Tax Implication of Publicly Traded Partnerships: Why Purveyors or the US Tax Code Snarl at Investment Brokers.
My friend Roger Botterbusch recently put together a most excellent presentation on the tax implications of owning Publicly Traded Partnerships (PTPs), also commonly referred to as Master Limited Partnerships (MLPs). As a result I developed a new profound distaste for investment brokers pedaling these things for their 'prospective' fat returns whilst simultaneously poo-pooing the heavy, heavy administrative burden they bring at tax time.
The most interesting point of the presentation was that all but two PTP's traded in the United States kick out incredibly complicated year end K-1's to the owner for reporting on the 1040. In preparation for the presentation a ridiculous case study was bandied around about a taxpayer who engaged in 'day trading' PTP's. The 'trading' activities on their face were moderately successful but when taking into consideration that the tax practitioner had to process in excess of 100 very complicated K-1's creating an unbelievably large tax preparation bill the result was a marginal investment return so much so that the taxpayer would have been better off simply leaving his investments in a money market account for the tax year in question.
The second most interesting point is that PTP's kicking off in excess of $1,000 in the tax year of Unrelated Business Income (UBI) to the owner requires that the owner of the PTP not only process a complicated K-1 but also prepare IRS Form 990-T, that's right folks you read it correctly 990-T, usually reserved for 501(c) non-profits.
The following are the top 18 points garnered from the power point presentation delivered to the Colorado Society of Enrolled Agents:
1. By IRS Rules, PTPs are publicly traded partnerships tied to Natural Resources activities including Oil & Gas, Mining, Real Estate and Others.
2. PTPs can be invested in individual stocks, mutual funds, and ETFs
3. Most investors don’t realize they have invested in a PTP until tax time!!!!!! Thanks to the wolves of wall street.
4. Reasons to Invest in a PTP:
◦High Yields (Mid to High Single Digits Plus)
◦Payments (usually Cash Distributions) have special tax treatment versus normal dividends
◦Some PTPs pay out distributions even monthly (most pay out quarterly)
4. Traditional PTPs:
◦Pay out Cash Distributions rather than Dividends
◦Cash Distributions are tax deferred until investment is sold (Note: Basis is decreased by Cash Distribution)
◦Under Investors SSN (1040), if investment held until death, no tax will be paid on Cash Distributions (not the case for retirement accounts or business entities)
5. Most Traditional PTPs Kick off Complex K-1s adding profound complexity (and headaches) to tax returns
6. Institutional PTPs Do Not Have K-1s. Cash Distributions paid are Stock Dividends that will be subject to Capital Gain rules at time of sale
7. Some Mutual Funds and ETFs pay Dividends rather than cash distributions which tend to pay lower yields than traditional PTPs
8. PTP K-1 Forms:
◦Generally come between Feb 15 and Apr 15
◦Some K-1 Forms from GP PTPs can run Apr 15+
◦Most PTPs provide web sites where you can get soft copies of K-1 packages when ready
◦Roger recommends using K-1 Support (out of Tulsa OK) for PTP tax issues or problems with K-1 forms as they are "Great Folks to Deal with on Problems."
8. When PTPs are in Retirement Accounts most of the K-1 Form can be ignored.
9. Unrelated Business Taxable Income (UBTI): Found on K-1 in Box 20, Code V. If UBTI from ALL PTP K-1s in Retirement Account Adds up to $1000 or more, a Form 990 will be needed for the Retirement Account – Yes You Can End Up Paying Taxes on this UBTI each year. Note: Most Traditional PTPs will have UBTI < 0!
Warning: Many Financial PTPs tend to Throw Off Lots of Positive UBTI each Year
10. PTP K-1 Forms ‘Gotchas’:
◦Note IRC Statements need to be added to tax return as there is a possible Penalty per statement if missed
◦Note: If PTP in Pass-Thru Business Entity, Probably Good Idea to Pass-Thru IRC Statements to 1040
◦If PTP Investment Basis Drops below Zero, additional Cash Distributions are Taxed as Capital Gains (Raise Tax Basis to Avoid This Issue).
◦Box 13J: Section 59(e)(2) Expenditures are generally for Oil & Gas or Mining Development Costs. Either Amortize them over 5 or 10 years or take in tax year, but AMT adjustment on Form 6251 for each year until Amortization would be done or Investment Sold.
This is a complete pain in the ass to track. Also the K-1 never seem to tell you if it is a 5-Year or 10-Year Expenditure Item (Roger say always assume 10-Year)
11. For PTPs in Pass-Thru Business Entities:
◦Box 1 Income for PTP K-1 DOES NOT GO TO BOX 1 in Pass-Thru Business Entities K-1 to 1040 Clients. It goes to Box 10, Code E for Other Income
12. PTP Passive Losses:
◦Losses In PTPs Cannot be Mixed with Other LP Passive income or Other PTPs Losses.
◦Each PTP Loss must be carried forward separately in separate worksheets (no Form 8582) both for regular and AMT calculations
◦Most Software Packages will do this for you in a 1040 Return and you are probably on your own in a Business Entity Return.
◦Can only be taken at the time of investment sale AND Final K-1 received at the end of the Tax Year!
◦PTP Losses can cause trading Losses to become Passive Loss carryovers until time of sale – Sold PTP Stock could end up as SCH D Passive Loss Carry Forward if Client Doesn’t have Final K-1 at end of tax year (Usually 12/31).
13. What Happens when you Sell a PTP:
◦K-1 Form will generally show all adjustments for PTP units tax basis (Basis Adjustments on SCH D)
◦Many PTP Sales will have recapture of Cash Distributions via Section 1231 income
14. State Taxation Issues
◦Not an Issue in Retirement Accounts
◦For 1040 returns:
State non-resident tax returns may be needed for all states that PTP does business. ALL PTPs will send taxpayer information to all States where taxpayer received more than $500 or more in income from an individual PTP. Wash DC, Puerto Rico, US Virgin Islands, Guam, and Northern Mariana Islands income will require their own tax filings
15. How to determine if state taxes Owed?
1040 Return Formula
IF (State Income < .0001 X Federal AGI), state taxes will be $0
Note: Some States want tax returns even for state income less than zero (Example OH)
16. For Business Entity Returns (1120, 1120S, 1065):
Many States will want a business tax return for any business entity doing business in their state
Some States have Franchise Fees (range $25 - $4500 per business entity return)
Remember state tax ids for business entities. Some states require those state tax ids be registered for BEFORE you have investment income in the State (This can be a problem with some PTPs who add states where they do business during the year and client does not find out until receipt of K-1 at tax time)
17. Some Special ETFs Investing in PTPs:
◦Some Pass on ALL PTP K-1 Forms together in one Huge Package to Client for Tax Return Issues due to Investing in a Basket of PTPs
◦Note Each PTP portion of the overall K-1 needs to be treated as separate PTP K-1 data for tax purposes
◦Sorting out these Mega K-1 packages can be a real challenge!
18. Examples of How Taxpayers Can Make a huge Mess:
◦Invest in Too Many PTPs in Retirement Accounts
◦Day Trade PTPs
◦Put Traditional PTPs into Business Entities
◦Do All of the Above at the Same Time and Dropping the Mess on the Tax Professionals Desk.
In conclusion as Roger so eloquently put it "It's not a Circular 230 violation to assault your client or his/her broker."
For more information on this, please contact me anytime at your convenience.