Steinberg Talks Tax (TM) Vol. 4, No. 6, August 1, 2010 (www.steinbergtaxlaw.com) admonished taxpayers to avoid certain investments and strategies that unduly complicate one’s tax life. Among those I had suggested to avoid were foreign bank accounts, even if reported, ETF Commodities funds that are structured as partnerships and day trading in stocks
With regard to commodities partnerships, I wrote
- You will receive a Schedule K-1 that will make your accountant’s eyes light up, bulge and then circle in the sockets. What diversification is achieved may not be worth the added tax preparation fees and complexity.
- The Schedule K-1 usually will report many distinct items, some being arcane items like Section 1256 contracts or tax straddles, all small amounts, that must be reported in your tax return.
- You become subject to more complicated and protracted dispute procedures should IRS disagree with the partnership’s tax return.
- You become subject to possible extended statute of limitations, for example, if the partnership engages in options trading and does not separately report its short and long trades.
- You may have to file returns in one or more states and pay state income tax on local sourced partnership items.
A Wall Street Journal article “Extreme Tax Frustration” by Laura Sanders and Jason Zweig, June 25, 2011, repeats these warnings and notes additional tax traps these investment vehicles may hold:
- Many precious metal ETFs like SPDR Gold Shares hold gold bullion in a grantor trust which means the tax reporting flows through to investors. The physical gold holdings are collectibles taxed at 28% instead of 15% as would long-term gains on disposition of gold mutual fund shares. Commodity-pool gains are deemed 61% long-term and 40% short-term.
- Generally, more complicated tax structures create confusion and more complex tax reporting.
- Cost basis rules set to apply to brokers and mutual funds may not apply to ETFs. Thus, determining cost basis can be an arduous expensive task.
- Holding partnership interests in an IRA may subject income to corporate rates and the taxpayer to filing Form 990-T.
Finally, the WSJ authors interviewed tax preparers. One CPA states that it takes about an hour to reflect in a return all of the varied items reported on each Schedule K-1 from these partnerships. I have seen K-1s with over 30 distinct entries.
My suggestion: Follow the KISS principle, “Keep it Simple Stupid,’ unless, of course there are cogent business reasons for adding complexity.
As I’d written in the earlier newsletter:
Needlessly complicating your tax life adds to the misperception that you are accomplishing something and often creates tax problems instead of solving them. Our human perception limitations suggest that we ought to try to simplify our lives wherever and however possible. The normal tension that exists between order and chaos is not relieved by adding needless complexity. The balance point called “the edge of chaos” is not a stable position, however. Constant effort is required to keep one’s balance in life. Perhaps, the trick is to focus, as Marie Dressler said, on the “few things (that) are really important.” In tax matters I believe, for most circumstances, Leonardo da Vinci was correct in saying, “simplicity is the ultimate sophistication.”
Copyright 2011 by Robert S. Steinberg
All rights reserved.