Publicly Traded Partnerships (MLPs)

Since K-1’s generally come out in early to late March, please review the below UBTI rules and let me know if you have any questions:

PTP tax (MLP)
Increase basis by profits and contributions
Decrease basis by cash distributions and losses

When completely liquidated, losses are released.

· You will receive a K-1 if you own a MLP/PTP whether you own it in a taxable or tax deferred account.

· Trustees for IRAs (including traditional, Roth, Coverdell, SEP, and SIMPLE IRAs) that have $1,000 or more of UBTI in an IRA must file Form 990-T.

o   UBTI above the first $1,000 is taxed at the trust tax rates because IRAs are considered trusts for this purpose.

o   The tax on UBTI is owed by the IRA itself as it is the partner in the partnership.

o   Many brokerages will prepare and file the 990-T for the client and pay the taxes from the IRA

·        UBTI from each partnership is found on the Form K-1 in box 20, code V

o   If your total UBTI is below $1,000, then there is no filing or tax issue.

o   Generally, income from REITs is exempt from UBTI. General support for this is found in Rev. Ruling 66-106

· The term “unrelated business taxable income” generally means the gross income derived from any unrelated trade or business regularly conducted by the exempt organization, less the deductions directly connected with carrying on the trade or business. IRAs are considered exempt organization for UBTI purposes.

· Excluded from UBTI - All dividends, interest, annuities, payments with respect to securities loans, income from notional principal contracts, and other income from an exempt organization's ordinary and routine investments

o Example - An IRA is a partner in a partnership that operates a factory. The partnership also holds stock in a corporation. The IRA must include its share of the gross income from operating the factory in its unrelated business taxable income but may exclude its share of any dividends the partnership received from the corporation.

The way ROC works is that rather than pay taxes right away, you deduct them from your cost basis. Then when you sell units of MLPs, you pay taxes on your units sold. This can have a powerful long-term benefit. For example, say you invested $10,000 in an MLP. If you hold the units long enough, eventually your cost basis will go to $0. As long as you don't sell, then $10,000 of otherwise taxable income will be permanently deferred from the IRS. You can pass on MLP units to your heirs, and as long as they don't sell them, they don't have to pay taxes, either. However, this only applies as long as your cost basis is above zero.

As a result of these tax benefits, MLPs get a bit more complicated. For example, if you do sell your units of an MLP, some of the profit will be taxed as long-term capital gains, and some will be "recaptured" (taxed as ordinary income). This includes things like depreciation, inventory appreciation, and unrealized receivables. This information can be found in the annual K-1 your MLP will send you.

What about after your cost basis has hit zero? Then most of the ROC is taxed as long-term capital gains. Herein lies the true benefit of MLPs, because long-term capital gains taxes are much lower than regular income tax levels.

https://www.fool.com/investing/general/2014/11/13/mlps-3-tax-facts-all-dividend-investors-need-to-kn.aspx

 What is a Master Limited Partnership (MLP)?

A master limited partnership (MLP) is a limited partnership that is publicly traded on an exchange. It combines the tax benefits of a limited partnership with the liquidity of publicly traded securities. There are two types of partners in this type of partnership: The limited partner is the person or group that provides the capital to the MLP and receives periodic income distributions from the MLP's cash flow, whereas the general partner is the party responsible for managing the MLP's affairs and receives compensation that is linked to the performance of the venture.

Partnership traded on an exchange. IRC 7704

 How are MLPs taxed?

In place of the 1099 tax report you’d get on shares of a corporation, you’ll get a much longer K-1 from your MLP. If you sell the MLP shares, you’ll get a statement explaining how to handle the proceeds on your tax return.

Sends out K1 -

• An MLP, like all partnerships, is a pass-though entity which pays no tax itself. It is treated by the tax code not as a separate entity but as a collection of partners.

• The unitholder, as a limited partner, is treated for tax purposes as if he is directly earning his share of the MLP’s income.

• Each unitholder is allocated on paper a proportionate share of the MLP’s income, gain, deductions, losses, and credits. This is reported annually on the K-1 form.

• The unitholder enters these items on his tax return and pays tax on the net income at his own tax rate. The tax is owed whether or not the unitholder receives a cash distribution.

• If there is a net loss, it cannot be used to offset the unitholder’s other income. It must be carried forward and used against future income from the same MLP. Any loss still remaining may be deducted against other income when the unitholder sells his entire interest in the MLP.

http://www.naptp.org/PTP101/Print/Basic_Tax_Principles.pdf

 Are distributions tax-deferred until I sell my units?

• The quarterly cash distributions are not the same as your share of the MLP’s income.

• Under the tax code, the distributions are a return of capital and are not taxed when received.

• Your basis in your partnership units (the amount you paid, increased or decreased by various adjustments) is lowered by the amount of the distribution.

• Thus, when you sell your units, your taxable gain (sales price minus adjusted basis) is increased by the amount of the distributions.

• Often you will hear someone say that “80% (or a similar number) of the MLP’s distribution is taxdeferred.” What they mean is that your share of the MLP’s net taxable income, as reported on the K-1 form, equals about 20% of the tax-deferred cash distribution.

http://www.naptp.org/PTP101/Print/Basic_Tax_Principles.pdf

 What if I have a net loss from the MLP?

Unless you are an active participant in the MLP’s management, a net loss from an MLP is considered a "passive loss" under the tax code. If you come out with a net loss for the tax year, you cannot deduct it from your taxable income, not even income from other MLPs. However, you can carry it forward into future tax years and use it to reduce your taxable income from the same MLP. Any remaining loss may be used against other income when you dispose of your entire interest in the MLP. 

 Can I hold MLP units in my IRA?

$1000 dollars or more in IRA UBTI subject to trust tax rates

Yes, but MLPs may not represent the best investment for a retirement plan.

First, an MLP offers significant tax benefits that are better utilized in a taxable account. Secondly, an IRA (or any tax-exempt entity earning income from an outside business) is subject to the “unrelated business income tax” (UBIT) after the first $1,000 of net income from a business that is unrelated to its exempt purpose (unrelated business taxable income, or UBTI). Since an MLP is a pass-through entity, the IRA would be considered to be “earning” the MLP’s business income, which is almost always considered to be unrelated to the IRA’s exempt purpose. If the IRA’s UBTI from all sources is over $1,000, the fund custodian will have to file a return and pay tax on the excess out of the IRA’s funds. Most advisors feel that unless there is reasonable certainty that the net income received from MLPs will be less than $1,000 each year, it is better not to hold them in an IRA. This is equally true of regular and Roth IRAs.