Check Your Clients’ IRA Form 990-T

By Janet C. Hagy, CPA-Austin

Master limited partnerships (MLP) owned within IRA accounts are problematic. Many investors were unaware of the possible tax consequences when the MLP was purchased. Even the IRS did not get interested in the unrelated business taxable income (UBTI) issue until about 2015 when it ruled that the fiduciary and not the account holder was responsible for filing tax returns for the IRA account. Up until then, most fiduciaries expected the IRA holder to file any necessary tax return reporting UBTI.

With outright sales and the recent conversion of many MLPs to corporate status, individuals holding MLP interests within their IRAs are receiving shockingly high tax bills for UBTI on Form 990-T, Exempt Organization Business Income Tax Return, for the sale of the MLPs. Most of the institutional investment firms are using a Big 4 firm to prepare the Forms 990-T. The problem is that prior year UBTI losses are routinely missed in the calculation of gain and tax due on the sale of the MLPs. 

Usually, the clients are not specifically asked for the old Schedules K-1 before the 990-T is prepared. If the client has not retained copies of the prior year Forms K-1, those prior year K-1s are difficult to obtain. Tax Package Support and other silos only keep three years of K-1s. The investor relations department of the MLP is usually unable to provide older K-1s, as well.

In addition to the lack of prior year K-1 information, a critical piece of information needed to check the calculation of the taxable capital gain is also hard to find. The UBTI rules only tax capital gains to the extent the company is debt financed. The taxable percentage to apply to the UBTI gain can be verified by obtaining the workpapers from the tax preparer and talking with investor relations of the MLP.

A third complication is the fiduciary status of an IRA. The fiduciary is the client of the tax preparer, not the IRA holder. Only the fiduciary is allowed to sign the Form 990-T. Therefore, it is not a matter of simply preparing an amended Form 990-T if one has already been filed. The IRA holder must provide supporting documentation to the fiduciary for them to submit to the tax preparer. This makes it a very cumbersome process to change the 990-T. In one case, the fiduciary agreed to assign the IRA holder the tax return filing responsibility. That may be a way to help a client rectify a problematic 990-T.

The IRS does not seem to care who signs the return at filing time, but that could be a problem if the return is audited. The IRS could take the position that no return was filed if the IRA holder signs it and penalize the IRA account for failure to file. However, if the proper tax was paid, failure to file penalties might be a moot point.

Consistently, the tax owed by the IRA is paid late, thereby generating penalties and interest that are charged to the IRA holder’s account. Late filing and payment penalties and interest can be avoided if the client is aware of a sale of the MLP and pays any tax by the original due date of the Form 990-T, usually May 15. If we are advised of a sale during the year, we may be able to estimate the tax owed and avoid penalties and interest.

We can also be of assistance by advising clients to retain copies of all Forms K-1 and to obtain any missing years’ K-1 forms before selling the investment. Providing those copies to the CPA and investment advisor can also help avoid erroneous 990-T filings. 

Alert for IRAs holding master limited partnerships (thetaxadviser.com)

Comments

[Patty Wyatt]

Thank you for your comment, Kathryn.

[Kathryn Kucera]

I have firsthand experience with this. I had a client whose IRA paid $25,000+ in tax on 990-T. I re-prepared the form using loss carryovers, the tax was $0. It took quite a lot of convincing the Big Four firm to amend the return but eventually they did. It would have been much more efficient for me to prepare the return for my client and allow him to sign it. I would bet that there are many, many incorrect 990-Ts being filed, and too many IRA owners are completely unaware.