Perhaps someone can help me with this issue: I bought 5000 units of CEP and sold them three years later at a substantial loss. I never received any cash distribution. However, I have been notified by the IRS that I owe thousands of dollars in taxes based on company profits during the period that I owned the units, even though I owned them in a 401K. Has anyone else been faced with this situation?
Sorry, after writing the response below, I re-read your post and noticed that you said the units were held in a 401k. In that case it is easy. You don't owe any tax. Just respond to the IRS that these units were in a tax-deferred account. That will resolve the situation.
The K-1s are supposed to note if it is for a IRA/401k or a taxable account but sometimes the information is wrong. A letter to the IRS should resolve this.
I do not normally post, but I thought I might be able to be of some help with this discussion.
A person can owe taxes on a 401k account, it is refered to as Unrelated Business Income Tax. The first $1000 of income is exempt, but after that taxes are owed. This is why it is not always a good idea to own a MLP in a 401k.
I did not say anything in response to bluecentaur10, because his concerns sound very strange. I can not believe that he would owe thousands of dollars in tax with only owning 5,000 shares. Maybe he meant 50,000? but even then if he took the exemptions allowed he should not owe much.
Did you never declare the numbers on the K-1s you received?
You were supposed to file every year and yes there would have been taxes to pay each year as CEP was reporting income each year even though not paying distributions.
However the income you received (and were supposed to pay tax on each year) also raises your cost basis so your taxable loss when you sold would be even larger.
Since you already sold the net effect balances each other out - the tax you should have paid each year is offset by the tax reduction you would have got when you declared the sale leaving you with just the capital loss you expected. The IRS is probably saying you never paid the yearly taxes from the K-1 but is ignoring the fact that you didn't claim a big enough loss on sale (they only care when you don't pay enough, they don't care if you pay too much)
It sounds like you didn't file any of the taxes correctly. The end result should be what you expect in dollar terms but it sounds like you need to revise 3 years tax returns. Each year you were supposed to report all the numbers in boxes 1-20 of the K-1. And in the year of sale you report the sale using the sales schedule of the K-1 and not your brokerage 1099. If you ignored the K-1s (as I assume you did if you got the letter from the IRS) then you have only yourself to blame for the situation. It is pretty obvious from the K-1 that it is important tax information which is also reported to the IRS and must be declared. So if you did not know what to do with it you should have used a tax accountant.
So, in summary:
good news: you probably don't owe thousands in taxes
bad news: you need to revise 3 or 4 years tax returns
I think you're missing a few things - if the shares are held in a tax deferred account, the custodian files the return, it's not 1040 income. Also, I don't think you can use the loss on sale in a tax deferred account to offset partnership income, but I'm not at all sure about that - it's an interesting question.
For whatever reason IRS has contacted a lot of CEP holders. I believe it does pertain to UBTI - this is overstated on the CEP k1, as they don't subtract allowable depletion.