Thousands hit with surprise tax bill on income in IRAs-By Laura Saunders

Affected are investors holding master limited partnerships in retirement accounts

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On Oct. 13, two days before the final 2014 tax-filing deadline, investor Steve Goldston of Phoenix received a surprise tax bill for $24,321. It was for units of a master limited partnership affiliated with Kinder Morgan Inc. that Mr. Goldston held in his Roth individual retirement account. The total included nearly $6,000 of late-filing penalties and interest.

“I was outraged,” says Mr. Goldston. “Here was a tax form, completely filled out and signed on my behalf, saying that I owed this money and it was coming out of my IRA—but that was the first I heard.”
Mr. Goldston wasn’t alone. According to Pershing, the custodian of Mr. Goldston’s Roth IRA, it filed such forms for about 5,000 people who held Kinder Morgan MLP units in IRAs. Pershing is a unit of BNY Mellon and serves as a clearinghouse for about 800 financial firms. Kinder Morgan is a pipeline firm based in Houston.
Master limited partnerships typically transport, store, produce and refine energy and pass the bulk of their earnings to shareholders.
Thousands of investors holding MLPs in IRAs at other firms may owe similar taxes that they aren’t aware of, experts say.
The unexpected bills are painful reminders that even widely held investments such as MLPs can contain tax traps, experts say.
“People need to understand what they are investing in, especially the taxes and fees,” says Don Williamson, an accountant who heads the Kogod Tax Center at American University.
In this case, the traps have ensnared advisers and brokerage firms as well as investors. Here’s why, and what investors need to know.
The rules
Under the tax code, IRAs and Roth IRAs have significant benefits—such as tax-free growth—but they come with limits. When owners use IRA funds to invest in partnerships, as opposed to stocks, bonds and funds, they owe tax on certain annual income from the partnership exceeding $1,000 because of an antiabuse provision. This levy is known as Unrelated Business Income Tax, or UBIT, and its top rate of 39.6% can take effect at about $12,000 of taxable income.
A further, unique twist is that when this tax is due, the IRA custodian or trustee—such as Pershing or Charles Schwab—is responsible for obtaining a special tax ID number and then filing and signing an IRS Form 990-T reporting the income. The IRA owner is typically responsible for paying the tax.
Because of this complexity, experts often caution investors to avoid putting publicly traded partnerships into IRAs. But many, including Mr. Goldston, were unaware of this advice.
What happened at Pershing
The 5,000 late 990-T filings by Pershing, including Mr. Goldston’s, involved highly popular MLPs controlled by Kinder Morgan. The largest, Kinder Morgan Energy Partners (KMP), had 465 million units with a market value of $47 billion last year. Individual investors liked its high payouts and that taxes were deferred.
In 2014, the parent firm did a roll-up of the MLPs that triggered long-postponed taxes for many holders and generated UBIT for many investors holding units in IRAs. Mr. Goldston’s 1,365 units of KMP, for example, generated net income of nearly $52,000 and tax of $18,484.
According to Pershing’s spokesman, its tax adviser found that Kinder Morgan’s K-1 forms for investors didn’t have enough information to determine their taxes. By the time Pershing learned this, it didn’t have time to file for six-month automatic extension requests.
The tardy forms, which required complex information, triggered late-filing penalties and interest, raising Mr. Goldston’s tax bill by nearly one-third. Pershing’s spokesman says the firm is asking the IRS to abate the penalties, and experts say there is a good chance it will—but the tax is still due.
For its part, Kinder Morgan said in a statement that it “did not provide specific advice on unrelated business taxable income” because it didn’t “have specific knowledge of unit holders’ facts and circumstances.”
A spokeswoman for PricewaterhouseCoopers, which prepared the tax forms for Pershing, said it doesn’t comment on client matters.
An ongoing issue
Pershing says that for over a decade it has filed 990-T forms for IRAs when necessary. A spokesman for Charles Schwab said it also files the forms “if holdings or activity within a client’s IRA require such filing.”
Other firms have different policies. A Fidelity spokesman said the firm works with customers “to pay any necessary taxes from IRAs upon their request” and will have a system in place to file 990-T forms for 2016. There are reports of IRA owners with large Kinder Morgan MLP holdings held by other custodians who have heard nothing about this issue.
A spokesman for the IRS said the instructions for Form 990-T require custodians of IRAs with at least $1,000 of gross unrelated business income to file the form, a requirement that was clarified in 2014.

Meanwhile, this issue could create tax headaches for other investors. Earlier this month Targa Resources Corp., a Houston-based pipeline firm, announced plans to acquire Targa Resources LP in a taxable deal—so it could also generate UBIT for investors holding the MLP units within IRAs.

Culled from The Wall Street Journal