Understanding Master Limited Partnerships and TaxesEnergy master limited partnerships (MLPs) have become increasingly popular with investors due to a combination of the recent quest for yield, a booming North American energy infrastructure environment, and rising income tax rates. However, despite a range of options, finding a tax-efficient, vehicle is easier said than done.
Direct Investment: Maximizes Partnership Tax Benefits But Increases Tax Paperwork
For tax purposes, MLPs are treated as partnerships rather than corporations. The benefit of this arrangement is that the MLP owes no corporate income tax, thus eliminating double taxation. Any tax is solely the responsibility of the MLP’s limited partners, and taxes are assessed on their share of the MLP’s taxable income, at their individual rates. Additionally, any cash distribution in excess of taxable income, is considered return of capital and therefore is not subject to tax until the units are sold, creating a valuable deferral mechanism for long-term holders.
The cost of this beneficial arrangement comes in the form of a more burdensome annual tax filing process, as each MLP issues a multiple line K-1. Although many investors successfully handle the K-1 process, others forego it by selecting from a number of MLPs focused investment vehicles which deliver only a single 1099 form. However, these “single 1099” vehicles are not generally as tax efficient and contain other caveats.