Navigating Tax Season with a Tax-Advantaged Plan

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A lucrative investment strategy may carry tax considerations, but the beauty of tax-advantaged accounts lies in your ability to defer some or all of the taxes on your annual earnings. However, depending on the nature of your account-held investment, tax season can present certain responsibilities that you should keep in mind. Together, we will walk through some important considerations for you to remember as tax season approaches.

 

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What is Unrelated Business Income Tax (UBIT)?

UBIT is a unique cost of doing business inherent to some IRA-owned assets. If, in a given year, your account earns money from debt-financed property or income from a pass-through operating business, your account may owe UBIT for said year.

Unrelated Debt-Financed Income (UDFI)

Your account will owe UBIT if it makes money with borrowed funds. UDFI is the portion of earnings attributable to any debt your account incurs to engage with an investment. UBIT on such earnings is essentially the cost of making money by investing funds that weren’t yours in the first place.

For instance, say you want to invest in real estate with your self-directed IRA, but you don’t have enough money to purchase a property in full. Your account has enough to purchase 50%, so it takes out a loan for the other 50% to take 100% possession of the property. If the 50% debt percentage remains the same for the duration of the following year, 50% of the property’s earnings, in accordance with the debt percentage, would be subject to UBIT. The 50% that your account purchased outright and without debt will not be subject to UBIT. If your IRA has a positive net income, the UBTI (and thus the UBIT) will be lower the lower the debt-financed percentage is.

Unrelated Business Taxable Income (UBTI)

UBTI is money earned by an operating business that isn’t taxed at the corporate level. For example, let’s say your account holds a private equity stake in an operating business that doesn't pay taxes at the corporate level. The business is considered a "pass-through" entity because the tax burden is passed through to investors. Upon distributing untaxed returns to the investors, the IRS will look to your account to cover its share of the unpaid taxes (UBIT).

What is a Schedule K-1?

How do you know if your account owes UBIT? A Schedule K-1 is an IRS form that reports income or losses from certain types of investments. You may receive a Schedule K-1 from NDTCO that describes any UDFI or UBTI your account earned for the year, if relevant.

It’s worth noting that the applicable box(es) on a Schedule K-1 may include a negative number. While a negative return would be unfortunate, negative returns in one year can be used to offset earnings in the future.

It’s also important to remember that your account may owe UBIT even if you don’t receive a Schedule K-1. Consult with your tax professionals if you have any questions or concerns about your account’s UBIT obligations.

What is Form 990-T?

If you receive a Schedule K-1 and it’s determined that your account owes UBIT, you will need to file a Form 990-T on behalf of your account. This is similar to (though distinct from) your personal income tax filing, except you must separately file your account's taxes as an independent “investor” and it must pay its own taxes; you may not cover your account’s UBIT with personal funds.

To submit a UBIT payment:

  • Log in to your client portal at portal.ndtco.com.

  • Click “Pay Bills” on the left side of the screen.

  • From the “Select an asset to pay a bill” drop-down menu, choose the asset for which you wish to submit your payment. Click the “Pay Now” button once the asset has been selected.

  • Choose Check for “Payment Type,” One Time Payment for “Payment Frequency” and UBIT Payment for “Payment Type.”

  • On the “Check Memo: Invoice/Acct. #” line, enter the EIN on your approved tax return and the tax year you are paying for (e.g. “EIN 55-5555555 2020”).

Send us an e-mail at cashmgmt@ndtco.com if you need assistance with submitting your UBIT payment.

It is optional, but not required, that you file a Form 990-T if your account-held investment generates a negative return. As mentioned above, you can offset future earnings (and thus future UBIT) with a negative return, but only if it’s reported via Form 990-T.

Get Help When You Need It

Navigating tax season with a self-directed plan can seem complicated at first. If you have specific concerns around what you may owe or need to report, we encourage you to contact a tax professional experienced in self-directed plans.

If you are looking for additional help, IRA Tax Services, our sister company, would be happy to help with any matters relating to UBIT or a Form 990-T filing.

For any other questions related to your self-directed IRA, 401(k), or Health Savings Account, please don’t hesitate to give us a call at 877-742-1270 or send us a message through the client portal.