For investors that may not know when buying stock in KMP in your IRA or a retirement account there could be taxes owed on your distribution every year called "Unrelated Business Taxable Income" (UBTI)even though it is in your retirement account. It is taxed the same as if you had a CD in the bank etc, That is because KMP is set up as a Master Limited Partnership (MLP). That is information that Jim Cramer may not have mentioned when he mentioned buying good dividend paying stocks. That would cut the yield down considerately.
THE GOOD CHICKEN
I agree with ZLenny. Most of the "other people's money" used for growth he is talking about is from new investors, or existing investors who are reinvesting dividends.
In order to grow faster than they could from retained cash flow, they actually go the market to raise new funds to buy or build new stuff that will be profitable. Gee, sometimes they even borrow money (sell bonds) to buy/build even more stuff. No wonder some nut jobs see this as a Ponzi scheme...a company getting new money from suckers to do silly stuff like grow the business in ways that increases net cash flow?
If an MLP is NOT increasing their business, especially their physical equipment, they will not be able to increase their distributions. A well run MLP can usually pay the the current distribution out of funds from current operations. But the basic value proposition about MLP investing is the potential increase of the distribution. There is a very strong correlation between the current distribution effective yield and expected future growth. Some MLP yields are high because of risk; others are high because of expected slow growth in the distribution. Some investors are quite happy with high yields now; others are looking at the long run and care much more about distribution growth. Some want it all...and seek out the balance among the large energy MLP universe alternative investments.
There is not magic in being organized as an MLP; there have been big energy MLPs that crashed and burned. There have been new ones introduced that didn't cut it, and steadily sank into pink sheet obscurity. Still others have stagnated for a long time, paying quarterly but rarely if ever increasing the distribution. In the case of the sick or dying ones another MLP eventually steps up and buys the hardware and the rest of the carcass (usually at a price way less it was worth, much like any distressed situation sell), and puts the dying dog out of its misery.
You are missing a very important point;
You only owe tax on the sum of all amounts of UBTI you receive in a year within IRAs registered in your name (SS#).
KMP has never generated a penny of UBTI to anyone since at least 2000 (I think since the beginning, but I have no data to establish that).
Many MLPs generate little UBTI in a year (i.e., less than 5% of the distributions they pay are UBTI). If you reinvest the distributions in the same MLP, your UBTI from that will most likely never grow.
If in a few years your cumulative UBTI exceeds $1k, you may use previously declared negative UBTI (many MLPs, including, declare negative UBTI in a year) to roll forward to offset any + UBTI from the same MLP. This should help you manage your UBTI well to stay under the $1k tripwire.
If the UBTI of an MLP eventually gets to high, you can sell it. You do not "recapture" previous UBTI...all you will get reported the year you sell is the normal amount of UBTI from that MLP.
Many MLPs are very UBTI-efficient (generate little UBTI for new investors). Some, however, are not. In general the E&P sector MLPs generate a lot of UBTI, and complex MLPs with a big chunk of E&P activities will generate more than the UBTI-efficient MLPs.
NOTE: except for the E&Ps, UBTI and taxable income are usually very, very close together. Therefore any UBTI-efficient MLP is also a tax-efficient MLP. Hence all data on real world UBTI experience is not only relevant for IRA investors, but sheds a lot of light on the tax shield performance for investors holding in regular (taxable) accounts.
A few more things to know:
The first $1000 of UBIT is exempt from taxes.
If you do go over the $1,000 limit on UBIT, your IRA custodian will need to file IRS Form 990-T on your behalf. The distributions will be taxed at corporate rates, since it's the tax-deferred account that's taxed, not you personally. Moreover, a typical charge for the paperwork is about $200 for each MLP you own.
You must have some liquid cash in your account to pay the taxes due and preparation fees. Otherwise, if you pay these charges out-of-pocket, your payment will be considered a contribution to your account, which could result in penalties if you've already topped off your contributions for the year. State taxes can also add a layer of complexity to the filing.
Some MLPs warn the investor that their distributions are all UBIT (Breitburn Energy is an example.) Some, as mentioned earlier have large negative UBITs (FGP and KMP) in prior years.
I hold KMP in my IRA account. I've spoken at length with the IRS regarding this subject and have been told the following:
Final word on UBIT
I finally can report how such tax is handled on such tax liability. I hold 4 MLP’s in my IRA account. The IRS tells me the following:
1/ Income tax is captured in my IRA and income taxes are paid when funds are withdrawn.
2/ Other taxes levied (including UBIT) are accountable to the tax ID on the K1s received each year. If your SS number is not in Part II box E, the IRS will not associate you to the K1 and the MLP is handling such tax liability.
3/. MLP’s are great dividend generators and should be considered in an IRA account. If you want further clarification and to verify what I have said here, Call 800-829-1040, enter option 2, then option 2 again, and then option 3. An operator will select someone in your area of concern. State the following: “I receive K1’s form 1065 yearly and wish to clarify my tax liability for UBIT from MLP common stock that I own”.
I own several MLP's. I have then in both IRA's and individual accounts. I do my own taxes using Turbotax. They walk you through everything, but there are always errors. I call the company (MLP's) for help. This seems to work for me, but I keep all records (more then 10 years)something may come back and bite me in the butt down the road, but I feel safe at the moment from the IRS.
The explanations here are quite accurate as I have been down all the roads mentioned here. Lets all keep up the good work of helping others, cause I really am not sure anyone at the IRS can help any of us with a K-1 filing.