In the United States, a master limited partnership is a limited partnership that is publicly traded on an exchange qualifying under Section 7704 of the Internal Revenue Code. It combines the tax benefits of a limited partnership with the liquidity of publicly traded securities.
By definition, a master limited partnership is a limited partnership that is publicly traded. MLP’s are usually operational in the field of natural resources, real estate industries, and the financial services. MLP's brings together the tax benefits under limited partnership along with the liquidity of securities that are publicly traded.
MLP is not considered as a single entity. It is deemed as the total of partners that are allowed for a ‘pass through’ income. This means, that MLP’s are not liable to any corporate taxes. Each owner or partner is personally responsible for taxes, on their specific portions of the gains, losses, deductions and incomes of the newly formed MLP. This is an advantage for the owners as it sheds off any ‘double taxation’ that otherwise are applied for corporations.
Under MLP’s distributions are made on a quarterly basis, and are similar to dividends in their characteristics. However, MLP does not guarantee cash distributions; the unit holder is liable to pay taxes on their income proportion.
MLP units can be purchased from brokers, where a unit holder’s tax will be based on the amount paid for the units, initially. With each distribution or losses, the basis will fall, while it will increase with each income allocation. However, a percentage or portion of certain distributions can act as returns on the investor’s capital, which can reduce a unit holder’s basis for taxes.
Overall, when MLP pays more in terms of distribution than it would earn from taxable incomes, then this would reduce the unit holders tax basis in terms of the difference that is between the cash received and the taxable income of the MLP’s. Also, if the unit holder sells off the units owned, then any gain from the sale will be taxed on the unit holder’s income tax rate (ordinary income tax rate).
First, the fact that MLP are not subjected to income tax brings good news for partners/investors as it leaves more cash that can be used for distributions. This makes MLP units attractive when compared to shares of corporations that are of similar nature.
Investors should bear in mind to evaluate the MLP’s effectiveness, if it is able to meet the present distribution and if it will be sustainable in the future.
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