I just heard of Master Limited Partnerships (MLPs) for the first time this month. Initially, I was intimidated. However, after some discussion at the November AAII (American Association of Individual Investors) Boise Group meeting, as well as some research at home, I realized it’s just another way that the government complicates our lives with a hieroglyphic tax code and it’s constant meddling in the business world.
The gist of it is this:
- MLPs were set up as an investment structure in the 1980s to stimulate investment into certain industries that the government wanted to grow. The target industries were energy related, but these are not utility companies. Companies involved in producing and moving energy products, such as oil, were the main emphasis.
- MLPs utilize company organizational models much like partnerships, but allow for multiple “partners” being able to invest money without being part of the management engine.
- There are two kinds of partners in an MLP. The manager, or general, partners run the company. The limited partners, or unit holders, provide capital.
- The government requirements for what can qualify as an MLP have changed some over the years, as the government decided to limit even more what types of businesses would receive preferential tax treatment.
- MLPs affect everyone’s taxes differently because the investor’s return from the investment is taxed based on overall individual tax liability, as opposed to the standard rate (whatever rate that happens to be at a given time) at which capital gains are taxed.
- MLPs are now traded basically like shares of stock, but are given the technical term of “unit.”
- MLPs are obligated to disburse a certain (high) percentage of their profits back to the limited partners. Because of this, they are considered a good investment choice for many who need to be receiving income from their investments.
- There is no reason to hold MLPs in an Individual Retirement Account (IRA).
Because MLPs are not taxed the same way as common stocks, there are a few things that should be evaluated by each investor before investing in an MLP:
- The distribution structure for MLPs makes it challenging for them to get final tax information to the investors before March.
- The tax information will arrive on what is called a “K-1” form.
- It might be a good idea to talk to your accountant, if you use one, before adding MLPs to the mix, even if it does sound like it never added more than $20 to an accountant’s bill. Also, apparently Turbo Tax is set up to allow those who do their own taxes to figure it out with no extra cost.
- There may be a small chance of being taxed on phantom income in some cases.
- There have been some concerns about tax changes for MLPs going on right now. This article at Seeking Alpha seems to be up-to-date and helpful.
If you think you might want to invest in MLPs, you can use a screen, just like what can be used when choosing a stock. Yahoo! Finance Screener is a good, free place to start. If you have an account with an online broker (like Fidelity, Scottrade or Charles Schwab, for example) they probably have the tools to do this on their websites. You should be able to determine if the MLP/company has a history of growth and good management.
A more thorough explanation of MLPs can be found on the National Association of Publicly Traded Partnerships (NAPTP) website, and by clicking on this link to their pdf that specifically talks about MLPs. Which ever way you decide with MLPs, don’t let the government’s web of a tax code keep you from managing and investing your money in the most fruitful way possible!
