Making Sense of Master Limited Partnership Tax Rules
by Mary Lyman
So you’ve finally bought some shares in a master limited partnershipafter hearing everyone rave about this equity investment that gives you a high yield, pays out cash every quarter and has tax advantages.
A couple of quarters go by, your investment pays off as promised, and you’re a happy camper. Then tax season rolls around and instead of the familiar Form 1099, a new form called a Schedule K-1 (Form 1065) shows up in the mail, with numerous boxes labeled with different types of income and deductions. What’s going on? What are you supposed to do with this?
In this article
- The Basics
- Distributions Are Not Dividends
- Dealing With the K-1
- Passive Loss Rules
- Adjusted Basis
- Selling Your Units
- State Taxes
- MLPs and Retirement Accounts
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For those who are new to them, the first thing to understand is that an MLP is simply a publicly traded partnership. (Not all PTPs are MLPs, however; a number of PTPs are simply commodity pools.) By buying shares, technically referred to as “units,” in an MLP, you become a partner (or a “unitholder”) in this very large partnership. As a partner rather than a corporate shareholder, you enter a whole new world of taxation. Partnership taxation is what makes MLPs a tax-advantaged investment, but it also makes them more complex than many other investments.
As a partnership, an MLP is not considered to be a separate entity for tax purposes the way a corporation is, but rather is a pass-through entity—sort of an agglomeration of all its partners. An MLP does not pay corporate tax; instead, all the things that go into calculating tax—income, deductions, gain, losses and credits—are divided up among the unitholders as if they had earned the income themselves. Part III of the K-1 tells you your total share of each of these items.
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