Why shouldn't you hold Master Limited Partnerships in tax-sheltered accounts?
Does it really matter? Is there a law of some sort against it?
Additional Information:
For those of you who might be affected by this:
According to Schwab, K1s will be sent by the MLPs to the individual by the end of the first quarter. These K1s have to be faxed to Schwab (the Custodian of my IRA in which I held MLPs) and Schwab will calculate any taxes and take them out of the IRA to pay them. NO TAX PAYMENT made is subject to penalties for early withdrawal. There are only taxes owed on UBTI over $1,000/person. Because this involves an IRA, it does not stop me from filing my taxes now because the Custodian of the IRA has to file these particular taxes, if owed.
I've sold my MLPs so it is not an issue next year!
Answers
2222 points
readytoretire answered 10 months ago …
It has to deal with the cash distribution portion of the amount that the MLP pays each year. To Uncle Sam, it is unrelated business taxable income-income that is unrelated to the activity that gave the fund its tax exempt status. So you would get income from the MLP and end up paying income tax on it even though you held it in an IRA. As most MLPs that deal in real estate, oil, gas, etc. have very good tax efficiencies, it is recommended that you hold them outside of the IRA.
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989 points
rvilmur answered 10 months ago …
I am not in agreement with the taxing issue in readytoretire's answer. No income to an IRA is taxed until it is withdrawn. What you don't get in an IRA with MLPs is the ability to write off any of the other tax advantages that are available in many MLP's such as depletion. There is no law against holding a MLP in an IRA. The whole issue is in the tax consequences.
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356 points
Dusty answered 10 months ago …
I have read careful, detailled discussion about the taxing of distributions from MLP's. There are specific rules and twists that make readytoretire's answer the right one. If I remember correctly, there may be more that can affect the entire tax sheltering of the entire IRA for at least the entire year during which these distributions are earned. I can never remember well enough to quote. I just make mental notes of things to do or not do. Do not put a MLP stock into an IRA.
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2775 points
Oldman answered 10 months ago …
I have several detailed responses to this question (and it applies to any security that issues a K-1, including Merill-lynch Holdrs, such as "OIL"; ETFs such as DBA, GLD, etc, wqith indexes set by Deutsche Bank), and grantor-trusts;
The problem is item 20V on a K-1 that is Unrelated Business Taxable Income, UBTI.
This is income generated and passed through to the limited partners from activities unrelated to the tax-shelter registration.
In the 1940's, to protect businesses that did pay income tax, the Treasury required this to be separately stated for MLP's that otherwise would have had an unfair competition with tax-paying businesses. How may UBTI arise: from loans and sales of partnership interest...if it's a pipeline partnership...and it sells at a profit, the limited partnership holders' share of the profits is UBTI. Then on the K-1, item 20V is shown...and if >$1000.00 is acumulated in one year, to the taxpayers shelters, the taxpayer has to notify the fiduciary (e.g., the brokerage) that a Form 990t Unrelated Business Taxable Income must be paid by the IRA to the Feds.
Since the K-1's come from the accountants at the MLP's or the index maker, and not from the brokerage (unlike 1099's), and they come after March 15, the taxpayer can't directly pay the UBITax, because (a) it's after the fiscal year for deposits...considered an 'excess" deposit, and (b) the IRA, to get relief, needs a "Taxpayer Identification Number", to file and pay the UBIT, The fiduciary may be totally unaware of the K-1 20V ammounts, and will charge >$200 and sometimes much more to establish a TIN and file 990t and the proceeds must be deducted from the IRA,
If the tax is not paid, the tax-sheltered status of the taxpayers accounts (S, SEP, 401K, 403b, IRA, Roths) are removed and all values accumulated and tax-free deposits BECOME TAXABLE!
In addition, some of the other responders have alluded to the current year's taxable benefits of MLPs in a taxable account...e.g., the "return of capital', instead of short-term taxed dividends, the tax-loss carry-forwards that shelter future gains, etc...which are wasted in an IRA, because withdrawals from IRA's are always taxed at marginal rates...there's no favorable treatment as to long-term gains or basis reduction in those accounts.
Any other income from the MLP in a tax-sheltered account doesn't get reported to the IRS...only Item 20 V UBTI....it's reported electronically and instantaneously by the MLP's accountants with the IRA account # and the MLPs Tax-shelter Registration No....just as the totals are from the regular 5498 IRA form forwarded by the IRA's fiduciary (which doesn't detail the holdings or gains/losses; only beginning, ending balances and deposits/yr)
If DBA (a Deutsce Bank indes sold as an agricultural commodity index ETF) makes $10k in income from "contracts and 'straddles' for your IRA...that's of no interest to the IRS; doesn't get reported separately; and is just a bookkeeping note for the IRA...but if it generates UBTI, then it is.
