A master limited partnership (MLP) is also sometimes known as a publicly traded partnership (PTP). It’s a limited partnership that’s traded publicly on an exchange.
An MLP offers the tax advantages of a private partnership along with the liquidity of publicly traded securities. It issues units, rather than stock shares.
It is a unique legal entity that combines elements of two business structures: a partnership and a corporation.
How does a master limited partnership (MLP) work?
An MLP (master limited partnership) is considered to be the aggregate of its partners, rather than a fully separate legal entity. It technically has no employees.
The MLP normally involves one or more general partners (managers) plus a number of limited partners (investors). The general partner(s) are responsible for the day-to-day operations of the business. They normally hold a 2% stake and have the option to increase their ownership through buying limited partner units.
Limited partners buy the units issued by the MLP. They are commonly called unitholders rather than shareholders. They’re paid through quarterly required distributions, the amount of which is stated in the contract between the general partners and limited partners.
What types of companies are MLPs?
The MLP has to receive 90% of its income from specific passive sources, including natural resources like oil and natural gas, real estate, or commodities. Otherwise, it will be taxed as a corporation rather than an MLP.
This means that most MLPs are in an energy-related business or real estate. Most of the energy businesses operating as MLPs include oil, natural gas, or refined product pipeline businesses. There are also a number of finance and investment companies structured as MLPs.
Pros and cons of investing in MLPs
MLPs typically produce steady cash flows over the long term. They also offer tax benefits, as limited partners are only taxed when they receive distributions. Because the quarterly dividends are treated as a return of capital, capital gains tax is deferred until the limited partner’s units are sold.
This means that MLPs are an advantage in estate planning. When a limited partner gifts their units to a beneficiary, no taxes are paid at that point, as the units have not been sold.
The key disadvantage of investing in MLPs is that doing so can be complicated from an accounting and tax perspective. Each limited partner is responsible for paying their share of the MLP’s income taxes and may also be responsible for paying taxes on partnership income.