TAX REFORM
1986
FUELS THE RISE OF THE MASTER LIMITED
PARTNERSHIP
I.
INTRODUCTION
The Tax Reform Act of 1986 has inadvertently become the
most significant influence in the overwhelming growth and popularity of the Master Limited Partnership (MLP).' Although the
Treasury Department was looking forward to the increase in tax
revenues resulting from the corporate tax changes made by the
Tax Reform Act of 1986, a different result is on the horizon. Key
changes made by the Act create incentives to disincorporate.
Such changes include a more rigid alternative minimum tax
within the existing double tax system,2 passive loss limitations,3
and the repeal of the General Utilities doctrine.4 Passive activity MLPs' have begun to take advantage of these new Tax Code
provisions thereby bypassing corporate tax hikes, double taxation and restrictions on deductions. The MLPs have unquestionably become a major concern in the economic arena.
This Note will discuss the MLP, its structure, the tax reasons behind its rise in popularity, its advantages and disadvantages, and its impact on the national economy. The Note will
1. Tax Reform Fall Out; Congress Will Re-examine Some Issues, Daily Tax Report (Jan. 13, 1987) (LEXIS, Fedtax library, BNA Daily Tax Report frm file) [hereinafter Tax Reform Fall Out]. Master Limited Partnerships are large publicly registered
partnerships whose interests, like corporate shares, are traded on stock exchanges similar
to corporate shares.
2. See I.R.C. section 11 which reads in part: "A tax is hereby imposed for each
taxable year on the taxable income of every corporation." I.R.C. § 11 (1986). I.R.C. section 301 reads in part: "Except as otherwise provided.., a distribution of property...
made by a corporation to a shareholder with respect to its stock..." shall be taxable
under section 301(c). I.R.C. § 301 (1986). (Together, section 11 and section 301 of the
I.R.C. constitute the corporate double tax.) See also I.R.C. section 55 which sets out the
alternative minimum tax structure. I.R.C. § 55 (1986).
3. See I.R.C. § 469 (1986) (limits the use of losses and credits derived from activities in which the taxpayer does not materially participate, i.e., tax shelters).
4. See General Utils. and Operating Co. v. Helvering, 296 U.S. 200 (1935). The
General Utilities doctrine provided that corporations did not have to recognize gains or
losses upon the distribution of appreciated property to shareholders or upon the sale of
appreciated property in preparation for liquidation. Id.
5. See generally I.R.C. § 469 (1986). Passive activity MLPs are ones in which the
interest holder does not materially participate in the trade or business. Id.
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then go on to explore the possibility of characterizing the MLP
as an association 6 in order to subject the entity to the corporate
tax. This would severely limit disincorporation activity and insure that substantial tax revenues intended to be collected
under the Tax Reform Act of 1986 are in fact collected.
II.
A.
THE MASTER LIMITED PARTNERSHIP
Origin, Definition, and Forms of the MLP
The MLP is a newly evolved entity with origins dating back
only as far as 1981. 7 In that year, Apache Corporation rolled up
several existing oil and gas partnerships into a single, or
"Master", partnership.8 Since the early 1980s, interest in the
MLP has grown tremendously. Well over 30 MLPs are in existence at present, all trading separately from the shares of their
respective parent companies. s
MLPs are heavily touted by leading Wall Street firms, large
investment houses and anguished oil companies concerned about
soft crude oil prices, low stock prices, and possible takeover at6. See TREAS. REG. § 301.7701-2 (1983). The term "association" refers to an entity
having characteristics which require it to be classified, for purposes of taxation, as a
corporation rather than as another type of organization such as a trust or partnership.
Id.
7. See Vinocur, Master Partnerships,REITs Both Gain from Tax Reform, Barrons
Oct. 20, 1986 at 78, col. 1 (discussion of the emergence of the MLP and a comparison
between the MLP and the Real Estate Investment Trust (REIT)). Although the limited
partnership has actually been in existence since 1822, Master Limited Partnerships are
recent to partnership evolution. Note, Tax Classificationof Limited Partnerships:The
IRS Bombards the Tax Shelters, 52 N.Y.U. L. REv. 408 (1977).
8. See Vinocur, supra note 7, at 78, col. 3. Apache corporation (primarily an energy
company) combined a number of existing partnerships and then sold off interests of the
resulting MLP. Id. See also Master Limited PartnershipsExpected to Flourish Due to
Tax Bill, Daily Tax Report (Oct. 22, 1986) (LEXIS, Fedtax Library, BNA Daily Tax
Report frm file) [hereinafter MLP Expected to Flourish] (progress of the MLP in the
last year); Tax Reform Fall Out, supra note 1 (repercussions of MLP utilization).
9. Tell, Hottest Thing in Oil: A Look At MLPs, Barrons Oct. 7, 1985 at 16, col. 2.
T. Boone Pickens, Chairman of Mesa Petroleum Company, put MLPs in the bright light
when he announced in August of 1985 that he had converted all of Mesa Petroleum into
an MLP. Id. However, both Unocal Corporation and Diamond Shamrock already had
created MLPs. Id. See also Sloane, Your Money: Oil Slide Hurts Tax Shelters, N.Y.
Times, Feb. 22, 1986 section I, at 32, col. 1. Within the oil and gas partnerships sold to
the public, income partnerships which aim to achieve high annual incomes dropped
74.3% while MLPs which trade units publicly and are not traditional tax shelters increased greater than fourfold. Id. at 32, col. 2-3.
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MASTER LIMITED PARTNERSHIPS
tempts.1" Reports estimate that 23 new MLPs are now or will be
registered in 1987. This will result in raising $1.8 billion in capital." Although the energy companies were the first to use the
MLP form of business, a recorded $2 billion worth of interests in
real estate MLPs have been sold to date and another $2 billion
are in registration."2 Such real estate ventures include shopping
centers, hotels, retirement homes, restaurants, and entire home
building operations.13 MLPs have also been used in the sale of
interests in professional football and basketball teams. 4
10. See Tell, supra note 9 at 16, col. 1. Sun, one of the largest of the oil companies,
declared that it would create an MLP into which it would sell off all its domestic oil and
gas properties. Id. As well as helping the oil companies, MLPs are allowing the securities
firms to help themselves to especially large fees as energy outfits convert. Id. Oil men hit
upon the MLP as a new, improved substitute for the royalty trust which must self liquidate, unlike the MLPs which can grow with reinvestment. Id. at 16, col. 3, See Cohen,
Burrough, Master Limited Partnerships Take Off, But Some May Fall Short of
Promises, Wall St. J., Dec. 2, 1985 at 23, col. 4 (Unocal Corp. formed a MLP to fend off a
hostile takeover attempt by a group led by T. Boone Pickens, chairman of Mesa Petroleum Co.).