In addition, the Publication 590 indicates that U.S. minted coins and certain bullion may be kept in an IRA, but IRA's can't hold commodities. Now, the IRS hasn't yet received a Treasury ruling (an IRC #) regarding ETF's that hold Bullion or other commodities. So this caution also applies to the limitations on holding of commodities...and strictly speaking, MLPs., which may store petroleum or gas for more than 90 days, are considered "commodity -holders" under Treasury rules. They do this to get higher future prices when currnt prices are depressed (called "contango"). So this' yet another reason to avoid INDIRECTLY holding a commodity in an IRA. Who knows when & if the Treasury will rule on this...but why waste the tax benefits from MLPs in a sheltered account...and potentially jeopardise the tax sheltes)S- that one has.
Finally, some states, particularly AZ, CA and NV, but not TX, will send income tax demands for taxes on trust, MLP's and other dividend - payers that are headquartered in their states. It's against Fed. rules to try to tax a security in an IRA, but the paperwork to pay these piddling amounts in a taxable account are >>>K-1 entries in TurboTax or Tax Act software.
So- In summary beware K-1 reporting securities in any tax-sheltered account; beware of state taxes originating in the headquarters of the Partnership.
Finally, there are regular securities for many MLPs, that pay taxes and issue 1099s and NOT K-1's, that are the beneficial holders of much of the MLPs' shares and pay dividends based upon their ownership: KYE is Kayne Anderson fund that holds shares of KYN, an MLP...it pays dividends on income it gets from the KYN PTP(Publically Traded Partnership)...and as a Chapter C company (tax-paying) it issues dividends suitable for an IRA, and reports on a std 1099. EEQ is the company for Enterprise, KMR is the company for KMP...etc. These securities are more suitable for a tax-sheltered account, because they skim off some of the income from the MLP, and much like a REIT holding company, pay dividends that are otherwise taxable at marginal rates ...so they're suitable for sheltered accounts without the hassle of the K-1s. Some of these companies' dividends rise as the PTP income rises, so there is some variability in the dividend stream, but all of them take first, and the "Limited Partners", you and I - get the divvied up remainder of any profirts and losses.
I have written -more or less- the same response to many others who've asked the same type of question here and at seekingalpha.com.
2775 points
Oldman answered 10 months ago …
P.S., in my detailed responses, I left out the qualifying "if it sells a pipeline" at a profit, when its registration is to sell gas or oil through the pipeline or get royalties on the shipment or storage of the commodity, then this is Income unrelated to the tax-shelter registration. I din't mean to imply that the MLP gets UBTI from its profits...only from profits those that are unrelated to the tax-shelters registration description.
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Bully68 answered 10 months ago …
Oldman,
Thanks for your explanation of why it is not a good idea to hold MLPs (those that distribute UBTIs as reported on a K-1 report) in an IRA. Could you further explain if the >$1,000 limit is a cumulative value for all MLPs or is it per MLP? For example is one held two MLPs in a IRA and each distributed $900. Would the total of $1,800 exceed the limit or would each one be under the $1,000 and thus the problem not be realized?
2775 points
Oldman answered 10 months ago …
To Bully68...I answered your query separately, but for others reading this chain of answers...it's UBTI/taxpayer > $1000/yr in the sum of all tax-sheltered accounts: SEPs, S-corp, Roths, IRA's.
Read more from Oldman356 points
Dusty answered 9 months ago …
The question has been answered fully by others. My own solution is to keep a taxable brokerage account for trading and for securities like the MLP's. This is in addition to the tax sheltered accounts.
KCI Publications has been discussing the special tax situation of MLP's in their free E-letters recently. It is that time of year again!
2775 points
Oldman answered 9 months ago …
To Jillybeanisme...The K-1's will still come next year, for the period this year, in which you held them...even if it was only for a week or two. But as long as your Fiduciary (Schwab) can handle the paperwork..., it won't be a problem for you.
But the general nature of my reply and all the other paragraphs were for others, as well. And, you're right, since the K-1s and the 990t's and etc are after the regular tax-filing season ends (except if you need an extension, if the K-1 forms come late for a taxable account...it's not a big problem to get an extension), that's the reason the Fiduciary has to get a Tax-Payer ID No for the IRA(a TIN) and file the 990t for you for the sheltered account to pay any Federal Tax ...if the combined total of Item 20V is >$1000, for all of your tax shelters.
The deadline for K-1's is "mailed by March 30", and hopefully everyone will get them before the final taxable 1040 returns need to be filed (DON'T FORGET to include the Tax-Shelter I.D. # on the form at the end of the 1040 submission)
