| Master Limited Partnerships |
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A Master Limited Partnership (MLP) is a
publicly traded partnership (PTP) that meets
the IRS requirements to be taxed as a
partnership. The income is passed through
on a Form K-1 to be reported on the share-
holder's individual income tax return.
The main advantage of the MLP form of
ownership is that the double taxation of the
corporate form of ownership is avoided
(where profits are taxed at the corporate
level and then taxed again when dividends
are paid to shareholders.)
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Because of the highly efficient tax structure, generous yields, and secondary market liquidity, many sophisticated investors are interested in including MLP's in their investment portfolios.
Owners of substantial holdings may be required to file income tax returns in the states in which the MLP operates if their allocated profits exceed the state filing limits. Some MLPs like Energy Transfer Partners LP (NYSE:ETP) and Enterprise Products Partners LP (NYSE:EPD) are active in 41 states! However, investors in typical small retail quantities may fall below the state filing threshold limits.
The determination of cost basis for MLP's is tricky because it is NOT the original purchase price, despite what appears on your brokerage account statements. You have to adjust your cost basis for all the income items that were passed through on all the K-1 forms since you bought it, and reduce it for all the cash distributions you received from the MLP. The K-1 package often includes a schedule which makes this basis calculation for you.
Passive losses on MLP's are subject to the passive activity loss limitation rules (you definitely need to see your accountant on this one.) In addition, the passive loss from a MLP cannot be used to shelter passive income from a second MLP; the passive losses are "suspended" until they can be applied to future passive income from the same MLP.
Another quirk in MLP ownership is that part of the gain when you sell it will be taxed as ordinary income to the extent of the depreciation deductions that were passed through by the partnership as return of capital.
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Prominent examples of MLP's include:
The Blackstone Group - BX
Buckeye Partners LP - BPL
Constellation Energy Partners LP - CEP
Genesis Energy LP - GEL
Kinder Morgan Energy Partners LP - KMP
ONEOK Partners LP - OKS
Plains All American Pipeline LP - PAA
Sunoco Logistics Partners LP - SXL
Terra Nitrogen Co LP - TNH
Williams Pipeline Partners LP - WMZ
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The National Association of Publicly-Traded Partnerships formerly provided excellent resources for finding out which states a particular MLP operates in before making an investment. This organization was replaced by the Master Limited Partnership Association and state-by-state information is no longer available on their public website.
Click on the PDF icon for a list of all the states with operations for various MLP's in 2010.
The states that do not impose an individual income tax are: Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming.
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MLP States |
CAUTION: You don't want to buy any MLP's in an IRA! Why? You are creating a UBIT problem for yourself. UBIT is Unrelated Business Income Tax which is owed on business income passed through on the Form K-1. It is owed even if the MLP is held inside an IRA. Why is this a problem? Because first you pay income tax on the income inside the IRA, and then you pay again when you withdraw distributions from your IRA (taxed at your marginal ordinary income tax rate.) You just created a double tax for yourself.
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One way to get around both the UBIT problem in an IRA and the need to file state income tax returns in numerous states is to invest in MLPs though corporate-form ETFs or closed-end funds. ETFs that are structured as corporations pay taxes at the fund level and then pay dividends to their shareholders free of UBIT complications and free of non-resident state income tax filing requirements. The yields are less than pure MLPs but are still generous compared to average market yields. Some popular ETFs that specialize in MLPs are:
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