11. Economists Praise Tax Overhaul, But Criticize Move Toward Disincorporations, Daily Tax Report (Dec. 3, 1986) (LEXIS, Fedtax library, BNA Daily Tax Report
frm file) [hereinafter Tax Overhaul] (Tax Reform has created an incentive for corporations to disincorporate and create partnerships with corporate characteristics).
12. See MLP Expected to Flourish,supra note 8 (tax reform should increase the
popularity of real estate MLPs).
13. Id. See also Saunders, Tax Reform's Tax Dodge, Forbes, Oct. 20, 1986 at 103,
col. 1. (oil companies, motel' chains, home builders, mortgage bankers, and firms that can
get all or part of their assets out of the corporate form and into an MLP are doing so);
Barker, Prime Cut: Burger King's Master Limited Partnership,Barrons, Apr. 28, 1986
at 16, col. 1 (Pillsbury re-names Burger King the Burger King Investors MLP and sold
98% of the restaurant's equity to the public); Vinocur, supra note 7, at 78, col. 4. Southwest Realty, listed on the American Stock Exchange, was the first roll up real estate
MLP. Id. REITs are falling behind in the investment race with the MLP. Id. REITs are
limited in the types of investments that they can make and in the types of activities
which they can engage in, MLPs are not. Id. MLPs are able to pass losses through to
their investors, REITs cannot. Id. REIT investors are reassured by the knowledge that
their interests are watched by independent directors or trustees, while MLP investors
cannot be so reassured. Id. For more on REITs, see H.R. REP. No. 841, 99TH CONG. 2D
SESS. Vol. 2, at 214-21 (1986) [hereinafter Conference Report].
14. See Boston Celtics Hope for Luck of Irish in Sale of Equity, Wall St. J., Oct.
20, 1986, at 12, col. 3. Influenced by the new tax laws, Celtics' owners wanted to sell a
40% stake in the team to the public by the year's end. Id. The 40% holding in the
Celtics was thought to bring in $40 million to $50 million in capital. Id. Current owners
intended to hold 60% of the partnership, ensuring their control. Id. The Green Bay
Packers Football Team has 1,800 holders of shares in the team; however, those holders
do not reap all the benefits that a true MLP provides. Id. Unlike the MLP agreement,
Packer shares do not pay dividends and cannot be sold without the team's executive
committee's approval. Id. See also Wong, Boston Celtics Set Price for 40% Stake at
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An MLP is a large publicly registered partnership consisting
of several hundred partners who own publicly registered and
traded interests in the partnership. 15 MLPs pass through income
and losses to individual partner-investors like traditional limited
partnerships, however, the MLP provides investors with greater
liquidity.16 MLP units are traded on national security exchanges
like corporate shares. The MLP also has the ability to issue additional units in the future.17 This system enables the MLP to
be an active, growing business, or an investment vehicle, thus
combining the attractions of a tax shelter with the marketability
of publicly traded units.18
There are three forms of MLPs. They are: the roll up MLP,
which
a number of existing partnerships are combined;" secin
ond, the roll out MLP, used by corporations to spin off their real
estate assets;20 and third, the initial public offering MLP, the
most popular and contemporary of the three.2"
B.
Tax Reform 1986: Making the MLP Strong
1. Avoidance of Double Taxation
Recent efforts to disincorporate and to convert to the MLP
are a result of the desire of organizations to enter into a new way
of doing business so as to avoid the corporate income tax structure.2 This is seen as a consequence destined to happen in a
Over $50 Million, Wall St. J., Oct. 29, 1986, at 6, col. 5 (company plans to sell 2.6 million
limited partnership units at an estimated price of between $19 and $21 per unit).
15. See, e.g., Tax Reform Fall Out, supra note 1; MLP Expected to Flourish,
supra note 8.
16. See MLP Expected to Flourish, supra note 8.
17. Id. See Tell, supra note 9, at 20, col. 1. A typical arrangement entails a company which contributes properties to a newly created MLP, but retains majority control
while selling limited partnership units to the public. Id. Current shareholders may receive MLP units as dividends in addition to their regular dividend payout. Id. Although
the corporate cash dividend is reduced, the MLP distribution, which is free from corporate tax and dividend tax with respect to the holders, more than makes up the difference. Id. If used in the field of oil and gas, the MLP unit holders may also receive energy-related tax benefits. Id.
18. See Burrough, supra note 10, at 23, col. 4.
19. See, e.g., Vinocur, supra note 7, at 78, col. 3. Apache Corporation combined or
"rolled up" several of its existing oil and gas partnerships into one MLP. Id.
20. See Barker, supra note 12, at 16, col. 1 (Pillsbury's roll out of Burger King
properties).
21. Burrough, supra note 10, at 3, col. 4.
22. Tax Overhaul, supra note 11 (Larry Dildine, director of tax and economics at
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MASTER LIMITED PARTNERSHIPS
system with double taxation.2 3 The corporate tax is a system of
double taxation. " One tax is imposed at the corporate level on
the corporation's taxable income and a second tax is imposed at
the shareholder level on dividend distributions.2 5
The Tax Reform Act of 1986 made several significant
changes to the corporate tax structure designed to increase the
revenue raised by the corporate tax. First, the Act revised the
regular corporate tax rate structure.2 6 For the first time in tax
history, the top rate for corporations (34%) is higher than the
top rate for individuals (28%).21 Second, the Act has revised the
alternative minimum tax in order to ensure that all corporations
incur some tax liability.2 8 Under the Act, this additional tax has
been raised from 15% to 20%.9
Unlike corporations, partnerships are taxed at the shareholder level only. 30 Under this system, items of partnership inPrice Waterhouse, states such a proposition).
23. Id. See generally Warren, The Relation and Integration of Individual and
Corporate Income Taxes, 94 HARV. L. REv. 717, 730 (1981) (corporate income subject to
double taxation; the investment incentives derived therefrom; fairness as an issue).
24. See I.R.C. § 11 (1986), infra note 25.
25. I.R.C. section 11 imposes a tax on the corporation's taxable income and section
301 taxes corporate distributions. I.R.C. §§ 11, 301 (1986).
26. See I.R.C. § 11(b) (1986). The old corporate tax rate system imposed a tax of
15% on the first $25,000 of taxable income, 18% on taxable income in excess of $25,000
but not more than $50,000, 30% on taxable income in excess of $50,000 but not more
than $75,000, 40% on taxable income in excess of $75,000 but not more than $100,000,
and 46% on taxable income in excess of $100,000. Id.
27. See I.R.C. § 11(b) (1986). The new corporate tax rate system imposes a tax of
15% on the first $50,000 of taxable income, 25% of taxable income in excess of $50,000
but not more than $75,000, and 34% of taxable income in excess of $75,000. Individuals
could be taxed on up to 50 percent of taxable income under the 1954 Code unlike the
28% top tax rate under the 1986 Code. I.R.C. § 1 (1986). For a definition of taxable
income, see I.R.C. section 63 (1986).
