Master Limited Partnerships (MLPS)

 

This little-known, rising-star asset class has created quite a buzz lately. At least for those in-the-know investors who have heard of them (again, very few investors have). You are ahead of the rush that will surely come toward MLPs by reading this.

In this article we will cover some basics on Master Limited Partnerships (MLPs), and the tax planning issues involved.

Unlike corporations, MLPs pay no corporate-level tax. The partnership company passes the majority of their income to investors.

MLP investors are actually just what the name implies, partners in the public company (technically you are called a “Unit Holder” or a Limited Partner). MLP ownership is measured in units (not shares as with stocks). The quarterly income payments are called distributions (not dividends). Distributions are usually 80-90% tax free, because as a partner you share the income and expense depreciation.

Because of this depreciation allowance, 80-90% of the income payments you receive from a typical MLP is considered a return of capital by the IRS. Which means you won’t pay taxes immediately on that 80-90% of the income. The other 10 or 20% will be taxed at your normal earned-income rate.

This tax treatment actually can cause a few issues for investors. MLPs are not normally recommended as investments for your IRA. However, there are now a few ETFs that are primarily investing in MLPs, and paying dividends out to investors. Since the ETF is a normal corporation, it does pay taxes and issues 1099s and NOT K-1’s (which is what you will get as an MLP unit holder).

Since MLPs allow investors to defer 80-90% of their personal income tax liability for years, or possibly indefinitely, you probably want to get the help of a competent CPA or tax advisor. In addition to the tax deferred issue, you may be required to file state taxes in the states where your MLP does business (this may not affect you at all unless you are a major player).

But don’t let that scare you off. The tax hassle is well worth the benefits! With many MLPs you can earn well over 10% on your money (again with 80-90% tax deferred) in quarterly distribution checks. Where else can you get that kind of return? The unit price (like a rising stock) can add even more to your yield. I’m not a big fan of the buy and hold strategy, but these are investments you may want to hold many years for Rock-Solid income!

Your favorite tax software will walk you through the whole tax issue fairly quickly. MLPs send K-1 tax forms around March 15 (as do LLCs), and the whole K-1 process was recently made clearer by the IRS.

MLPs trade on the major exchanges just like any stock. They can be purchased easily through your online discount broker at the same low commissions you pay to buy any stock.

However, getting information on MLPs can be difficult. Currently there is no official clearing house of information on these little-known securities. You have to do your homework to find them.

Here are a couple ETFs you might look at that invest in MLPs:

JP MORGAN ALERIAN ETF (AMJ)

KYE is a Kayne Anderson fund that holds shares of KYN, an MLP.

Here are a couple of my current favorite MLPs:

Plains All American Pipeline LP (PAA)
Enterprise Products Partners LP (EPD)

Be sure to subscribe to my Email Alerts here at EzineArticles as I will be sharing many of my favorite MLP plays in upcoming articles.

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