Think twice before you put an LLC in your IRA

A reader asks:

I just received a k-1 1065 from a new LLC which is included in my IRA  this year.

Because my investment is included in my IRA portfolio do i have to report the income shown on the k-1?

That's a great question. It would be an even better question to ask before buying an LLC in your IRA. That's because LLCs often generate income that is - surprise! - taxable to the IRA.

The tax law frowns on tax-exempt entities like IRAs holding business assets. While it's OK to hold investments that generate interest and dividends in an IRA, Congress thought it would be unfair for taxable businesses to have to compete against tax-exempts. That's why the tax law imposes the Unrelated Business Income Tax, or UBIT, on business income earned by tax exempt entities. The UBIT is, in general, the corporation tax system applied to business income earned by exempt entities.

When UBIT applies to an IRA, the IRA has to pay income tax itself on Form 990-T at rates up to 35 percent. State income taxes can also apply. Of course, the after-tax income of a traditional IRA may be taxed again when it is distributed to the IRA owner.

If you have income taxable to an IRA coming from an LLC taxed as a partnership, it should be on line 20 of the LLC's Form 1065 K-1, listed with code "V". In this case, "V" doesn't stand for "Victory."

The Moral: LLCs and IRAs are a poor mix unless the LLC only holds investments that generate interest and dividend income. If you own an LLC that generates business income in your IRA, you may need to file Form 990-T by April 15.