Making Sense of Master Limited Partnership Tax Rules
by Mary Lyman
So you’ve finally bought some shares in a master limited partnership (MLP) after hearing everyone rave about this equity investment that gives you a high yield, pays out cash every quarter and has tax advantages.
A couple of quarters go by, your investment pays off as promised, and you’re a happy camper. Then tax season rolls around and instead of the familiar Form 1099, a new form called a Schedule K-1 (Form 1065) shows up in the mail, with numerous boxes labeled with different types of income and deductions. What’s going on? What are you supposed to do with this?
In this article
- The Basics
- Distributions Are Not Dividends
- Dealing With the K-1
- Passive Loss Rules
- Adjusted Basis
- Selling Your Units
- State Taxes
- MLPs and Retirement Accounts
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The Basics
For those who are new to them, the first thing to understand is that an MLP is simply a publicly traded partnership (PTP). (Not all PTPs are MLPs, however; a number of PTPs are simply commodity pools.) By buying shares, technically referred to as “units,” in an MLP, you become a partner (or a “unitholder”) in this very large partnership. As a partner rather than a corporate shareholder, you enter a whole new world of taxation. Partnership taxation is what makes MLPs a tax-advantaged investment, but it also makes them more complex than many other investments.
As a partnership, an MLP is not considered to be a separate entity for tax purposes the way a corporation is, but rather is a pass-through entity—sort of an agglomeration of all its partners. An MLP does not pay corporate tax; instead, all the things that go into calculating tax—income, deductions, gain, losses and credits—are divided up among the unitholders as if they had earned the income themselves. Part III of the K-1 tells you your total share of each of these items.
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Discussion
What tax software programs do you recommend to handle the K-1s?
posted 4 months ago by Sebastian Lasher from Virginia
Will Turbo Tax automatically compute the K1 information on my Tax return?
posted 4 months ago by Walter Wiatre from Florida
Comments above don't seem complete, re MLPS in IRAS.
What's missing, is taxation on sale of an MLP in an IRA.
Also, how tax is payed--ie who prepares the tax statement??
NAPTP is wholly incomplete on this issue.
Please publish the answers to above, for the benefit of the members??
posted 4 months ago by Gerald Lanois from Florida
Walter - Here is what Intuit says about Turbotax and the K-1: http://turbotax.intuit.com/support/iq/Investment-Income/Schedule-K-1-Information/GEN12344.html
Gerald - Capital gains realized in an IRA from a MLP are not taxed. As the article states, UBTI can be, if it exceeds a certain level.
-Charles
posted 4 months ago by Charles Rotblut from Illinois
TurboTax does MLP K-1s easily, the cheapo programs either don't compute MLP K-1s or prove totally difficult to enter MLP K-1 info.
posted 4 months ago by Joseph Steffan from New York
I have been under the impression that for capital gains tax purposes, the original basis is used to calculate the gain or loss. There is of course recapture on the portion of income that was tax deferred. This is based upon the example in the old Wachovia MLP Primer.
Table 2 is the same info contained on the NAPTP web site and I would like to have this clarified please.
posted 4 months ago by David Phillips from Alabama
Yes, the K1's are not that difficult using Turbotax. One problem I found is that the information from the MLP often arrives very late so one has to wait until early April to finish putting the info into the forms.
posted 4 months ago by F paul Brady from California
@F paul Brady: Good point. The deadline for issuing a K-1 is March 15th, unlike a W2 which is Jan 31st, for instance. It can be anxiety-producing if you aren't expecting it.
If you prepare your own tax return, I usually prepare it when I have all w2, 1099-x, etc. forms. I add the K-1 info as I receive them. Entering everything but the K-1 info early allows time for review and discovery of potential problems with enough time to correct them. [Like better planning of 1040-ES payments next year! :-) ]
If you have someone else dong the preparation, I would submit all information minus the K-1 forms as soon as I have it. That allows the preparer to enter the information and just complete the 1040 when the K-1 becomes available. That should result in a better quality (accurate) return, rather than delivering a whole sheaf of tax information during the CPA's "crazy season".
posted 4 months ago by Greg Mckelvey from Georgia
CHARLES,
THE FOLLOWING IS A RESPONSE FROM THE AUTHOR:
RE: My post about your recent article in Nov 2012 in AAII
Hide Details
FROM: mlyman@naptp.org
TO: gdlanois@yahoo.com
Message flagged
Thursday, November 1, 2012 5:40 PM
Thanks for your comment. I generally don’t get into the issue of taxation on the sale of an MLP in an IRA unless specifically asked, because it is not a completely settled issue (the IRS has never ruled on this question) and I am not a tax advisor. It is clear that the portion of gain from the sale that would be taxed at the capital gains rate in a capital account will not be taxable to the IRA. The question is, does the IRA have to pay tax on the recapture portion, the amount that is taxed as ordinary income in a sale from a taxable account? Of the MLP tax experts I’ve consulted—some tax lawyers, some accountants—some feel that there’s an argument to be made that the transaction would be completely tax free to the IRA. Others argue that there is only one interpretation, that because the tax code gives precedent to depreciation recapture over any other rule, the recapture amount is treated as unrelated business income and the IRA must pay tax on it. All agree that the IRS would take the latter position; the only question is which position would prevail in the Tax Court and any subsequent appeals. Again, I don’t give tax advice, but the safest route is probably to assume that recapture applies.
