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My question is concerning the unrelated business income tax on partnership interests inside a Roth IRA. Specifically, I own common stock in a company that's technically classified as a Limited Partnership (Icahn Enterprises L.P. to be exact), which I guess means that I'm technically considered a junior partner and get a K-1 form from them.

My question is: why is this considered an "unrelated business" for tax purposes? Unrelated to whom or what, exactly? One example of an "unrelated business" that the Wikipedia article I link to gives is a university that owns a pizza parlor. I understand how that example is unrelated to to the university's educational mission (and therefore taxable income), but I don't understand exactly how that reasoning applies to me as an individual.

And why does the tax code mandate that income derived from it be potentially taxable, even if held within an IRA? Why does the government consider this different than, for example, an "ordinary" dividend?

  • As additional help, the IRS definition is provided here: irs.gov/charities-non-profits/unrelated-business-income-defined and the official publication noting how Roth/IRA qualifies as an organization that must consider it, along with additional details (Publication 598 pdf): irs.gov/pub/irs-pdf/p598.pdf But after reading them, I'm still at a loss myself - good question! – BrianH Apr 16 '19 at 18:23
  • @BrianH Yeah, I'm confused too - I see how it would apply to an organization, but I'm at a total loss as to how that applies to me as an individual. What is it supposed to be unrelated to? – EJoshuaS - Reinstate Monica Apr 16 '19 at 18:26
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The term can mean different things in different contexts, even within taxes. The example you reference with the university is in the context of determine non-profit status i.e. if the business is not related to the mission of the university it doesn't necessarily qualify for tax-exempt status.

In the context of IRAs, it typically has to do with the requirement that investments be at 'arms-length', specifically most transactions dealing with disqualified individuals (essentially the owner of the IRA and their family) are prohibited. For more info see the Prohibited Transaction section of IRS Publication 590. My understanding is they are trying to prevent self-dealing issues, like purposely undervaluing a company to bypass contribution limits and thus avoid taxes.

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