The IRS has released a draft of the new Form 5500-SUP which includes, and in some cases brings back, retirement plan compliance questions specifically of interest to the IRS. The 5500-SUP, or an electronic equivalent, will be required beginning with 2015 plan years (unless the IRS elects to defer implementation until 2016, which appears increasingly unlikely). One of the questions on the new form asks whether the plan incurred any unrelated business taxable income, and if so, in what amount.
What is unrelated business taxable income? The Code imposes a tax on unrelated business taxable income (“UBTI”), income derived from unrelated business activities of an otherwise tax-exempt entity. UBTI prevents tax-exempt entities, such as qualified retirement plan trusts, from competing unfairly with taxable entities. Without UBTI, a retirement plan Trustee or participant could elect to use plan assets to purchase an active business (such as a gas station or bakery). As a tax-exempt entity, the plan would not owe income tax on the profits derived from the business and the business would be able to operate at higher profit margins or sell its products at a lower cost than its taxable competitors. UBTI eliminates this advantage.
For a retirement plan, UBTI is the gross income derived by the plan from unrelated trade or business conducted in the plan, less any allowable deductions associated with the activity. The tax rate for UBTI within a retirement plan is based on the Estate and Trust tax schedule and ranges from 15% for the first $2,500 of income to 39.6% for income in excess of $12,300 (in 2015), although the first $1,000 of UBTI is deductible and not taxed. UBTI is calculated and remitted using IRS Form 990-T and any required tax is paid by the plan out of plan assets, not by the associated participants or beneficiaries out of their personal funds.
When does UBTI apply? An activity is considered an unrelated business subject to UBTI if three requirements are met:
1. The activity is a trade or business
2. The activity is regularly carried on, and
3. The activity is not substantially related to the exempt purpose of the organization
A trade or business includes any activity carried on to produce income from the sale of goods or the performance of services. The “regularly carried on” requirement is facts-and-circumstances based, but will generally be satisfied if a plan owns an ongoing business operation. Any business operated by a retirement plan will be considered “not substantially related to the exempt purpose” of the plan (unlike, for example, a tax-exempt industry organization that holds a for-profit trade show).
The IRS recently published on its website examples of unrelated trades or business they have identified which plans have conducted. Examples include operation of a vending machine route, subdivision of land, operation of a fruit orchard, and rental of personal property.
What is unrelated debt-financed income? UBTI also applied to unrelated debt-financed income (“UFDI”). In general, unrelated passive income received by a plan (such as interest income, dividends, rents, royalties, etc.) is not UBTI and is excluded from taxation. However, when such income is derived through the use of debt financing, the income becomes UFDI subject to UBTI. If, for example, a plan Trustee or participant purchases securities with borrowed funds, the interest or dividend income derived from those securities will be subject to UBTI. The gains on the sale of debt financed property are also subject to UBTI. The includible income is proportionate to the debt on the property, so if the plan purchases the securities using 50% cash and 50% debt (margin) then 50% of the income from and 50% of the gains associated with the sale of the securities will be taxable.
With limited exceptions, this rule similarly applies to debt-financed real estate held within a plan. While rental income is generally exempt from UBTI, rental income is subject to UBTI to the extent it is derived from debt-financed property, unless an exception applies.
Why does this matter? The inclusion of the question regarding UBTI on the draft 2015 Form 5500-SUP suggests that the IRS is concerned that Plan Administrators may be failing to properly report and remit unrelated business income tax. By placing the question on the 5500-SUP, the IRS is placing the onus on Plan Administrators – under penalty of perjury – to identify and disclose the existence and amount of UBTI with each plan year. It is reasonable to expect that a “yes” answer to this question on the 5500-SUP will cause the IRS to look for the related Form 990-T submission and payment of the calculated tax liability.
The preparation of the Form 990-T is preparation of a tax return (as opposed to the Form 5500 series returns, which many practitioners consider to be an information return) and will likely fall outside of the expertise of many TPAs and recordkeepers. Nevertheless, retirement plan professionals who prepare Form 5500s would likely be very well served in identifying instances where UBTI may apply and advising potentially impacted clients to retain the services of a tax professional experienced in UBTI calculations.
=========================================================
6 Summer Classroom Seminars
401(k) Plan Workshop
Form 5500 Workshop
PPA Pre-approved Plan Workshop (Corbel or PPD)
Safe Harbor 401(k) Plan Workshop
Advanced Cross-tested Plan Workshop
Fundamentals of 401(k) and Other Qualified Plans
Back-to-back scheduling!
The 401(k) Workshop and the Form 5500 Workshop are scheduled over two days in the same cities. A multi-program registration discount is offered for those who wish to attend both programs at the same location. This discount also applies if you attend both the Safe Harbor 401(k) Workshop and the Advanced Cross-tested Workshop in the same city.
Take advantage of the early fee, register online today. View dates, locations, and program details for these workshops, and to register: www.relius.net/events/events.aspx?Seminar
Upcoming Webcasts
Fiduciary Investment Advice, 5/29, 12:00 PM ET
Fundamental Series 14: Fiduciary requirements, 6/1, 12:00 PM ET
Form 5500 for Welfare Plans - A Two-Part Program, 6/4-5, 12:00 PM ET each day
Form 5500 for 403(b) Plans - A Two-Part Program, 6/18-19, 12:00 PM ET each day
For more details about these programs, and to register online: www.relius.net/events/events.aspx?Web
Chicago Advanced Pension Conference – September 2-4 – Save the date
Just for ERPAs Workshop, Chicago IL – September 1, 2015
Online registration will open in June, here: http://www.relius.net/Events/seminardetail.aspx?CID=26684
Newly Archived Web Seminars
Fundamental Series, sessions 01 - 13
Beyond Fee Disclosures
Service Agreements
The New Tools in the EPCRS Box
Tribal Plans
For program details about archived Web seminars, and to register: www.relius.net/events/events.aspx?Archive |
