Fellow Tax Experts/Nerds 🙂
I recently started buying MLPs and realize that I might be in over my head with some of the nuances so wanted to tap the expertise on this forum. In particular, there are two areas that are still very confusing to me:
1) If I just hold an MLP for a few days/weeks (without receiving any distributions) and I sell out, what will be shown on my K-1? I understand that I will get a K-1 even if I hold an MLP for a second, but how would the income be allocated to me? Is it based on the taxable income times my prorated holding period times my % ownership? So if I held 0.1% of the MLP's units for a month and the taxable income was $12mm, then my K-1 taxable income would be $12mm x 0.1% x 1/12 = $1k?
2) Is there a rule of thumb for materiality in determining when to file state tax returns for the MLP? For example, if my MLP gets taxable income in 30 different states, do I need to file income taxes in every single state? What is the penalty if I don't? I mean would I be on the hook just for the unpaid taxes + late fees or could the states sue me for additional penalties?
Thank you!
1) If I just hold an MLP for a few days/weeks (without receiving any distributions) and I sell out, what will be shown on my K-1? I understand that I will get a K-1 even if I hold an MLP for a second, but how would the income be allocated to me? Is it based on the taxable income times my prorated holding period times my % ownership? So if I held 0.1% of the MLP's units for a month and the taxable income was $12mm, then my K-1 taxable income would be $12mm x 0.1% x 1/12 = $1k?
yes. in general income is prorated on a per-share per day basis. however, you are in for a surprise. every MLP will also send you a disposition schedule and the surprise on that for many of the MLPs will be gain subject to recapture as ordinary which is not included on the k-1 itself. example sell $49 basis $48 (includes adjustment for k-1 income/loss) gain thus $1. however, gain subject to ordinary income recapture maybe $2. net result $2 ordinary income $1 capital loss = the net gain of $1. this is a trap for the unwary.
2) Is there a rule of thumb for materiality in determining when to file state tax returns for the MLP? For example, if my MLP gets taxable income in 30 different states, do I need to file income taxes in every single state? What is the penalty if I don't? I mean would I be on the hook just for the unpaid taxes + late fees or could the states sue me for additional penalties?
every state has different thresholds for non-resident filing. cerrtainly all the income /loss will be taxable in your home state if it has an income tax. if you don't file in a state that you are required to, expect a notice in a few years for the taxes, interest, and penalties. the worse part is that if your home state has an income tax you generally are entitled to a credit for income taxes paid to other states, but by the time you get such notice it may be too late to amend your home state o get a refund.
In addition to the guidance provided by @Anonymous , many MLP's are also PTP's.
What this means is that the tax treatment of this activity is handled separately and is not combined with any other passive activities that you may hold. If input into TT correctly, the software will handle this correctly. This can be confusing. At a high level, what this means, is that if your MLP is also a PTP and generates losses, those losses will only be able to be utilized to the extent that this specific MLP (PTP) generates income.
Each PTP is tracked separately within TT and are not grouped with any other passive activities.
I don't believe that the non-resident state income tax is that big of a deal. I own 10,000 shares of EPD with annual income over $20,000. I have a negative balance in my capital account, so my K-1 reflects income in 30 or so different states. The biggest was Louisiana at about $850. The state tax calculation came out to $14. The next biggest was New Mexico. That came out to $6. The other states were $2 or less. I ignored all of those. With EPD, the state taxes are a nonissue.
If you are that worried about it, go to each states tax website, download the form and start filling it out. It takes about minutes per state. It's not that difficult.
If you want to do it by the book PTP's/MLP's are a nightmare. Many states have no minimum threshold for filing and you may have to deal with apportionment on your home return. It is easy to think it is no big deal when you have losses each year. When you sell however you will have to deal with calculating your cumulative adjustment to basis, Section 751 recharacterization of gain or loss (hot assets) and you will also receive a listing of states requiring non-resident apportionment of the gain/loss to their state. You will also have to correctly track the yearly carryforward losses which as mentioned by Rick19744 can only be used inside the individual MLP "Canister" until full disposal. Don't make the mistake I did and fall in love with the advantages of MLP's without recognizing the substantial burden you will be placing on yourself.