Unrelated Business Taxable Income

Tax-exempt organizations (such as pension plans, individual retirement accounts, foundations, and endowments) are subject to “unrelated business income tax” (UBIT) on their “unrelated business taxable income,” often referred to as UBTI. In connection with their investments in private investment funds, many tax-exempt investors seek to avoid or limit the funds’ generation of UBTI.

To avoid UBTI, the fund cannot incur indebtedness and cannot invest in flow-through operating entities, except through “blocker” structures.

Blocker structures: set up a corporation because debt incurred by a corporation (or other entity that is treated as a corporation for federal income tax purposes) is not treated as a debt of its shareholders, and there is an exclusion from UBTI for dividends received from a corporation, an investment in or held through a corporation generally does not generate UBTI (unless the shares themselves are debt-financed, as described above).