28. I.R.C. § 55(b)(1)(A) (1986).
29. Id. See also Gould, The Fading Allure of Incorporation,N.Y. Times, Sept. 7,
1986 S III at 11, col. 1. Companies now have to include half of their book income, which
is the profit they report to their shareholders, in their minimum tax calculation. Id. Unlike corporations, individual taxpayers do not have to make this adjustment. Id. For this
reason, and because a partnership pays no tax, many closely held businesses might find
it profitable to operate as partnerships rather than as corporations. Id. The change in the
alternative minimum tax rate is very disheartening to incorporators. Id. See also Conference Report, supra note 13, at 1 and 158; Tax Reform-1986; An Analysis of the Internal Revenue Code of 1986, at 5, (Ernst & Whinney 1986) (individual return items) (corporate revisions) (Individual Return Items) [hereinafter Tax Reform-1986].
30. See I.R.C. § 701 (1986) (partners, and not the partnership itself, are subject to
tax); see also Tax Reform Fall Out, supra, note 8.
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BRIDGEPORT LAW REVIEW
come, gain, loss, deductions, and credits are calculated at the
partnership level but then passed through to the partners and
figured into their individual tax returns. s No tax is imposed on
the partnership as an entity. 2 Thus, the MLP has been able to
give high rates of return to its investors.33
2. Passive Activity Limitations
Some of the most significant new provisions of the 1986 Tax
Reform Act are those which make it virtually impossible to use
losses or credits derived from tax shelters to reduce taxable income from other sources such as portfolio income, 4 salaries, and
dividends. 35 The passive activity loss and credit limitations
under new Code section 469 limit the use of losses and credits
derived from passive activities only to the extent that they are
utilized to offset income generated from any passive activities. 6
A taxpayer's ownership interest is generally regarded as passive
if the taxpayer does not "materially participate
3
7
in the con-
duct of the trade or business at issue, or in the rental of tangible
property."
31. See I.R.C. § 701 (1986). A partnership is not subject to income tax. Id. However, persons carrying on business as partners are subject to income tax in their separate
or individual capacities. Id.
32. Id.
33. See generally Tell, supra note 9, at 20, col. 2. The average rate of return being
10%-14%.
34. See I.R.C. § 469 (1986). Portfolio interest is defined as that income which includes dividends, interest, royalties, and capital gains or losses attributable to the disposition of property held for investment. Id. Portfolio income is not passive income. Id. See
also Tax Reform-1986, supra, note 29, at 23; Conference Report supra, note 13 at 146
for further discussion of the treatment of portfolio income.
35. I.R.C. § 469 (1986).
36. See I.R.C. § 469(b)(c) (1986). For a discussion on the workings of section 469
and the passive activity loss and credit limitations see, Real Estate Leases and Improvements: Summary to Accompany Tax Management Portfolio Number 47-4th-United
States Series, Daily Tax Report (Jan. 5, 1987) (LEXIS, Fedtax Library, BNA Daily Tax
Report frm file) [hereinafter Real Estate Leases and Improvements], and Conference
Report, supra note 13, at 137-55.
37. See Conference Report supra, note 13, at 147-48. "[An individual who works
full-time in a line of business consisting of one or more business activities generally is
likely to be materially participating in those activities (except to the extent provided
otherwise in the case of rental activities), even if the individual's role is in management
rather than operations." Id. See also I.R.C. section 469(c)(1986) for a definition of passive activity.
38. See supra note 36 and infra note 40 and accompanying text (discussion of passive activity). See also Tax Reform-1986, supra note 29, at 22, 23 (1986) (passive
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MASTER LIMITED PARTNERSHIPS
Unlike the interests and dividends generated from stocks
and bonds, MLPs are considered passive investments 9 from
which
passive income may be offset by passive losses and cred40
its.
The passive activity entity, or MLP, will provide passive
income, rather than ordinary income, which will create an offset
against tax shelter benefits, passive losses and credits.41 This will
decrease the final taxable income for the year by depleting the
total taxable income. Unfavorable tax treatment 3 of ordinary
activity).
39. See, e.g:, On Line Supplement TRA86 Summary (Text) Sales And Portfolio
Number 36-3rd United States Series, Daily Tax Report (Jan. 2, 1987) (LEXIS, Fedtax
Library, BNA Daily Tax Report frm file) [hereinafter On Line Supplement] (discussion
of passive activity rules).
40. See I.R.C. § 469 (1986). Passive activities are defined as any trade or business
activity in which the taxpayer is not a material participant, or includes any rental property activity regardless of the degree of participation. I.R.C. § 469(c)(1986). Passive income, as that derived from MLPs, does not include portfolio income such as income from
interest or dividends. Id. at § 469(e)(1986). Credits subject to new passive activity limits
are suspended and may be utilized in subsequent years only against tax liability resulting
from passive income. Id. at § 469(b)(1986). The passive activity limits apply generally to
individuals, estates, trusts, and personal service corporations. Id. at § 469(a)(1986). The
passive activity loss and credit limitation rules will be phased in over a four year period
if the taxpayer was already engaged in the passive activity, or was under a binding written contract to acquire an interest in the activity. Id. at § 469(1)(1986). Under the phasein, qualifying taxpayers shall be disallowed under subsection 469(1)(a) only the applicable percentage of the amount which would have been allowed otherwise under subsection
(a). Id. The applicable percentages are:
Applicable Percentage
Taxable year beginning in Jan. 1
1987 ........................................
35% disallowed
1988 ........................................
60% disallowed
1989 .......................
................. 80% disallow ed
1990 .......................
. ...............
90% disallowed
Id. at § 469(1)(2)(1986). For example, a couple purchases a limited partnership interest
in 1986 and incurs $15,000 worth of limited partnership loss. They have received salary
and other portfolio income to total $80,000. The passive activity rules apply for 1987, but
the couple is entitled to some relief. Under the phase in rules, 35% of their limited
partnership loss will be disallowed for 1987 ($9,750), while the remaining $5,250 is suspended and carried forward to future years. Tax Reform-1986, supra note 29, at 27.
41. See Real Estate Leases and Improvements, supra note 36. Non-corporate taxpayers subject to passive loss limitations should consider investing in publicly-traded
MLPs. Id. MLP income will be "per se passive" so that it may be offset by passive losses
and credits. Id. The interest and dividend generated by stocks and bonds, on the other
hand, would not be subject to offset. Id.
42. Id. Taxable income is the taxpayer's gross income minus the above-line deductions of section 62 and the below-line deductions of section 63. I.R.C. § 63 (1986).
43. See I.R.C. §§ 1211(a), (b) (1986). Capital losses are fully deductible to the ex-
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income combined with the inability to offset that income with
tax shelter benefits or passive losses result in the creation of
more passive activity entities, or MLPs."'