The article actually does indicate how the unrelated business income tax is paid (unless it was edited out; I haven’t seen the published version), as does the material on the subject on the NAPTP website: it is the responsibility of the plan’s custodian—for example, Fidelity if you hold your IRA in a Fidelity account—to file the appropriate tax return (Form 990-T) and pay the tax out of the IRA’s funds. Perhaps I should have emphasized this more, as there is a of lot confusion among investors about how affects their taxes. If you are the beneficiary of the IRA it has absolutely no effect on your taxes—the IRA itself is the taxpayer owing money to the IRS, and any tax payments come out of its funds not yours.
Feel free to post this reply
posted 4 months ago by Gerald Lanois from Florida
And folks wonder why we need a simplified tax code. Nice Job Mary.
posted 4 months ago by Robert Carr from New York
I had been using TaxCut for years but it doesn't automatically handle the MLP K-1's. Switched to TurboTax several years ago and that works fine for me.
posted 4 months ago by Henry Absher from Georgia
All of the discussion on MLP taxation appears to reinforce the conviction some people have that the USA is in need of a serious rework of our tax law patchwork. I assist elderly people with taxes, including some K-1's, through the AARP volunteer network and even people with modest incomes are overwhelmed by some tax considerations.
posted 4 months ago by Herbert Edminster from Kentucky
When dealing with multiple MLPs in an IRA (a Roth IRA) is the exemtion $1000 per MLP or $1000 for the entire IRA.
posted 4 months ago by Bill Askwyth from Florida
It should be mentioned that there are at least three MLP based stocks that pay stock dividends or cash based on the parent MLP--KMR (KMP), EEQ (EEP), and LNCO (LINE). This means no K-1 and no tax hassels.
posted 4 months ago by John Brennan from Texas
When you sell your MLP does the company provide information on cumulative distributions and adjusted basis or do you have to go back to your K1's from each year of ownership and add it all up? I use Turbotax for my K1's, BTW.
posted 4 months ago by Dean Fisher from Texas
I have been preparing my own taxes since 1991 using TurboTax and its prior versions. I started doing this because when I sent my tax info to my accountant it would be after April 1st each year and he would then request to file an extension in August. So, I got the same software he used and began preparing my own returns on time. He would then review my return and make any corrections if needed then he would file an amended return. I never needed to file an amended return so this has worked well. In a few years I stopped having my accountant review my return. After I file my return, I make a copy of the filed return and use it as a template to estimate the following year's return as the tax data changes such as; deleting the prior year's income, capital gains/losses and dividends then I enter the current year's income, capital gains/losses and dividends. I keep the same K-1 data and deductions from the prior year because it is nearly the same for the following year. When the following year's TurboTax software is released, I transfer all the information from the prior year's return and then use the template to enter the changed data and update the K-1s as they are released. Using this procedure I never have any tax surprises and I always know what my tax situation will be ahead of time.
posted 4 months ago by Richard Sturgill from California
One of my MLP's has come in real late (EPD). In order to expedite this, and avoid the hassle of a late report, I use the following website to get it on to the CPA:
www.taxpackagesupport.com
posted 3 months ago by Howard Winegarden from Oregon
Having sold KMP, after 10 years, I found the recapture rather ominous. I thought that the reduction in tax base was the long term tax, and that was it. Now, my MLP investments will ride with me to the estate!
posted 3 months ago by Howard Winegarden from Oregon
Fabulous article. information that needs to be repeated every year or semi annually.
thanks
posted 3 months ago by G Bruggeman from Massachusetts
Based on the above MLP article, I assume that holding a MLP in a Roth IRA avoids the need to process the K-1 through yearly federal and state tax filings.
I make this assumption based on the Roth IRA process that income is tax free as long as the rules are followed (ie after five years, withdrawals are tax free).
Comments/replies are invited.
posted 3 months ago by L Woolford from Wyoming
K-1 schedules Turbo Tax Business edition generates K-1's (1041) for estates, trusts.
MLP will generate K-1's ( 1065 ) , send them to unit holders in February, March following particular tax year in question. Hence, you need to specify in your question what type of K-1 are you referring? Thanks; john 1/15/2013
posted 2 months ago by John Callahan from California
FYI.
A member asked if the unrelated business income tax rules also apply when a MLP is held in a Roth IRA. I checked with Mary about this and she said the rules apply, regardless if you are holding the MLP in a traditional or a Roth IRA.
-Charles
posted about 1 month ago by Charles Rotblut from Illinois
turbotax should put out to all their
customers a detailed explanation of how
to handle tax accounting for MLPS from
purchase to completion of sale. that would
put them way ahead of other tax prep programs
and create many happy customers.
posted about 1 month ago by Wesley Davis from California
turbotax should put out to all their
customers a detailed explanation of how
to handle tax accounting for MLPS from
purchase to completion of sale. that would
put them way ahead of other tax prep programs
and create many happy customers.
posted about 1 month ago by Wesley Davis from California
Roth IRA question for MLP's was never answered until end of post and apparently it was answered by a customer. Strange. Maybe he's right, maybe wrong? Leaves one in limbo. Best and simplest was the MLP's that pay dividends or cash.KISS
posted about 1 month ago by William Briggs from Maryland
Avoid all the tax mess. Invest in an ETF.
ALERIAN MLP ETF (SYMBOL, AMLP)
They invest in several MLP's and do all the tax work and distribute dividents just as a mutual fund does.
posted about 1 month ago by Samuel Shepard from Louisiana
Can someone summarize the pros and cons of holding a MLP in a Roth IRA? Thanks
posted 29 days ago by Lee Hausman from California
great story any ideas KMR IN IRA DID NOT KNOW THEIR WAS ETF IN MLP THANKS MIKEEEEEEEEEEEEEEE
posted 27 days ago by Mike Harrington from New York
CAN I EMAIL THIS STORY TO MY SELY MIKEEEEEEEEEEEE
posted 27 days ago by Mike Harrington from New York
