Master Limited Partnerships (MLPs)
Income Tax & Liability Considerations
by Harry Domash
Master Limited Partnerships (MLPs) offer a potential tax advantage because a portion of their payouts can be tax-deferred. However, they may not be suitable for tax-sheltered accounts, and the required income tax reporting is more involved, so consult your tax advisor before investing in MLPs.
MLPs usually specify the percentage of each distribution that is shielded from ordinary income taxes. That percentage may vary from distribution to distribution depending on a variety of factors. MLPs mail individualized K-1 tax forms to each unitholder in late February or early March of each year that specifies the tax treatment of the prior year's payouts.
The portion of a cash distribution that is not taxable must be subtracted from you original purchase price to compute your new cost basis. When you sell, some of your gain will be taxed at the lower capital gains rate, but the portion of the gain that results from deductions such as depreciation lowering your basis
downwards will be taxed as ordinary income.
If your MLP is held in a tax-sheltered account such as an IRA, the portion of the distributions designated as "ordinary income" may be considered unrelated business taxable income (UBTI), and subject to tax. However, UBTI is usually a small percentage of total distributions and it will not be taxed as long as the amount of this income and all other sources of UBTI does not exceed $1,000 in any year.
Unitholder Liability Considerations
Unlike corporations, where shareholders have no liability for the corporations actions, an MLP is a partnership, and, in theory, all partners are liable for the obligations of the partnership. There are limitations on limited partners liabilities, but they are not fully shielded the way corporation shareholders are. However, according to a spokesperson for the MLP trade group (see below), in practice, individual unitholders have never been held accountable for an MLP's actions.
For more information about Master Limited Partnership tax and liability considerations, consult the "Master Limited Partnership Association (MLPA)’ site (www.naptp.org ).