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>>> How the Kinder Morgan Deal Affects Investors’ Taxes



http://blogs.wsj.com/totalreturn/2014/08/12/qa-how-the-kinder-morgan-deal-affects-investors-taxes/



Aug 2014

By Laura Saunders

—Bloomberg News



Note: This post has been updated to answer additional questions from readers.



Tax advisers say some individual investors in Kinder Morgan’s two master limited partnerships could face an unwelcome tax bill as a result of the reorganization announced by the company.

A spokesman for company says it believes that “a KMP unitholder will be substantially better off on both a pretax and an after-tax basis versus the status quo when all aspects are taken into consideration.”

Here are answers to investors’ tax questions about the deal.

Q: I own Kinder Morgan MLP units, and I have been receiving tax-free payouts. Why would I owe a tax on the exchange of my units for cash and stock?

A: The MLPs are organized as partnerships that benefit from substantial tax deductions, and the taxes on the payouts aren’t eliminated but rather deferred. When the units, as shares in an MLP are called, are sold or exchanged—as they will be in the reorganization—the deferred taxes come due.

Q: What’s the tax rate on the exchange of units for cash and shares?

According to Bob Gordon, a tax strategist who heads Twenty-First Securities in New York, that depends on an individual’s overall income. But most of the gains on this transaction will probably be taxed at higher rates for ordinary income, rather than at lower long-term capital-gain rates.

Q: Could I have skipped the tax by holding the MLP units until my death?

A: Yes, says Mr. Gordon, because at that point the deferred taxes would no longer be due. The exchange proposed by Kinder Morgan, however, makes this strategy unavailable.

Q: How much tax per unit will an investor owe on the proposed transaction?

A: According to estimates released by the company, the tax owed by an average investor in KMP units could range from $12.39 to $18.16 per unit, depending on the individual’s tax rate. The estimates also assume that passive losses haven’t already been used by the investor and that the KMI price per share is between $36.12 and $44.44, the company said.

Mr. Gordon expects the impact on individuals to vary widely, depending on when the units were bought and other factors. The company has said it expects to distribute $10.77 of cash per unit of KMP, which wouldn’t cover the tax bill for an average investor cited above.

Q: Could I avoid the tax by making a charitable gift of some MLP units?

A: MLP unit holders won’t be able to mitigate taxes by using the units to make their charitable gifts, says Mr. Gordon. While donations of appreciated stock shares are often deductible at full market value, donations of partnership units are not, he says.

Q:What about giving units away to a friend or relative in a lower tax bracket?

A: MLP unit holders who already intend to make gifts to individuals in a lower bracket could minimize taxes by giving away units, says Robert Willens, an independent tax adviser based in New York. The recipient would owe the tax on the exchange of units for shares, but at a lower rate. The recipient would then own shares in KMI going forward.

Q: What will be the tax effect of the exchange if I invest in a fund holding Kinder Morgan’s MLP units?

A: Mr. Gordon says the tax effect on funds that are “closed-end” or organized as C-corporations should be minimal, because they already have set aside money for the deferred taxes.

However, mutual funds that are “registered investment companies” will realize taxable income if they hold the affected MLP units. They will pass this income through to their investors unless the fund has losses to offset it, says Mr. Gordon. In these mutual funds, the MLP units typically make up less than 25% of total assets.

Q: What if I hold shares in KMR, a Kinder Morgan limited-liability company?

A: A much smaller group of investors hold shares in KMR. These investors will have no tax due on the exchange of their shares for shares in KMI. They are slated to receive no cash, and the tax cost of their original shares will “carry over” and become the tax cost of the shares they receive from the exchange, according to Mr. Willens.

Q: What if an investor holds Kinder Morgan MLP units in an Individual Retirement Account or Roth IRA?

A: Experts say it usually isn’t a good idea to hold MLP units in a tax-deferred retirement account, because if a taxpayer has more than $1,000 of certain MLP income, it’s subject to current tax even though the account itself is tax-deferred.

This income is known as UBTI, for Unrelated Business Taxable Income, and typically the MLP’s K-1 statement lists the amount of UBTI per unit.

According to Mr. Willens, the sale or exchange of MLP units held within an IRA or Roth IRA is likely to generate taxable income as well.

Q: Would the tax be lower if I sold my MLP units now?

Mr. Willens says the tax will likely be lower, but only because the investor will receive less. The current exchange offer contains a premium that will become more certain as the exchange date approaches. (Kinder Morgan has said it expects the deal to close in the fourth quarter, but it hasn’t specified a date.)

Selling units now doesn’t avoid triggering deferred taxes, Mr. Willens adds.

Q: Which unit holders will owe the most taxes—those who bought years ago or those who bought recently?

Experts say that the longer an investor has held MLP units, the higher the taxes are likely to be.


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