The main topics of this lesson are: Publicly Traded Partnerships; Pass – through Entity; Taxation Distributions; Reporting – the K-1; Cost Basis for Calculating Gain or Loss on Sale; and Section 199A – Qualified Business Income Deduction. For this lesson refer to the Study Notes and watch the video for a synopsis.
What is a publicly traded partnership?
A publicly traded partnership (PTP) is a business organized as a partnership – which is a pass-through
entity – traded as a stock on an exchange. Also referred to as Master Limited Partnerships (MLP) – the
concepts are the same. The purpose is to combine the tax benefits of a partnership with the liquidity of
a publicly traded security.
Pass – through Entity
A pass-through entity is an organization that does not pay income tax directly but rather passes through
any income (or loss) to be taxed on the individual tax returns of the owners of the organization. There
are different types of pass-through entities. The most common of which are partnerships and Scorporations. Limited Liability Companies or LLCs are technically non-existent under the tax code. Their
default treatment for tax purposes is as a partnership. However, LLCs may elect to be treated as
corporations for tax purposes.
Why publicly traded partnerships?
The first PTP was created in 1981 when corporate income tax rates were greater than individual income
tax rates. The obvious purpose was to avoid the high tax on corporate earnings by passing-through the
income to the individual owners of the partnership.
Initially, all types of industries, restaurants, hotels, real estate, oil and gas, and even amusement parks
took advantage of this structure. In 1987 Congress limited the types of businesses that could be
organized in this way, limiting it to organizations which earn at least 90% of gross income from
transportation, processing, storage and production of natural resources and minerals.
Like many partnerships, MLP/PTPs have two classes of ownership; the general partners – who are the
“management” and make the operating decisions, and limited partners who provide funding and receive
profits (and losses), but do not have decision making authority.
MLP/PTPs make quarterly payments to the owners. Because they are publicly traded, they are often
thought of as dividends, but for tax purposes they are more aligned with return of capital payments.
When an interest in an MLP/PTP is purchased, it is as if the investor contributed to the equity of the
organization. Income is earned and taxed on the investor’s income tax return with the net income
adding to the equity investment in the PTP/MLP. When a distribution is made, the equity in the
investment is reduced by the amount of the distribution.
Reporting – the K-1
Since distributions from the PTP/MLP are NOT dividends they are not reported (except as other non-tax
distributions) on your annual 1099Div. All income (loss) is reported to each owner on form K-1 annually.
This reporting comes directly from the partnership and is not available to brokers for individual
accounts. The income shown on the K-1 is reportable on your individual income tax returns and may be
more or less than the distributions you receive.
Cost Basis for Calculating Gain or Loss on Sale
The K-1 income (loss) recognized on your return and the distributions you receive adjust the basis of the
PTP when it is sold. PTP/MLPs are not covered securities, meaning that the cost basis is not reported to
the IRS on the 1099B. It is the taxpayers’ responsibility to track this over the ownership of the security.
Tax lot rules and the holding period rules apply.
Section 199A – Qualified Business Income Deduction
Beginning in 2018 a new deduction was implemented to encourage small businesses and attempt to
equalize the now higher personal income tax rates with lower corporate rates.
Section 199A – the Qualified Business Income Deduction is used to reduce taxable income from
operating partnerships and other entities subject to certain income limitations. For PTP/MLPs, and all
other pass-through entities filing a tax return, this information is now part of the K-1 reporting.
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Disclosure: Tax-Related Circular 230 Notice
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