Do I have to worry about UBTI if I own an MLP ETF in an IRA?
The short answer is no. But that wouldn’t make for a fun post, would it?
Let’s start at the very beginning, a very good place to start. For those of us who sometimes get lost in a sea of acronyms, we’re dealing with two sets of capital letters here: UBTI, or Unrelated Business Taxable Income, is the income that can trigger UBIT, or Unrelated Business Income Tax. UBTI is kind of like realizing your most expensive bracelet has somehow slipped off your arm on Christmas Eve: it gives you something to worry about on an otherwise carefree day.
UBTI is the portion of income that could be taxed in an otherwise tax-exempt entity. What does this mean? It means a public university would have to pay taxes if it owned a taco stand on campus because the taco stand is not related to the reason why the university has tax-exempt status in the first place—that is, public education. In the same way a public university is exempt from federal taxes, IRAs (including traditional IRAs, Roth IRAs, Coverdell IRAs, SEP-IRAs, and SIMPLE IRAs) are “organizations” exempt from tax. If you are an investor in an MLP, you are actually a limited partner in a business. If everyone could put a partnership in his or her IRA with no tax consequences, then it would be game over for the IRS.
Tax-advantaged accounts that invest directly in MLPs could face UBIT when UBTI exceeds $1,000 in a year. Let’s be clear about this. Unrelated Business Taxable Income is NOT the same thing as cash distributions received, nor is it the same thing as net income. The only way to see how much taxable income your MLP generated last year is by looking at your K-1.
If you’re considering owning an MLP directly and want to know how much taxable income was generated in a previous year, this is something MLP investor relations teams may be able to help you with. While metrics from last year do not guarantee a repeat, it’s still a better response than “I don’t know.”
In recent days we’ve received lots of questions about owning MLP ETFs in tax-advantaged accounts. This makes sense because people are probably looking for entry points, and if unit prices rebound from current levels and we see a reversion to the mean in terms of valuation, it’d be nice not to be subject to capital gain taxes on that appreciation. The great news is that owning MLP ETFs in your tax-advantaged account is the same as owning any other ETF. UBIT is not something you have to worry about because you own the ETF, not the underlying LP units (aka unrelated business).
To learn more about Unrelated Business Income or to put yourself in a coma, you can read IRS Publication 598 which discusses this topic in painstaking detail. And if a 22-page PDF doesn’t fill your appetite, the Internal Revenue Code, Section 512 has even more exciting tidbits.
As always, Alerian is not qualified to and does not provide tax advice nor investment advice, so please contact your tax professionals with your specific questions. I, however, feel fine about providing life advice. And today’s is to not let things that don’t matter, like losing a piece of jewelry, ruin your time with family this holiday.