UBTI Reporting Requirements for Partnerships and S Corporations

UBTI Reporting Requirements for Partnerships and S Corporations

Before one determines how to report unrelated business taxable income (UBTI) on a Schedule K-1, a quick review of the basics of UBTI is in order. It is worth noting that most tax-exempt organizations are subject to the UBTI rules. Sec. 511 details the organizations subject to tax on unrelated business income, which include:

Trusts, corporations, and any other organization exempt from taxation under Sec. 501(c), excluding U.S. instrumentalities exempt under Sec. 501(c)(1);

State colleges and universities;

Qualified pension, profit sharing, and stock bonus plans under Sec. 401;

Individual retirement accounts (IRAs), including Roth and SEP IRAs; and

Charitable remainder trusts.

UBTI is "the gross income derived by any organization from any unrelated trade or business (as defined in section 513) regularly carried on by it, less the deductions allowed by this chapter which are directly connected with the carrying on of such trade or business" (Sec. 512(a)(1)). This definition can be broken down into three components: (1) income from a trade or business that is (2) regularly carried on and (3) unrelated to an exempt purpose.

In determining whether the UBTI rules apply, a tax-exempt organization must first determine whether the income is from a trade or business. Any activity that is carried on for production of income and possesses the characteristics required to constitute a trade or business within the meaning of Sec. 162 will generally be considered a trade or business under the UBTI rules (Regs. Sec. 1.513-1(b)). The phrase "production of income" is important, as the regulations note that activities entered into with the intention to produce income will still be classified as a trade or business even if they generate a loss (Regs. Sec. 1.513-1(b)). Numerous classes of income (generally including most items typically associated with portfolio investment income) are specifically excluded from UBTI, including dividends; interest; royalties; rental income from real property; and gains or losses from the sale, exchange, or other disposition of property (Sec. 512(b)). Read more on The Tax Advisor.