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Tax Considerations for MLP Investors

MLPs, or master limited partnerships, are an attractive investment vehicle as they offered tax-advantaged assets, high dividends, and good prospects for growth. They are traded on the exchanges, just like stocks, although investors buy partnership units rather than shares of stock. Because an MLP is a limited partnership it is not subject to double taxation. By comparison, most companies are obligated to pay a corporate income tax, and shareholders pay dividend taxes as well.

Tax Advantages

Accounting for an MLP quarterly distribution can be quite favorable. In most instances, only 10 to 20% of the distribution is counted as net income. Therefore, shareholders pay regular income tax rates on this portion. The rest of the distribution is considered a capital return, so is not subject to an income tax. The biggest advantage of an MLP is that it offers a tax-shielded distribution that has a good history of growth over the past few tax years.

IRAs and K-1s

An MLP may become more difficult where the computation of taxes is concerned. The shareholder must fill out a K-1 form rather than the simplified 1099 form. To make matters more difficult, sometimes holders have to fill out a K-1 form for each state where the MLP does business. Holders should not think of MLP as a retirement account investment for a variety of reasons. Most of the income received from an MLP is tax-deferred to start with, so there’s no need to put it into the retirement account. Additionally, if MLPs are held in an IRA, the holder may have to pay taxes on unrelated business taxable income. These payments can be as much as $1,000 per year, although the income is generated in a tax-advantaged retirement account.

ETNs and ETFs

Holders can avoid K-1 issues by purchasing an ETF or exchange-traded fund. Alternatively, they can buy an exchange-traded note or ETN. Both of these are a representation of an assembly of MLPs, where distributions are treated as regular dividends at tax time. Furthermore, these investments can be held tax-free in an IRA. Get more investment advice here or consult a local broker.