Investors in Kinder Morgan Energy Partners (“KMP”), Kinder Morgan Management (“KMR”) and El Paso Pipeline Partners (“EPB”) are now the proud owners of Kinder Morgan Inc. (KMI) after the reorganization of the Kinder Morgan empire last year. While I consider this to be a great development for shareholders, it does raise a few questions come tax time.
I love MLPs. I love the high cash distributions, and I love the fact that in most years the distributions are considered mostly tax-free returns of capital. Congress was really on to a good idea when they created the MLP investment vehicle in 1986.
But as much as I love MLPs, the taxes can be messy, even in the absence of a merger reorganization. You have to input K1 data into your tax return, and energy MLP K1s can be several pages long and filled with obscure accounting for depreciation and depletion.
Let’s dig into the details and see what Kinder Morgan shareholders should expect when filing their 2014 taxes.
Holders of Kinder Morgan Inc.
I’ll start with an easy one: Shareholders who owned KMI going into the reorganization. If you owned KMI , then absolutely nothing changes for you. Dividends are reported on your broker’s 1099-div, and any sales in 2014 will show up on your broker’s 1099-b. There is nothing new under the sun here.
Holders of Kinder Morgan Management
Here too, the tax accounting is simple. If you owned KMR, you received 2.48 shares of KMI for every share of KMR you owned before the reorg. This is not a taxable transaction, and your cost basis in KMR becomes your cost basis in KMI. The only taxes due would be for cash received in lieu of fractional shares.
Kinder Morgan Management was always a quirky security. It paid its distribution in shares rather than cash and thus avoided current-year taxes. It was also safe to hold KMR in an IRA as it did not produce any unrelated business taxable income. Shareholders who previously held KMR in a taxable account will have to get accustomed to paying taxes on their new KMI dividends. But shareholders who previously held KMR in an IRA account will no new tax obligations at all.
One adjustment you might want to make, however, is instructing your broker to reinvest your KMI dividends if dividend compounding was a reason for your original ownership in KMR.
Holders of Kinder Morgan Energy Partners and El Paso Pipeline Partners
Here is where it gets complicated. In the case of both KMR and EPB, the conversion to KMI shares is deemed a “sale” in the eyes of the IRS regardless of whether you accepted KMI shares, cash or a combination of the two. Per Kinder Morgan investor relations, “The sum of the cash received and stock value received ($41.535 times KMI shares received) equals the deemed ‘sale price’ of your partnership units.”
So, long-time investors in KMP and EPB may be looking at significant capital gains taxes due, particularly if accumulated depreciation lowered their cost basis. Additionally, some portion of your taxable gain will be considered ordinary income.
This sounds complicated, but your broker 1099-B and the K1 package that Kinder Morgan sent will have the information you need to sort it out. Look for the page titled “2014 Sales Worksheet” about halfway through the K1 package. At the bottom of the page, you’ll have 11 boxes. The first three boxes should be prefilled with the number of units owned, the date you bought and the date you sold or converted your shares to KMI. Box 6 should also be prefilled with the adjustment to your cost basis from accumulated depreciation.
Now for the fun part. You can find the correct sales proceed amount for box 4 by looking at your 1099-B sent to you by your broker. You’ll need to add up any cash proceeds and value of the KMI shares at time of conversion. It’s a pain to hunt and peck for, but the information should be there. If it’s not, call your broker.
You might need to dig through old statements to find your cost basis for box 5, or it might be included on the 1099 you received from your broker. It really depends on when you bought and who your broker is. But box 5 should be the original amount you paid for your KMP or EPD shares.
Bear with me…we’re almost done. To calculate box 8—“Total Gain/Loss”—you add boxes 5 and 6 together and subtract the total from box 4. (If box 6 has a negative value—and it should—it will have the effect of lowering your cost basis.)
We’re almost to the finish line. Subtract the value in box 9 from box 8, and put the result in box 10. This is your capital gain that should be reported on Schedule D of your 1040. The ordinary income reported in box 9 should be inputted into Line 10 of Form 4797, Part II.
If your head is spinning, don’t worry. I understand. But take the process step by step, and you’ll find it’s not quite as tedious as it first appears. And the good news is that you’ll never have to do this again. These will be the last K1s you ever receive from the Kinder Morgan companies!
One final note: If you owned KMP or EPB in an IRA or Roth IRA, none of this is necessary, as gains are not taxable. The only exception would be if you had $1000 or more of “unrelated business taxable income” in line 20. In this case, you would need to file a separate tax return for your IRA. If you find yourself in that situation, I would recommend hiring an accountant to take care of the paperwork for you. That gets into a level of complexity better left to the professionals.
Note: This article was intended to explain in plain English the expected tax issues that you might face as an investor in the Kinder Morgan companies, but it is not specific tax advice. I am an investment adviser representative, not a CPA. If you have questions about your specific tax situation, you should consult your tax professional.
Disclosure: I am long KMI.