Clients are starting to receive 2019 Forms 990-T, Exempt Organization Business Income Tax Return, with tax due from the sale of publicly traded partnerships (PTPs) owned within individual retirement accounts (IRAs). A Form 990-T is required to be filed when unrelated business taxable income (UBTI) exceeds $1,000 in a year. The IRA fiduciary is responsible for signing and filing the return and paying any tax due, which is usually done by outsourcing the preparation of Form 990-T to an accounting firm without contacting or notifying the IRA owner. (For background on this topic, see "Alert for IRAs Holding Master Limited Partnerships.")
PTPs are unique as to deducting partnership losses. Unlike with other passive activities, any PTP losses passed through to the partners may only be deducted against income from that specific PTP until the year of sale. Therefore, a loss carryover from year to year can be created. In the year the PTP is sold, the accumulated losses are allowed as a deduction.
Most IRA owners are unaware of the tax implications of owning PTPs within their IRAs. Until about 2015, most fiduciaries did not perform their duty to file Forms 990-T. Many IRA owners did not retain Schedule K-1, Partner's Share of Income, Deductions, Credits, etc., from the PTPs owned within their IRA, or submit copies to their tax preparer, assuming the income was not taxable until withdrawn.
Now that fiduciaries are taking their return filing obligation seriously and many PTPs are cashing in, the IRA owners are seeing the cost of owning PTPs in their IRA accounts for the first time. In many cases, IRA owners are not being asked for prior year Schedules K-1 before the return is prepared. This results in an overstatement of taxable income in the year of sale if there are unused carryover losses.
The IRA owner typically has very little time to review the Form 990-T before the fiduciary pays the associated tax and no workpapers supporting the tax return are provided. There is no requirement that the IRA owner authorize the withdrawal to the pay the tax. It is quite alarming to get a notice that $(fill in the amount) is going to be deducted from your IRA in 10 days to pay tax on income that was assumed to be deferred.
If your clients have an IRA that invested in PTPs, here is what is needed to help them pay the correct amount of tax.
- Obtain all Schedules K-1 for each entity for each year. The important information is the amount of UBTI, or loss, for each year, currently shown in Box 20 Code V. Accumulated unused losses are the most underreported item on Forms 990-T. Many PTPs have merged with other PTP entities over the period of ownership or the client may have sold units in prior years. Therefore, some research may be needed to determine what entities were owned in prior years. The Schedule K-1s for all entities will be needed. If the client does not have or cannot get all the K-1s, the tax preparer for the fiduciary will not adjust the loss carryover.
- Obtain year end statements that show sale and basis information for the investments in the IRA account.
- The capital gain amount is affected by the debt ratio percentage. Simply put, if the activities of the PTP are debt financed, then a portion of the capital gain is taxable. The debt ratio percentage tells the preparer how much to include. Getting the debt ratio percentage is difficult. It is not published anywhere and can only be obtained from the entity itself. The fiduciary should be able to provide this information.
- All Sec. 751 ordinary income is taxable. This ordinary income is part of the overall gain (or loss) from the sale. This amount is provided by the partnership on the K-1.
- The tax preparer for the fiduciary is usually reluctant to provide the workpapers. Demand that the fiduciary provide whatever documents and spreadsheets the preparer used. In most cases, this will be just an excel spreadsheet.
- Begin now to collect prior and current Schedules K-1 for any PTP holdings within the IRA, even if the client has not sold the interest. Most of the commercial K-1 services, like Tax Package Support, delete Schedules K-1 for the entities they support after three years. Other sources, such as investor relations for the PTP, might have a longer retention period. Advise clients to keep all Schedules K-1 until seven years after the entity is sold.
- If the client cannot convince the fiduciary to file a corrected or amended return, consider negotiating a release of liability with the fiduciary and have the client assume responsibility for filing the original or amended Form 990-T.
To their credit, as part of their fiduciary duty, fiduciaries are trying to comply with IRS regulations. However, the amount of tax owed is not their priority. It is up to the IRA owner, with the assistance of their CPA, to protect their investments from erroneous tax assessments.
— Janet C. Hagy, CPA, is a shareholder of Hagy & Associates PC in Austin, Texas, and is also a former member of the AICPA Tax Practice and Procedures Committee. To comment on this article or suggest an idea for another article, contact Sally Schreiber, senior editor, at Sally.Schreiber@aicpa-cima.com.