Although many supporters of Tax Reform admit that limiting deductions from investments that were promoted under
prior tax rules is bad policy,"5 the projected revenue of $23.4 billion over five years is a positive consequence." Other tax experts
fear, however, that because section 469 creates an added incentive to disincorporate and allocate interests to passive investments, the return of the projected $23.4 billion may be substantially diminished.'7
3. Repeal of the General Utilities Doctrine
The General Utilities doctrine generally provided that a
corporation did not recognize taxable gains upon both liquidating and non-liquidating distributions of appreciated property to
its shareholders or upon the sale of property prior to liquidation.'8 The General Utilities doctrine provided a valuable excep-
tion to the general rule of corporate double taxation.'9 Throughtent of capital gains but may offset only up to $3,000 of ordinary income in a taxable
year. Id. The remaining capital gains, if any, will be treated as ordinary income and will
not be given the preferential treatment they received under the old section 1202. I.R.C. §
1202 (repealed 1986). This results in less favorable tax treatment of income. See also
Tax Reform Fall Out, supra note 1 (experts project future ramifications of
disincorporation).
44. See, e.g., Vinocur, supra note 7, at 78, col. 1; MLP Expected to Flourish,supra
note 8.
45. See Tax Reform Fall Out, supra note 1 (experts project future ramifications of
disincorporation).
46. Id.
47. Id. See also On Line Supplement, supra note 39 (most obvious planning technique is to increase deductions and credits which will be subject to the new passive
limits).
48. General Utilities, 296 U.S. 200. See Shube, Corporate Income or Loss on Distributions of Property: An Analysis of General Utilities, 12 J. CORP. TAX'N 3 (1985)
(assuming that the corporate double tax structure is desirable, General Utilities should
be reversed). The term General Utilities Rule shall be used to refer to the treatment of
liquidating and non-liquidating distributions alike. Id. at 3, n.2. The General Utilities
Rule was codified in I.R.C. sections 311, 336, 337 (repealed 1986).
49. See I.R.C. §§ 334(a), 301(d) (1986) (gain inherent in appreciated property is
untaxed at the corporate level and the shareholder receives the fair market value as basis). I.R.C. section 334(a) provides that where property is received in a distribution in
complete liquidation of a business, and gain or loss is recognized on receipt of such property (distribution), the basis of the property in the hands of the distributee shall be the
fair market value of such property at the time of distribution. I.R.C. § 334(a)(1986).
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MASTER LIMITED PARTNERSHIPS
out its history, however, the rule was plagued by criticisms that
it undermined the integrity of the double tax system50 and that
it was too complex.5
The 1986 Tax Reform Act has effectively repealed the General Utilities Rule with respect to both liquidating and nonliquidating distributions. 2 Code Section 336 now provides that gain
or loss will generally be recognized by a corporation on a liquidating sale or distribution of its assets as if the corporation had
sold the assets to the distributee at the fair market value. 3 Code
section 311(b) provides a similar rule regarding non-liquidating
distributions.5 4 Gain or loss is not recognized, however, with respect to any corporate distribution of property to the extent that
there is a non-recognition of gain or loss to the distributee under
the tax-free reorganization provisions of the Code. 5 Thus, gain
on liquidating and nonliquidating sales or distributions must
now be recognized and is taxable first at the corporate level and
I.R.C. section 301(d) also provides for a fair market value basis to distributees. I.R.C. §
301(d)(1986). Therefore, not only is the distributee (shareholder) subject only to a single
tax under section 311, but her potential gain will be less because of a higher basis; or a
loss may occur. I.R.C. § 334(a)(1986).
50. See Shube, supra note 48, at 53.
51. Id. at 44. For example, section 311(d), as originally enacted in 1969, provided
that a corporation must recognize gain on the distribution of appreciated property in
redemption of stock if the distribution did not fall into an exception under section
311(d)(2). Id. at 30, n.113. Section 311(d)(2) exceptions included 10% shareholders, distributions of stock or obligations of a subsidiary corporation, distributions pursuant to
an antitrust judgment, distributions to pay death taxes, distributions to private foundations, distributions by regulated investment companies, and distributions constituting
divestitures by bank holding companies. Id. at 31. Amendments were made in 1982
which repealed section 311(d)(2)(A), the 10%/12 month shareholder exception. Id. at 34.
The distributions pursuant to antitrust judgments and bank holding companies were also
repealed. Id. Section 336 was also enacted to provide that a corporation distributing
property to shareholders in partial liquidation did not recognize gain or loss. Id. The Tax
Reform Act of 1984 further modified section 311. Id. For an in-depth evaluation of the
section 311 modifications, see Shube, supra note 48.
52. See Conference Report, supra note 13, at 198-200 (conference committee repeal of General Utilities doctrine).
53. Id. See I.R.C. section 336 (1986) which states in part: "Except as otherwise
provided in this section or section 337, gain or loss shall be recognized to a liquidating
corporation on the distribution of property in complete liquidation as if such property
were sold to the distributee at its fair market value." I.R.C. § 336 (1986). I.R.C. section
337 concerns the nonrecognition of gain or loss for property distributed to parent in
complete liquidation of a subsidiary. I.R.C. § 337 (1986).
54. I.R.C. § 311(b)(1986) (dealing with distributions of appreciated property).
55. I.R.C. §§ 336(c), & 351 (1986) (dealing with reorganization provision; includes
the 80% distributee within §§ 332 and 337).
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once again when distribution to shareholders occurs.
The repeal of the General Utilities Rule fuels the rise of the
MLP. The MLP has the ability to recognize gains and losses
from the sale or distribution of property. However, because it is
a partnership under the rules of the Revised Uniform Limited
Partnership Act (RULPA),56 only the partners themselves, and
not the partnership, include such distributions in their individual tax returns.5 7 This undermines the purpose of the double tax
imposed on similar transactions under the corporate tax
system.
C. The Advantages and Disadvantages of the MLP
1. Advantages
Several tax advantages in using the MLP form of business
have already been mentioned. As discussed earlier, the MLP
produces passive income which can be offset by passive losses
incurred through already existing tax shelters.59 The MLP enjoys single taxation at reduced rates.6 0 Investors in the MLP can
get tax deductions for depleted assets whereas corporations cannot. 1 Private partners, who generally can sell their interests to
the sponsor 62 only, if allowed to at all, now also receive the liquidity of owning units which can be freely traded. 3 Taxpayers,
56. Revised Unif. Ltd. Partnership Act (1976) (§§ 503-504 deal with sharing of
profits and losses and sharing of distributions; §§ 601-608 deal with distributions and
withdrawal).
57. I.R.C. § 701 (1986) (partners, not partnerships, subject to tax).
58. See supra text accompanying notes 22-23 citing the avoidance of double tax as
a partnership.
59. See supra note 40 for a discussion of section 469, passive activity.
60. See Saunders, supra note 13, at 103. The benefit of such a tax structure persuaded Universal Development Corporation (UDC) to convert to an MLP. Id. Whereas
UDC used to pay close to 50% of its earnings in taxes as a corporation, it now pays
nothing. Id. UDC continues to reinvest 25% of pre-tax earnings in the business; however,
it now has three times as much in earnings available for distribution to its investors. Id.
