Articles for Financial Advisors

MLP Questions to Ask

MLP Questions to Ask

MLP investors are taxed differently, depending on the investment vehicle used. Some forms of ownership are extremely tax efficient (i.e., large tax deferral and long-term capital gains) and other structures are very tax inefficient (i.e., depreciation recapture and ordinary income taxes). In general, the longer the holding period, the better the tax benefits.

Who Should Consider a MLP Investment
Endowments, IRAs, pensions, and 401(k) plans generally do not invest in MLPs because cash distributions are viewed by the IRS as “unrelated business taxable income.” If a MLP is an appropriate asset for the client, it should be held in a tra-ditional (non-retirement) brokerage account. The client should be advised that a K-1 will be generated each year. The typical mutual fund sends out 1099 forms in November while a large number of MLPs send out their K-1 in February.

Advisor and client should fully understand the distribution sharing arrangement between the GP and limited partners. If a MLP index-type investment is used, it is doubtful total compensation to the various GPs will ever be learned. Still, MLPs (which can be owned by mutual funds as of 2004) should be considered as a viable option within most portfolios. The WSJ table below lists questions the advisor should ask before recommending a specific MLP investment.

MLP Questions To Ask

[A] How are annual payments taxed?
[B] What payout portion is expected to be tax-deferred until the MLP is sold?
[C] Will client’s annual tax preparation fees increase?
[D] Are annual multistate tax filings and payments required?
[E] Will client receive a 1099 or a K-1 report?
[F] Could taxable income be generated if held in a retirement account?
[G] Tax consequences if investor makes a gift of the MLP to a person or entity?
[H] What happens if MLP investor dies?
[I] Does MLP owe corporate-level taxes and what are their expected impact?
[J] Are any distributions subject to the 3.8% net investment income tax?
[K] Is the investment subject to a sponsor’s credit risk?

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