What to Know About a PAA K-1 From a Publicly Traded Partnership
Understand how a PAA K-1 from a publicly traded partnership affects your taxes, including income reporting, basis adjustments, and state filing considerations.
Investing in a publicly traded partnership (PTP) like Plains All American Pipeline (PAA) comes with unique tax considerations. Unlike traditional stocks that issue Form 1099, PTPs provide investors with a Schedule K-1, detailing income, deductions, and other tax-reporting items. This makes tax filing more complex than with regular dividend-paying stocks.
Understanding how to interpret a PAA K-1 is essential for accurate tax reporting and liability management.
K-1 Income and Deduction Items
A PAA K-1 reports various types of income and deductions, each with distinct tax implications. The most common is ordinary business income (or loss), found in Box 1, which represents the investor’s share of PAA’s taxable earnings. This income is taxed at ordinary rates rather than capital gains rates and is taxable even if no cash distributions are received.
Interest income appears in Box 5 and is taxed at ordinary rates. Box 6a and 6b report dividend income, which may include qualified dividends eligible for lower capital gains rates. Investors should verify whether these dividends meet IRS qualifications for preferential treatment.
Depreciation and other deductions significantly impact taxable income. Box 13 often includes Section 179 deductions or other depreciation-related adjustments, which lower taxable income but may be subject to recapture upon sale. Box 20 provides information on Section 199A qualified business income (QBI) deductions, which may offer a tax break of up to 20% under the Tax Cuts and Jobs Act.
Distributions to Unit Holders
Cash distributions from PAA are not taxed like stock dividends. Instead, they reduce the investor’s cost basis. These payments do not create an immediate tax liability unless the cost basis reaches zero, at which point further distributions become taxable as capital gains.
Since PAA does not pay corporate income tax, taxable income is passed through to investors. Due to non-cash deductions like depreciation, distributions often exceed reported taxable income, allowing investors to receive substantial cash payments without immediate tax consequences.
Over time, as cost basis declines, potential capital gains upon sale increase. Long-term holders who receive significant distributions may face a larger tax bill when selling. However, inherited units receive a step-up in basis to fair market value, potentially eliminating accumulated tax liabilities.
Adjusting Tax Basis
Tracking tax basis is essential for determining gain or loss upon sale. Basis starts with the purchase price but changes over time. Taxable income allocated on the K-1 increases basis, while losses, deductions, and distributions reduce it.
Passive activity losses (PALs) complicate basis calculations. If a reported loss cannot be deducted due to passive activity rules, it does not immediately reduce basis but carries forward until it can be used, typically when sufficient passive income is generated or the units are sold.
Debt allocations also affect basis. If PAA takes on debt, a portion is assigned to unit holders, increasing their basis. When debt is repaid or reduced, basis decreases. Investors using margin loans should account for basis reductions from debt repayment to avoid unexpected taxable gains.
State Tax Filing Variables
Owning PAA units may create tax obligations in multiple states. Since PAA operates in various jurisdictions, its income is apportioned across states, and unit holders may need to file nonresident tax returns. The K-1 provides a breakdown of state-specific income for determining filing requirements.
Some states tax nonresidents if they earn a certain amount of income there. For example, Wisconsin requires a nonresident return if just $2,000 of income is sourced there, while Texas and Florida do not tax personal income. Investors should review state-specific rules to avoid unexpected liabilities and penalties.
PAA may withhold state taxes on behalf of nonresident investors, which is reported on the K-1. This withholding can offset tax liabilities but does not necessarily eliminate the need to file a return. Some states allow credits for taxes paid to other jurisdictions, though the process varies.
Selling or Exchanging Units
Selling PAA units triggers tax consequences beyond those of traditional stocks. Since tax basis adjusts over time, gain or loss is not simply the difference between purchase and sale price. Investors must account for prior distributions, allocated income, and deductions.
A portion of the gain is taxed as ordinary income due to depreciation recapture. Prior deductions, such as depreciation and Section 179 expenses, reduced taxable income during ownership. Upon sale, these amounts are recaptured and taxed at ordinary rates, while the remaining gain is taxed as capital gains based on the holding period.
Exchanging or transferring units is generally a taxable event. A like-kind exchange under Section 1031 is not available for PTP units. Gifting units defers taxation for the original owner, but the recipient inherits the adjusted basis, potentially leading to significant tax liabilities upon sale. In contrast, inherited units receive a step-up in basis to fair market value, eliminating prior gains and reducing future tax exposure.