In 1984 UDC's effective corporate tax rate on distribution earnings for top bracket taxpayers was an overwhelming 75%. Id. As an MLP, by 1988 (when the Tax Reform's final
rates kick in), the effective top rate on the earnings UDC unitholders will receive will be
a mere 28%. Id.
61. Burrough, supra note 10, at 23, col. 4. See also supra notes 46-52 (General
Utilities Rule Repealed).
62. See Burrough, supra note 10 (for these purposes a sponsor is the corporation or
general partner, one giving security, a surety).
63. Id.
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MASTER LIMITED PARTNERSHIPS
therefore, have the freedom to trade, along with the tax benefits
of a shelter.6
Other advantages include the ability to trade MLP units for
property, taxes on which may be deferred until the seller sells
the MLP units.6 The MLP can be used as a financial tool, turning long term assets into quick cash. 6 MLP units also provide
high yields for investors.6 7 In addition, those spinning off assets
often get cash distributions which are greater than dividends
formerly paid.6 8 Furthermore, the changing of the legal form of
ownership from a corporation to an MLP does not necessarily
pose a liability problem. Limited partners bear no more liability
than the extent of their investment.6 9
2. Disadvantages
There are also disadvantages in choosing the MLP form of
business or investment. Due to the intricacies of MLP taxation,
investors who receive a large quarterly interest check may find it
difficult to determine whether an MLP is growing soundly or is
actually liquidating itself slowly, 70 thereby returning part of the
64. Id.
65. Vinocur, supra note 7, at 78, col. 5.
66. See Barker, supra note 13, at 16, col. 1 (the MLP termed a "hot financial
tool"). For example, in February of 1985, Pillsbury Company turned its subsidiary, Burger King Restaurant, into the Burger King Investors MLP and sold 98% of its equity to
the public for a total of $92.7 million. Id. In return, the partnership obtained the deeds
and leases to 128 Burger Kings. Id. After expenses and underwriter commissions, Pillsbury netted $86.3 million. Id. Investors "snapped up" the initial offering of Burger King
units and have since bid the price up from $20 to $24 per unit on the New York Stock
Exchange. Id. Also, because the restaurant's rent is tied to its revenues, any increase in
sales could prove a bonus to the partnership. Id. And if the properties appreciate in
value investors may possibly receive capital gains in the future. Id. See also Saunders,
supra note 13, at 103, col. 1. "Some companies are combining the incorporated and disincorporated forms." Id. For example, Commonwealth Financial Group, a Houston mortgage banker worth $1.6 billion in assets is putting a mortgage organization and servicing
division into a MLP. Id. The projected sale of 38% of the MLP would bring in approximately $230 million. Id. Freeport-McMoRan has also joined the bandwagon and sold all
of its sulfur, phosphate, and geothermal operations to the public for $238 million. Id.
67. See supra note 6 (MLP yields); see also Wong, supra note 14, at 6, col. 5
(Celtic partnership plans a first year distribution of $1.40 per unit or a 7% yield).
68. Burrough, supra note 10, at 23, col. 4.
69. Id. See Unif. Ltd. PartnershipAct, § 17 (Liability of Limited Partner to Partnership) [hereinafter U.L.P.A.].
70. See Tell, supra note 9, at 23 (depleted reserves or capital are further diminished through interest payments without refurbishing assets).
BRIDGEPORT LAW REVIEW
[Vol. 9:217
investor's own money. 7' Likewise, investors may fall victim to
roll ups used to disguise beleaguered businesses or inadequate
oil fields in order to make them appear profitable to investors.7 2
MLP distribution may defer tax until the units are sold; upon
such sale, capital gains taxes are imposed. 73 The MLP's ability
to make distributions is only as solid as the income from its
properties. 7 '
Gas and oil companies, as the primary source of MLP activity, are illustrative of some other disadvantages. Because unit
prices are based on yield, MLPs having below par earning prospects, or short-lived oil reserves, must pay a yield premium.7 5
Experts have warned that it would seem impossible for some
companies to sustain their promised cash distributions when
they pay out a majority of their cash flow without comparable
income entering into the partnership. 76 Dilution, or the selling of
additional units to fund added exploration and production of
new oil or gas reserves, is seen as one solution to the problem.77
On the other hand, one investing in an MLP, which fails to find
71. Saunders, supra note 13, at 103, col. 1. Similarly, the tax effect of MLP ownership is so complex that unit holders may find it difficult or impossible to calculate their
own tax picture at any given time. Tell, supra note 9, at 22, col. 3. This is because the
tax basis, percentage of depreciation, and other elements involved in partnership taxation vary from holder to holder and from partnership to partnership. Id.
72. Burrough, supra note 10, at 23, col. 4. Roll ups can also cause trouble when
investors in the private partnerships, who are given their first chance in years to liquidate their holdings through the publicly traded units, sell their units immediately, thus
driving down the price of the units. Id. Runs such as this were a major factor in the 45%
drop in the price of Damson Energy Corporation's Limited Partnership units and the
19% drop in NRM Energy Company's limited partnership unit price, since they began
trading in early 1986. Id. One way to combat this situation is to plan on making a number of payouts, approximately within the first year. For example, Walker Energy plans
five payouts in its first 13 months with a 6.4% yield in a 60 day period. Id.
73. I.R.C. § 1221 (1986) (capital asset defined); I.R.C. §§ 1222(1), (3) (1986) (capital
gains defined); I.R.C. § 61 (1986) (gross income defined). See Tell, supra note 9, at 22,
col. 5.
74. Tell, supra note 9, at 22, col. 2.
75. Id.
76. Burrough, supra note 10, at 23, col. 5. Arthur L. Smith, president of John S.
Herold Inc., an appraiser of oil and gas companies, projects a dismal future for companies which sustain high cash distributions under all circumstances. Id. T. Boone Pickens
uses Apache Corporation, Diamond Shamrock Corporation, and Transco Energy Company as examples of partnership distributors producing income at less than desirable
rates, thereby running the risk of depletion in five years of its current reserves if such
distributions continue. Id.
77. Id. (Apache is one MLP using dilution techniques). See also Tell, supra note 9,
at 22, col. 4, for a definition of "dilution."
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MASTER LIMITED PARTNERSHIPS
or sell enough gas, could ultimately be denied those alluring high
yields and the MLP itself may be placed in jeopardy. 8 Analysts
also worry that partnerships which issue additional units may
ultimately wind up diminishing the value of the units being held
by initial investors. 9
Although good for the general partners, MLP agreements
may subject their public partners to an array of contingencies,
caps, conflicts of interests and rents.80 Investors must be sure
that their limited partners have a commonality of interest. This
means that the general partners have a fiduciary relationship
with the limited partners, or simply put, the general partners
cannot get rich at the limited partner's expense. 81 Further, it is
important to note that MLP investors, dissatisfied with their
general partner, may find it extremely difficult to remove that
partner.8" Most important, there is always the danger that Congress will end the MLP invasion by taxing large limited partnerships as if they were corporations.s This will negate any of the
positive tax benefits derived from disincorporation.
