax liability. Any additional information may be submitted to Fidelity using the Supporting Information for Form 990-T Filing (PDF) form.
Mail completed forms to:
- Fidelity Investments
PO Box 770001
Cincinnati, OH 45277-0060.
Failure to file Form 990-T and pay any required UBTI tax can result in penalties.
We will notify you next year if your retirement account is required to pay UBTI for the applicable tax year.
Taxation related to UBTI can be complex. Depending on your financial situation and goals, having retirement accounts invested in UBTI-generating entities may or may not be to your advantage. Consult a tax advisor on this issue and others related to UBTI.