Have you ever heard of a Master Limited Partnership (MLP)? As background, an MLP is a limited partnership that is publicly traded on a stock exchange such as the New York Stock Exchange (NYSE) or NASDAQ. Due to their listings on stock exchanges, MLPs combine the tax benefits (more on this later) of a limited partnership with the liquidity of publicly traded securities. Some investors may be “afraid” of partnerships in general; It’s important to know that MLPs are regulated by the Securities and Exchange Commission (SEC) and must comply with Sarbanes-Oxley, just like other publicly traded companies. These conditions are attractive to investors, as they mean MLPs file annual and quarterly returns, notify investors of any material changes affecting the business, and are required to use enhanced accounting rules as enacted by Congress.
According to the National Association of Public Companies, the MLP structure is limited to companies that receive 90% or more of their income from interest, dividends, real estate rentals, proceeds from the sale or disposition of real property. , revenue and profit from raw materials. or futures of raw materials, and income and profits from activities related to mineral or natural resources. While there are some exceptions, the vast majority of MLPs operate in the energy industry. The focus on the energy industry stems from a section of the US tax code that says MLPs must operate in certain industries, most of which are relevant to the use of natural resources (read: oil extraction and transportation). and natural gas).
Benefits and tax considerations:
While MLPs are listed on stock exchanges like the NYSE, American, and NASDAQ just like companies like General Electric (NYSE-GE) and Microsoft (NMS-MSFT) do, the big difference is that because MLPs are not corporations , not pay a corporate tax. This “tax quirk” is in stark contrast to the experience of corporate shareholders (most corporations) who face double taxation: paying taxes first at the corporate level and then at the personal level when those profits are received as dividends. Owners of a partnership pay taxes only once, individually. Because MLPs don’t pay corporate taxes, all tax elements pass through to partners, theoretically leaving more MLP profits available to distribute to the unit owner (you). Also, for most of the time you hold your MLP position (units), you may not have to pay taxes on distributions like you do on corporate dividends. Specifically, distributions are considered a tax-deferred “capital return,” that is, a distribution that reflects a return on your initial investment. As you receive “capital return” distributions, you reduce the taxable income of your partnership units. And these disbursements are not taxed as current income. In addition, the unit owner (investor) may also recognize a prorated portion of the MLP depreciation on their tax form that serves to reduce the unit owner’s tax liability.
Although the tax advantages of MLPs are very attractive, there are some potential drawbacks. One of the disadvantages of MLPs is that you are responsible for paying taxes on your share of the partnership’s taxable income. Dividends paid to shareholders by corporations are considered “qualified” and therefore taxed at a lower 15% tax rate. This is not the case for cash distributions paid by MLPs. However, cash distributions generally exceed the taxable income of the partnership, which can negate the “net” impact of taxable income. Another consideration when owning MLPs is that your personal “tax complexity” is generally increased. Specifically, filing taxes can be more complex than investing in common stock because you will receive the partnership’s Schedule K-1 instead of a 1099. The K-1 will reflect your share of MLP income and losses and must be reflected in your tax return. And for unit holders with significant positions, there is the potential to meet state thresholds (your tax advisor can help you identify thresholds) that will require you to file tax returns in the various states in which the corporation operates. Finally, MLPs may not be attractive in tax-deferred IRAs because the partnership may generate taxable income in any given year. Tax considerations for institutional investors limit their participation and mutual funds have been slow to invest in MLPs. Consequently, the pool of potential investors is limited and may reduce the liquidity of the participants. At the time of sale, units may be worth more or less than their original cost.
Please note that the above “tax considerations” are not exhaustive and are for informational purposes only. Therefore, you should carefully consider the pros and cons of investing in MLPs and consult your tax advisor to fully determine the tax implications of any investment.
In conclusion, MLPs can be a solid option for income-oriented investors, as most offer very attractive returns that typically fall in the 5-7% range. In addition, such returns usually receive favorable tax treatment. As with most tax-friendly investments, there are some “tax complaints” associated with MLPs; however, for some the advantages far outweigh the disadvantages. In general, although MLPs are not well understood, they can be one of the most tax-efficient vehicles available to the investing public. And while there are some exceptions, the vast majority of MLPs operate in the energy industry. Because MLPs tend to be involved in the energy field, when one considers becoming a unit owner, the question arises where do you think energy prices will go in the next ten years? The next twenty years? Higher or lower? Good luck!