78.
Tell, supra note 9, at 22, col. 4.
79.
Burrough, supra note 1, at 23.
80. See Barker, supra note 13, at 16, col. 3. Barker discusses that the partnership
agreement regarding the Burger King MLP (see supra note 9 for agreement) has some
disturbing "qualifiers." Id. For example, "percentage rents", or 8.5% of sales that franchisees pay on top of the flat minimum rent whenever revenues surpass a given threshold. Id. Although this works well when sales are up, rent will not decrease proportionately even if sales are below the threshold. Id. Cash available for distribution will be
divided, 98% to public partners, 2% to Pillsbury until the public has received a 12%
return in any given year. Id. When that occurs, income and cash is split 75%-25% until
the public partners have received a 17.5% return. Id. From that point onward a 60%40% deal is stuck. Id.
81. Saunders, supra note 13, at 103, col. 3. (Price Waterhouse advisor warns to
examine the relationship and the fees to general partners closely because big fees to
general partners may indicate trouble); see also Lichtyger v. Franchard Corp., 18 N.Y.2d
528, 227 N.Y.S.2d 377, 223 N.E.2d 869 (1966). The relationship between the general and
limited partner is a fiduciary one-a relation of trust-similar to that of a corporate
director and a shareholder. Id.
82. Vinocur, supra note 7, at 78, col. 5 (comparison with REITs which give reassurances that investor's interests are watched by an independent board of directors or
trustees).
83. See infra notes 84-86 and accompanying text (IRS to reclassify the MLP as an
association for tax purposes).
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III. How
A.
THE
IRS
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CAN FIGHT BACK
Classification of the MLP as an Association
The possibility that Congress and the IRS will reclassify the
MLP as an association is seen by some as the only way to stop
the unfettered growth of the MLP. s4 Treasury officials have
urged Congress to investigate MLP use, and the Ways and
Means Select Revenue Measures Committee is expected to continue its work on this issue. 5 In order to be taxed as a corporation under the Internal Revenue Code, the MLP must be labeled
as an "association." 86 Regulations interpreting the statutory
term "association" set forth six characteristics possessed by corporations which distinguish it from other organizations.87 An en84. See Westfall, Corporation Analogues in Partnership Taxation, 80 HARV. L.
765 (1967) (because taxpayers are turning to opportunities afforded by partnerships, broader application of corporate tax doctrines to partnerships are necessary). See,
e.g., Saunders, supra note 13, at 103; 1986 Elections: Tax Committees Undergo Change,
Daily Tax Report (Jan. 13, 1987) (LEXIS, Fedtax Library, BNA Daily Tax Report frm
file) (growing concern over the popularity of MLPs and tax avoidance); MLPs Expected
to Flourish,supra note 8 (speakers predict at Washington seminar that MLP's days are
numbered because of possible future act by Congress to tax MLPs as corporations); Tax
Report: A Special Summary and Forecast Of Federal and State Tax Developments,
Wall St. J., Oct. 19, 1983 at 1, col. 5 [hereinafter Tax Report: Special Summary and
Forecast]. Proposals made to tax such MLP entities as corporations because easy transfer of ownership makes them similar to corporations. Id. MLPs should not be able to
avoid entity level tax while passing profits and losses through to unit holders. Id. Such
proposals are opposed by the American Bar Association's (ABA) tax section but are
backed by the American Law Institute (ALI). Id.
85 1986 Elections: Tax Committees Undergo Change, supra note 84. J. Roger
Mentz, Assistant Treasury Secretary for Tax Policy, testified before the House Ways and
Means Select Revenue Measures Subcommittee trying to convince the committee that
MLPs should be taxed as corporations. Id. See also Real Estate Industry, Former Tax
Official Takes Aim At Treasury's Position on MLPs, Daily Tax Report (Apr. 3, 1987)
(LEXIS, Fedtax Library, BNA Daily Tax Report frm file) [hereinafter Tax Official
Takes Aim] (further meetings of the subcommittee scheduled).
86. I.R.C. section 7701(a)(3)(1986) provides in part: the "term 'corporation' includes associations, joint-stock companies, and insurance companies." I.R.C. §
7701(a)(3)(1986). "Partnership" is defined to include "unincorporated organization(s),
through or by means of which any business, financial operation, or venture is carried on,
and which is not . . . a trust or estate or corporation." I.R.C. § 7701(a)(2)(1986). See
generally Hyman & Hoffman, Partnershipand "Associations": A Policy Critique of the
Morrissey Regulations, 3 J. REAL EST. TAX'N 377 (1976) (discussion on taxing real estate
ventures as corporations for tax purposes); Note, Tax Classificationof Limited Partnerships: The IRS Bombards the Tax Shelters, 52 N.Y.U. L. REV. 408 (1977) (for limited
partnership to be utilized as tax shelter, it is essential that it be taxed as a partnership
rather than as an association).
87. Treas. Reg. § 301.7701(a)(3)(1983).
REV.
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tity will be treated as an association if its corporate characteristics are such that it "more nearly resembles" as a corporation
than a partnership or trust.8 9 The attributes include: associates,
business purpose, continuity of life, centralized management,
limited liability, and free transferability of interests.9 0 Although
these attributes have not been codified in the Internal Revenue
Code, their provisions are deeply rooted in case law from the
Morrisey v. Commissioner decision of 193591 to the Larson v.
Commissioner decision in 197692 and Regulation section
301.7701.
B.
Continuity of Life
Under the regulations,9 3 an entity does not resemble a corporation, with respect to continuity of life, if the death, insanity,
88. Id. (this has been interchanged with "more closely resembles" as well).
89. Id.
90. Id. (associates and business purpose are not discussed as they are seen as givens and not as important factors).
91. 296 U.S. 344 (1935) (serves as the origin of corporate classification). The Court
determined that a business trust should be classified, for the purposes of federal taxation, as an association, not as a trust. Id. at 360. In its decision the Court established
that centralization of management, continuity of life, transferability of interests and limited liability would serve as the benchmarks of corporate resemblance. Id. at 359.
92. 66 T.C. 159 (1976). In Larson, the IRS unsuccessfully tried to restrict the use of
limited partnerships as tax shelters by classifying such enterprises as associations, taxable as corporations. Id. The petitioners owned limited partnership interests in Mai-Kai
and Somis real estate ventures organized under the California Uniform Partnership Act
(CAL.CORP. CODE §§ 15501 et seq. (West Supp. 1976)) and deducted losses therefrom in
their individual tax returns. Id. at 159-60. The Tax Court held that both entities lacked
continuity of life and limited liability, but possessed association attributes of free transferability of interests and centralized management. Id. at 173-84. The partnership status
prevailed because the organizdtions "more closely resemble" non-corporate characteristics than corporate characteristics. Id. at 185. See TREAS. REG. § 301.7701-2(a)(3)(1983).
