If some people choose not to invest in a particular master limited partnership because the underlying energy holding contains too much debt, I don’t blame them. That is sound investment analysis! If others don’t invest in an MLP because they invest through IRA accounts and they do not want to deal with the specialty rules that exist for IRAs that generate more than $1,000 in unrelated business tax income (UBTI), I understand and agree. And if some people just plain don’t understand this class of investments, that’s a fantastic reason to avoid MLP investments (sticking to your circle of competence and not straying is a properly well-regarded Warren Buffett quip, so long as it isn’t a crutch to stop learning).
But the dumbest reason I have heard for avoiding the MLP sector is the fear of dealing with the K-1 statement, usually described in hush hush terms as though it were a nearby listening Venus Fly Trap waiting to pounce.
A K-1 statement is just the partnership equivalent of a 1099. Since the “p” in MLP stands for master limited partnership, any investor that buys shares in these units are owning a pass-through entity (as distinguished from a corporation).
With a corporation, like Apple, the company pays its 21% or so taxes, and if it elects to send a portion of what remains to the shareholders as a dividend, the shareholders may then be responsible for a federal tax payment on that sum as high as 23.8% plus any state taxation that is assessed against the dividends. This is the dreaded “double taxation” that you hear about, which is unfair in general but exists for the purpose of thwarting dynastic wealth.
With a partnership, there is no taxation at the partnership level, and the partners themselves pay a pro-rata share of taxes on their individual returns. The K-1 statement is what investors in partnerships, whether limited or otherwise, and whether publicly traded or otherwise, receive for filing.
The way that some financial personalities write about it, you would think that K-1 documents required the hiring of fancy tax professionals charging hundreds of dollars per hour. For publicly traded MLPs, that is a misconception.
All you have to do is pay the $90 for the Turbotax Premier, download the app for it on your phone, type in “K-1” into the search box, take a picture of the K-1, and then have it uploaded. It takes two minutes.
And yet, there is the investment myth that persists regarding the difficulty of investing in MLPs because of the mysterious K-1s. The entry of the tax part for the K-1 is no different than the tax part for the 1099–it’s just a different IRS form. It is very simple and straightforward. I think a lot of people read articles online talking about the difficulty of dealing with a K-1 statement and put up a mental block that prevents them from realizing the process for entering the information into the software is the same as that of the 1099, or they do all their investing through retirement accounts, in which case, the concerns about the administrative hassles of K-1s are justified.