In recent years, millions of investors have discovered the advantages of investments that have a partnership-tax structure. From master limited partnerships to commodity-owning exchange-traded products, investors have obtained tax benefits along with access to some parts of the financial markets that were previously open only to those with commodity futures accounts.
Unfortunately, the benefits of investing in partnerships come with a cost: the hassles of special tax-reporting requirements that add a huge burden to tax preparation. Now, though, at least one of those hassles is going away, and that could spark new interest in the group.
In today's digital age, the idea of electronic delivery of tax documentation doesn't sound like anything all that special. Yet according to a blog post from Index Universe last week, electronic partnership-tax reporting is coming this year, and investors who have long feared the tax complexities of dealing with K-1 partnership information returns could find electronic K-1s a lot easier to handle.
To understand the benefits, let's first take a look at the problems that partnership investors have had in past years. Many commodity-based ETFs use the partnership structure, including energy ETFs U.S. Natural Gas Fund (NYSEMKT:UNG) and U.S. Gasoline Fund (NYSEMKT:UGA) as well as the crop-tracking PowerShares DB Agriculture Fund (NYSEMKT:DBA). As a result, investors in those and many other popular ETFs get their annual tax information on Schedule K-1 every year.
K-1s are a lot more complicated than the more-common 1099s that most investors are used to receiving. Unlike 1099s, which typically have only a few pieces of information to include on your tax return, K-1s have numbers you have to plug in across a number of tax forms, including some specialized and little-used forms. Moreover, because these forms are equally complicated for the reporting companies, they historically become available very late in the tax reporting season, forcing taxpayers who would prefer to file early to choose between delaying their refund or having to file amended returns once they have complete K-1 information.
But electronic K-1s will make it easier for you to get the tax information you need more quickly and efficiently. You can expect tax software packages to handle electronic K-1s much more seamlessly, and that could make a tough aspect of tax preparation a lot easier.
Although the focus of the blog post was on commodity ETFs, traditional master limited partnerships are also jumping on the electronic K-1 bandwagon. Enterprise Products Partners (NYSE:EPD)says that it's offering electronic K-1s as a new first-time option for the 2012 tax year, with those signing up for the service getting their tax reports a week or more earlier than mailed versions of paper K-1s. Kinder Morgan Energy Partners (UNKNOWN:KMP.DL) also allows investors to sign up for its tax-reporting service, which includes electronic K-1 delivery as well as automatically transferring amounts from K-1s onto the other tax forms that you'll need to file with the IRS or providing a Turbo Tax-compatible download.
Just the first step
Although these innovations will make tax filing a bit easier to handle, they won't solve all the issues that partnership investors face. Between requirements to file state income tax returns in states where partnerships do business and the limitations that retirement accounts like IRAs and 401(k)s have on income from MLPs, investors still have to watch out for potential traps.
Nevertheless, because of the popularity of investing in various types of partnerships, simplifying their tax burden should further boost their use. If that leads investors to feel more comfortable investing in partnerships directly rather than adopting costly alternatives just to avoid the tax hassle, then electronic K-1s will prove to be a major step in the right direction for investors as well as the partnerships that offer their units to them.