See also Kutzner v. United States, 413 F.2d 97, 105 (5th Cir. 1969) (court noted that the
four primary classifications used are "equally weighted procrustean criteria"); see generally Fisher, Classification Under Section 7701-The Past, Present, And Prospects For
The Future, 30 TAx L. 627, 641 (1977) (Larson implies a bias toward the classification of
an entity as a partnership); Tax Reform Fall Out, supra note 1. Treasury officials have
acknowledged the bias in favor of partnership classification and have sought statutory
authority to toughen these rules. Id. November 1984 tax reform included proposals that
would classify all partnerships made up of over 35 partners as corporations for tax purposes. Id. This was quickly overturned by Congress as a result of pressure from the private sector. Id. Assistant Treasury Secretary for Tax Policy, J. Roger Mentz, told the
Select Revenue Measure Subcommittee in June of 1986 that publicly traded limited
partnerships should be taxed as corporations. Id.
93. TREAS. REG. § 301.7701-2(b)(1)(1983).
BRIDGEPORT LAW REVIEW
[Vol. 9:217
bankruptcy, retirement, resignment or expulsion of any member
will cause a dissolution of the organization."4 Corporation status
will only be granted to an entity where the majority has the ability to prevent interruption of the business operations."5 Corporations do not depend upon events personally affecting their separate members. Yet under certain circumstances partnerships do
so depend.96 For example, bankruptcy of a member will cause
dissolution of the partnership."7 The regulations recognize that
where a general partner of a limited partnership is a corporation
controlled by the limited partners the general partner is really
the "alter ego" of the limited partners.9 " As a result, the general
partner is not likely to withdraw against the wishes of limited
partners and thereby cause the dissolution of the partnership. 9
Additionally, involuntary withdrawal of the general partner
upon the partnership's dissolution or bankruptcy can be checked
by the limited partners. 00 However, because the regulations are
clearly keyed to "non-dissolution" as opposed to "non-termination" of a business in order for continuity to exist,' 0° the contingent continuity of life10 2 possessed by partnerships does not adequately resemble that continuity of life possessed by a
corporation. 03
The MLP, like most partnerships, is formed under the same
0
ULPA rules as was the partnership in Larson.'
Because bank94. Id.
95. TREAS. REG. § 301.7701-2(d)(2)(i)(1983).
96. Fisher, supra note 92, at 641 (deals in part with involuntary withdrawal or
bankruptcy).
97. See TREAS. REG. § 301.7701-2(b)(1)(1986); Larson, 66 T.C. at 174-76. The California Uniform Limited Partnership Act (CULPA) and the Uniform Limited Partnership Act (ULPA) both have provisions disallowing partners such as in Mai-kai and
Somis to contract against dissolution in the event of bankruptcy of the general partner.
Id. at 176. See also Cal. Unif. PartnershipAct § 15031(5) (West Supp. 1976) (partnership is dissolved upon the bankruptcy of a partner).
98. See Fisher, supra note 92, at 653 (proposed regulations and interpretation on
continuity of life). See TREAS. REG. § 301.7701-2(d)(2)(i)(1983) (different considerations
involved when corporations, controlled by limited partners, serve as general partner).
99. See Fisher, supra note 92, at 653.
100. Id.
101. Larson, 66 T.C. at 175.
102. Id. Court cites Glensder Textile Co. v. Commissioner, 46 B.T.A. 176 (1942)
(contingent continuity of life did not adequately resemble that of a corporation).
103. Id.
104. See supra notes 92, 97 (regarding Larson agreement) and notes 110-113, 131
(regarding sections of the ULPA).
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MASTER LIMITED PARTNERSHIPS
ruptcy of general partners may cause dissolution of the business
there is no continuity of life guaranteed.' 0 5 The contingent continuity of life characteristic of the MLP may, therefore, fail in
this category.' 0 6
However, if the partnership agreement protects against dissolution despite bankruptcy of the general partner, an MLP may
adequately be classified as a corporation with respect to continuity of life. This conclusion, however, runs contrary to the
pattern of case law decisions on this point. 107 Nor is it in accordance with the Uniform Limited Partnership Act. 0 8a Therefore,
the IRS will conclude that the "continuity of life" characteristic
under the regulations and case law will not attach to the MLP.
C.
Centralized Management
The corporate form of management is centralized amongst
the officers and directors. Shareholders are involved only to the
extent of choosing their representatives. The general partnership
form of management is decentralized simply because any partner has the power to make binding decisions during the ordinary
course of business. 10 9 The limited partnership form of management, however, is centralized because the authority to manage
exists only with the general partners." 0 A limited partner who
takes part in the control of the partnership business will lose
limited liability status."' In contrast, the generally accepted
105. See supra note 97 (authority that bankruptcy will cause dissolution).
106. See supra note 102 and accompanying text ("contingent continuity of life"
mentioned).
107. See, e.g., Larson, 66 T.C. at 174-75 (disallowing the two companies involved to
contract against dissolution in the event of bankruptcy); Glensder, 46 B.T.A. at 185
(100% vote by limited partners required to elect a new general partner was contingent
continuity of life).
108. U.L.P.A. § 16 (1967). The limited partner can withdraw her interest on dissolution. Id. However, she can neither dissolve the partnership nor force dissolution at the
retirement, death, or insanity of a general partner if not in accordance with remaining
partners and the partnership certificate. U.L.P.A. § 20 (1967).
109. U.P.A. § 9 (1967) (Partner as Agent of Partnership as to Partnership
Business).
110. See U.L.P.A. § 9 (1967) (section 9 sets out the rights, powers and liabilities of
a general partner); U.L.P.A. § 10 (1967) (section 10 sets out the rights of a limited
partner).
111. See U.L.P.A. § 7 (1967) (limited partner not liable to creditors unless she
takes part in control of business); Larson, 66 T.C. at 176 (business entities had centralized management in GHL, the sole general partner).
BRIDGEPORT LAW REVIEW
[Vol. 9:217
view provides that centralized management will be found lacking
if the general partner has a meaningful proprietary interest in
the organization. " 2 This is so, regardless of the fact that continuing exclusive authority to make management decisions in connection with the business at issue is vested in one individual, a
group, or a corporation.11 3 In a corporation, management is centralized in the officers and directors, acting primarily in a repreConversely, partnerships are managed
sentative capacity."
more by the partners themselves, who have a proprietary interest at stake in the business. "'
The MLP will meet the centralized management requirement. It has been noted that the proprietary interest is not only
applicable to partnership interests, but includes most types of
ownership interests.11 6 Proprietary interests have been defined
as the interests of a holder or owner of legal title along with all
the rights thereto.1 17 These rights may include the right to participate in the control of an organization, economic rights in the
property or assets of the organization, and the right to share in
the distribution of the organization's assets. " Thus, corporate
shareholders and MLP interest holders alike may be seen as
having a proprietary interest. Furthermore, if both corporations
and limited partnerships have proprietary interests within management, then they both must have the same degree of centrali112. Glensder, 46 B.T.A. at 185.
