A growing number of employee benefit plans are using alternative investments as a means of increasing portfolio diversification and enhancing returns. These investments often produce unrelated business taxable income (UBTI). Even though an organization may be recognized as tax exempt, it still may be liable for tax on its unrelated business income.
Many plan sponsors are not aware of UBTI and need to evaluate their plan investments for possible implications of this tax. UBTI is typically deemed income from a trade or business regularly conducted by an exempt organization and not substantially related to the organization's exempt purpose or function. Plan investments that generate UBTI may be taxable corporations, private equities, partnerships, and real estate. The consequences of UBTI may be a requirement for the plan to file Form 990-T, Exempt Organization Business Income Tax Return, as well as any applicable state 990-T equivalent filings and foreign partnership information returns. Failure to file can result in significant penalties and interest to the plan. In addition to the federal tax implications, determining the various requirements for state filings can become extremely complex, as a single investment can produce income attributable to multiple states.
The actual determination of UBTI is often difficult and requires your tax preparer to evaluate the various K-1 filings associated with these alternative investments. This is a topic we are staying on top of as it affects many of our clients. Please let us know if you have any questions or concerns.
By Eric Wallin, CPA, Senior Manager, firstname.lastname@example.org