Now for the really bad news. The Forms T prepared by the accountant hired by the broker may be wrong, and not usually in the client's favor. For example, a prominent brokerage firm hired a major accounting firm to prepare two Forms T for for its client. The client received notice that the forms were ready to be filed on Sept.
The extended due date was Oct. Penalties and interest had already accrued due to late filing. No supporting documentation, such as facsimile Form B, Proceeds From Broker and Barter Exchange Transactions , or workpapers were provided by the preparer.
But the client was advised to review the returns with a tax adviser. Substantial tax was owed and paid out of the IRA on Oct. After the client became aware of the taxes paid from the IRAs, which occurred after Oct. The preparer procrastinated and just sent another copy of the tax return.
Over the next few months information was obtained from the broker, but not from the accounting firm hired by the broker, about the details of the sale of the MLP units. Upon review and reconstruction of the data by a preparer hired by the IRA holder, significant errors were discovered in the tax return. Ordinary income was not allocated correctly between the two IRAs, capital gains were overstated, and prior year suspended losses were not deducted.
The original preparer did not provide any information until the client's personal accountant prepared amended Forms T and submitted them for filing by the fiduciary. The amended return resulted in the following changes:. Basis adjustments to the purchase price and the ordinary income portion of the overall gain on sale are provided in the notes to the Schedule K Ordinary income reported from the sale of the MLP units is reported on Form , Sales of Business Property , and this ordinary income should match the Schedule K-1 amount.
The ordinary income is taxable in full. Any limitations related to Sec. Suspended UBTI losses are deductible on the return for the year of sale. Since the broker's accounting firm had only the current and one prior year Schedule K-1, and did not have any of the older years' Schedule K-1s, the suspended UBTI losses were completely overlooked for the years before the sale.
A huge red flag is when the basis adjustments are large reductions, but the UBTI losses claimed are relatively small or exactly match the amount reported on the Schedule K-1 for the year of sale. Basis adjustments include cash distributions, but the adjustments also include the suspended UBTI losses. When the basis is reduced for these adjustments, but the suspended UBTI losses are not claimed, taxable income is overstated.
When they are unavailable, the cash distributions schedule is usually easy to download from the MLP website on a per share basis, and distributions can be reconstructed for the client. Subtracting the cash distributions from the basis adjustments should give a reasonably close estimate of the accumulated UBTI losses.
These securities were made possible by the Tax Reform Act of , which allowed companies with primary business activities in real estate, commodities, or natural resources to issue shares of their partnerships to the public.
Because the shares of an MLP represent an interest in the partnership, any income they produce is considered a partnership distribution and is taxable as such. This becomes taxable income to the shareholder. That makes it subject to immediate tax, unlike most other investments you might hold in an IRA, where your earnings are usually tax-deferred or, in the case of Roth IRAs, tax-free. If you're tempted to buy shares in an MLP for your IRA, either a Roth or traditional one, it's worth consulting a tax advisor to work through the tax implications.
If you are interested in exposure to MLPs in your Roth IRA but would rather avoid the possible tax headaches, consider investing in an exchange-traded product that tracks MLP performance. Or, as an alternative, buy the MLP shares for a regular, taxable account. It is usually a good idea to hold individual MLPs in a taxable account versus a retirement account. Internal Revenue Service. Roth IRA. Income Tax.
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That big jolt of yield comes from the fact that MLPs pass cash flow onto a steady stream of income for investors. That structure is also what gives MLPs their tax advantages and why they don't work so well with retirement accounts. Consider this. Partnerships held in a retirement account can get caught in an arcane tax rule called unrelated business taxable income. You pay this when cash distributions from an investment are considered unrelated to the structure that gives an entity its tax-exempt status.
In plain English: Income from oil and gas is unrelated to saving for retirement, so the IRS wants you to pay some taxes on it. This usually affects only investors with big stakes in MLPs, but it can rear its ugly head if you have a particularly successful hit. Some analysts believe that UBTI is no big deal in a retirement account because it's actually the custodian's responsibility to file these taxes, not the individual's. And, even if they do, it's likely they'll charge a fee for these services, says Mark Willoughby, principal at Boston-based Modera Wealth Management.
One more tax angle to keep in mind no matter where you park an MLP: If the partnership operates across state lines you may have to file taxes in each of those states, a cumbersome and sometimes costly process. Bottom line: If you invest directly in MLPs, it's best to hold them in a brokerage account and take full advantage of the tax breaks and high yields. EPD - Get Report. We like the partnership's large portfolio and increasing shift toward natural gas, not to mention the 7.
For diversity's sake, some advisers suggest investing in exchange-traded funds and open and closed mutual funds that focus on MLPs. Shareholders in these accounts are not subject to UBTI taxes so they can easily put the funds in retirement accounts. The rub: extremely high fees. Because the fund companies are not considered "pass through" entities, they pay corporate taxes on MLP earnings.
To do that, they charge high fees. Plus, total returns are often lower than you might get from individual MLPs. At the least, if you're invested in MLPs, be sure the rest of your portfolio doesn't have too much exposure to energy investments. Receive full access to our market insights, commentary, newsletters, breaking news alerts, and more.
I agree to TheMaven's Terms and Policy. MLPs can be a great retirement investment but a terrible retirement account investment. Here's the good news. Income from an MLP is not taxed at the corporate level, which avoids the common problem of double taxation for corporations. Many MLPs operate capital-intensive businesses, such as oil and gas pipeline and storage facilities.
Securities and Exchange Commission. Internal Revenue Service. Accessed Dec. United States Congress. Income Tax. Tax Laws. Corporate Finance. Real Estate Investing. Your Money. Personal Finance. Your Practice. Popular Courses. Taxes Income Tax. Article Sources. Investopedia requires writers to use primary sources to support their work.
These include white papers, government data, original reporting, and interviews with industry experts. We also reference original research from other reputable publishers where appropriate.
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. Until about , most fiduciaries did not perform their duty to file Forms T. 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 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. 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. To comment on this article or suggest an idea for another article, contact Sally Schreiber, senior editor, at Sally. Schreiber aicpa-cima. The January issue marks the 50th anniversary of The Tax Adviser , which was first published in January Over the coming year, we will be looking back at early issues of the magazine, highlighting interesting tidbits.
This article discusses some procedural and administrative quirks that have emerged with the new tax legislative, regulatory, and procedural guidance related to COVID Toggle search Toggle navigation. By Janet C. Hagy, CPA. Obtain all Schedules K-1 for each entity for each year. Accumulated unused losses are the most underreported item on Forms 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. Or, as an alternative, buy the MLP shares for a regular, taxable account. It is usually a good idea to hold individual MLPs in a taxable account versus a retirement account.
Internal Revenue Service. Roth IRA. Income Tax. Your Money. Personal Finance. Your Practice. Popular Courses. Retirement Planning IRA. Article Sources. Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts. We also reference original research from other reputable publishers where appropriate.
You can learn more about the standards we follow in producing accurate, unbiased content in our editorial policy. Compare Accounts. The offers that appear in this table are from partnerships from which Investopedia receives compensation.
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