Kinder Morgan: Filing Your Taxes After the KMP-KMI Merger

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.

Charles Lewis Sizemore, CFA, is chief investment officer of the investment firm Sizemore Capital Management and the author of the Sizemore Insights blog.

18 Responses
  1. Tom

    Great information except for one error. When calculating the sales proceeds (item 4) investors should refer to the total value of KMI shares and cash they received. This should be accurately reported on the 1099-B statement provided by your broker. The line L item in the K-1 is just an accounting treatment for the disposition of KMP partnership units and has no impact on the sales worksheet.

  2. blaferty

    Why are you using K-1 Sec. L Withdrawals & Distributions as sale proceeds when you quote above that it is cash & KMI shares received? did you publish same in Forbes? Someone did.

  3. Emily Deitz

    blaferty is correct: the withdrawals/distributions of the capital account have nothing to do with the sales proceeds. The sales proceeds for Box (4) come from your broker’s 1099-B, the new shares of KMI and/or cash received.

  4. Michael

    Charles, are you stating that if you buy KMI right now in an IRA account, it is not susceptible to any taxes on the distribution/ any UBTI tax, and thats its just a 1099 stock? I thought it was an MLP? I read an article of yours that mentioned if you buy general partners you can keep them in an IRA without getting taxed on the dividends. Is this true? How can you tell if they are general or MLPS?

    Lastly, what if you buy Preferred Stock of an MLP?? for example, preferred B shares of the symbol TOO. On yahoo finance, the preferred shares symbol is TOO-PB. Are you still susceptible to taxes as UBTI on preffered offerings of a LP?

    1. Michael

      Also, for example, can I hold TK in an IRA without being susceptible to UBTI, since it appears to be the general partner (teekay corporation)

      1. Michael

        Sorry last but not least, it appears that some LP’s actually issue a 1099, so would they not be susceptible to the UBTI tax? For example, on Teekay’s website it states, “Teekay Corporation, Teekay Tankers Ltd. and Teekay Offshore Partners L.P. shareholders/unitholders
        receive a Form 1099 for tax purposes which is provided by your broker.
        Please contact your broker directly for all 1099 form inquiries”

        Therefore, would Teekay Offshore and Teekay Tankers Stock not fall under the UBTI issues?

    2. Hi Michael, you are correct, KMI and TK are organized as corporations and thus have none of the unique tax complications associated with MLPs.

      As for the preferred stock…I’m not sure. Chances are good that it is considered a debt instrument rather than equity, in which case it would not have any UBTI problems. Though it might vary from issue to issue. Check the prospetus. It should tell you!

      Thanks,
      Charles

  5. Marie

    I owned KMP in an IRA at Vanguard. The 2014 K-1 for this showed UBTI (column 20) as 620. Yet Vanguard submitted a 990-T for my IRA showing my gain from the merger (sale) as taxable and decuted those taxes from my account. So,either Vanguard is wrong or you are wrong in your statement regarding IRAs.

  6. Ralph Cramden

    There was a disturbing article in 10/14/15 WSJ about an investor who had 1300 shares of KMI in an IRA and was socked with $24,000 in taxes & penalties for $52,000 of UBIT net income. The above article glosses over the UBIT income which seems the biggest problem with holding MLPs, even in IRAs.

  7. Ralph Cramden

    There was a disturbing article in 10/14/15 WSJ about an investor who had 1300 shares of KMI in an IRA and was socked with $24,000 in taxes & penalties for $52,000 of UBIT net income. The above article glosses over the UBIT income which seems the biggest problem with holding MLPs, even in IRAs.

  8. Mitchell Mann

    Does anyone know approximately how many KMP shares would trigger the greater than $1,000 UBTI? I had these in my 401k and am worried I may trigger this. Thanks

  9. IRS Student

    I had 1000 units of KMP and got hit with a $23,000 tax bill in my Vanguard IRA. Dividing 1000 by 23 gives and answer of 44 shares being enough to trigger the UBTI $1000 level. I frankly don’t understand how it was arrived at. It looked to me that CPA Vanguard hired to figure the tax figured a capital gain but Vanguard insists it was all UBTI. UBTI was figured at trust rates not idividual rates because it was in the IRA. KMP proxy said the reorganization would be handled as a sale of the units and I expected that the capital gain would be sheltered in the IRA.

  10. IRS Student

    I had 1000 units of KMP and got hit with a $23,000 tax bill in my Vanguard IRA. Dividing 1000 by 23 gives and answer of 44 shares being enough to trigger the UBTI $1000 level. I frankly don’t understand how it was arrived at. It looked to me that CPA Vanguard hired to figure the tax figured a capital gain but Vanguard insists it was all UBTI. UBTI was figured at trust rates not idividual rates because it was in the IRA. KMP proxy said the reorganization would be handled as a sale of the units and I expected that the capital gain would be sheltered in the IRA.

  11. IRS Student

    After talking with the Price Waterhouse partner who calculated the UBTI for Vanguard I have to say that the opinion and advice given in this blog is 100% wrong. Capital gains in partnerships are not sheltered in the IRA. As explained to me, the IRS in the past turned a kind of blind eye but no longer and the KMI deal brought it to the forefront. C Corps profits are taxed twice…….once at the corporate level and again at the individual stockholder who gets a dividend. MLP’s no longer escape this double taxation. While it is not taxed at the corporate level the individual unit holder has to pay essentially his share of both sets of taxes. Therefore your basis in the MLP is reduced by all distributions received as well as the amounts of loss, deduction and credit reported to you on you K-1 The resulting capital gain is taxed at Trust rates. And new rules make the trustee of your IRA responsible to collect and pay the tax. Brokers have always recommended not holding MLP’s in IRA’s because the tax advantages of MLP’s can’t be utilized. Now that the capital gain is not sheltered there is really no good reason to hold an MLP in your IRA unless you plan to hold it forever and even those intentions won’t protect you from the IRS if the general partner wants to do merger or reorganization that gets characterized as a sale of your position. Its not fair and seems that Congress may never intended it that way…….but that’s the tax law.

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