Setrics Tracker
Retirement

Unrelated Business Taxable Income

Unrelated Business Taxable Income (UBTI) generally means any gross income gained from any unrelated business regularly conducted by an exempt organization.¹ Whether the income is UBTI depends on the type of tax-exempt organization that produces the income. UBTI rules are focused on the reasons why an organization is tax exempt and if certain activities of the organization do not align with that purpose.

Qualified trusts, for example, provide retirement income through contributions made to the trust. Consequently, the main purpose of a qualified trust is to generate investment income. A qualified trust is usually exempt from taxation gained from investment activity. This rule protects taxable entities from unfair business competition from tax-exempt organizations.² The following qualified trust income is considered exempt:

  • Gains from the sale of property
  • Common trust funds
  • Securities lending
  • Common investment income (interest, dividends)
  • Royalties
  • With limited exceptions, rental income from both real and personal property
  • Debt-financed property

If a qualified trust is active in trade or business, the income derived from the trade or business is taxed as UBTI. The sale and/or purchase of property generally is not considered UBTI. However, if multiple sales or purchases regularly occur, the trust may then be considered active in a trade or business.³

UBTI earned by qualified trusts is taxed according to Internal Revenue Code Section 1(e). To calculate the appropriate tax, substitute “UBTI” for “taxable income”. The law requires the assets be valued at fair market value. When determining the value of assets, trustees should be aware that valuation of assets may always be disputed. While frequent appraisals are helpful, overvaluing or undervaluing assets can potentially lead to a breach of fiduciary duty by the trustee. If there are other participants in the trust, account balances and participant distributions are based, at least in part, on asset valuation. Further, IRS Form 5500 requires reporting for owning more than 10% in any asset class. When purchased, real estate often exceeds 10%. By answering yes, the plan is often “red-flagged” for DOL audit.


1 https://www.irs.gov/publications/p598/ch04.html
2 Treas. Reg. Section 1.513-1(b)
3 PLR 91270145

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