113. Id. See also Fisher, supra note 92 at 642; Note, supra note 7, at 427. The Tax
Board declared that centralized control by general partners does not make the partnership analogous to directors of a corporation because partners act "in their own interests"
and not "merely in a representative capacity" for an entity with persons having limited
investments and limited liability thereunder. Id. (quoting Gelnsder, at 185); accord,
Zuckman v. United States, 524 F.2d 729, 738-39 (Ct. Cl. 1975); Larson, 66 T.C. at 177.
114. See Hanson Trust v. MLSCM Acquisition Inc., 781 F.2d 264, 273 (2d Cir.
1986). A director's obligation to a corporation and its shareholders includes a duty of
care in the execution of directorial responsibility. Id. A director has a fiduciary relationship. Id.
115. See infra note 130 (courts establish that there is a difference between a corporate board of directors and general partners).
116. See Note, Tax Avoidance Through Like-kind Exchanges of PartnershipInterest, 35 STAN. L. REV. 537, 559 (1983) (Tax Court should re-evaluate nonrecognition
treatment for partnership exchanges under § 1031(a)).
117. Id.
118. Id. at 559-60. Other types of proprietary interests include stock (an entity's
interest in a corporation), and securities (an entity's interest in some types of business
organizations, ventures, and associations). See Stroh v. Blackhawk Holding Co., 48 Ill. 2d
471 (1971) (stock certificates considered proprietary interests).
19881
MASTER LIMITED PARTNERSHIPS
zation. In order to tax the MLP as a corporation and avoid revenue losses, the IRS will have to adopt this line of reasoning and
allow all limited partnerships to possess the characteristic of
centralized management.
D. Limited Liability
The Larson court read Regulation section 301.77012(d)(2)"' to require a conjunctive test under which personal liability exists if the general partner either has substantial assets 2 '
or is not a "dummy" for the limited partners. 2 ' The presence of
one or both of these requirements will result in the noncorporate
characteristic of personal liability. 22 If an agent or dummy for
the limited partners acts as a director, however, limited liability
12 3
may be seen to exist.
The general rule with respect to limited liability compares
the percentage of interests that entail personal liability to the
percentage that does not.'2 " If the percentage of limited liability
is substantially in excess of the percentage of personal liability,
the entity resembles a corporation with respect to the attribute
of limited liability. 2 5 Generally, corporate resemblance will result where the limited partner's interests are greater than 60%
119. TREAS. REG. § 301.7701-2(d)(1983) provides that an organization will have the
corporate characteristic of limited liability if there is no partner personally liable for its
debts or claims against it. TREAS. REG. § 301.7701-2(d)(1983). In the case of a limited
partnership subject to a statute such as the Uniform Limited Partnership Act, personal
liability exists with respect to each general partner except as provided in subparagraph
(2) of the Treasury Regulations, which held that in the case of limited partnerships,
personal liability does not exist, with respect to the general partner, "when he has no
substantial assets (other than his interest in the partnership) which could be reached by
a creditor of the organization and when he is merely a 'dummy' acting as the agent of the
limited partners." Id. Furthermore, when the limited partners act as the principals of
such general partner, personal liability will result regarding such limited partners. Id.
Furthermore, if a general partner is a corporation with substantial assets, other than its
interests in the partnership, which could be reached by creditors of the limited partnership, personal liability will exist with respect to the general partner. Id.
120. Larson, 66 T.C. at 179-80. Technically, however, the general partner is always
liable as with an ordinary partnership. Note, supra note 7, at 429.
121. Larson, 66 T.C. at 179-80. See also Zuckman, where the Court concluded that
limited partnerships can never have limited liability. Zuckman, 524 F.2d 729, 741.
122. TREAS. REG. § 301.7701-2 (1983). See, e.g., Note, supra note 7, at 429-30;
Fisher, supra note 92, at 642.
123. Fisher, supra note 92, at 642.
124. Id. at 655.
125. Id. (citing TREAS. REG. § 301.7701-2(f)(2)(1983)).
BRIDGEPORT LAW REVIEW
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of the partnership.12 6
Under the Larson interpretations of Treasury Regulation
section 301.7701-2(d)(2), 12 7 the MLP might be seen as a system
which entails personal liability. Personal liability results mainly
when the general partner has either substantial assets in the
business or is not a dummy for the limited partners. 2 8 Although
unlikely, the IRS may be able to detect those MLPs with widely
held units resulting in no one partner's substantial liability. The
IRS may also discover those MLPs with a dummy corporation
set up as a general partner, also resulting in no one partner's
substantial liability. These forms of MLPs may be classified as
having only limited liability, a corporate characteristic. Thus,
only some MLPs would be taxed as associations and the majority would still take advantage of disincorporation.
E.
Transferabilityof Interests
Under Larson and the Treasury Regulations, unlike a stockholder's rights and interests in a corporate venture which are
freely transferable, a partner can only transfer his or her interest
in partnership profits and surplus and cannot assign other attributes of membership without the consent of all partners. 129 In
determining the freedom to assign a limited partner's interest,
however, the agreement should be controlling. 30 Therefore, only
when the agreement and governing state law allow all of the
rights of a substituted limited partner to be assigned, without
the discretionary consent of any other member, is his or her free
transferability equivalent to that of a corporation.
Contrary to the Larson opinion, the regulations "accord no
126. Fisher, supra note 92, at 655 n.103.
127. See supra notes 119-21 and accompanying text for the "conjunctive" interpretation of regulation.
128. Id.
129. See U.P.A. § 18(g) (1941) (Rules Determining Rights and Duties of Partners);
U.P.A. § 26 (1941) (Nature of Partner's Interest in the Partnership); U.P.A. § 27 (1941)
(Assignment of Partner's Interest); U.L.P.A. § 18 (1967) (Nature of Limited Partner's
Interest in Partnership); U.L.P.A. § 19 (1967) (Assignment of Limited Partner's
Interest).
130. Larson, 66 T.C. at 182-83. The Larson court concluded that the business entities in question, through right of assignment, "more closely resembled" the corporate
characteristic of transferability of interests. Id. at 182-84. The court went on to say that
even if it found modified free transferability, petitioners would still prevail since something less than two characteristics favored corporate status. Id. at 185 n.23.
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MASTER LIMITED PARTNERSHIPS
significance to consent that must be obtained prior to a transfer
but which cannot be withheld unreasonably." '' The regulations
provide that the corporate attribute of free transferability of interests may be found where transferable interests are substantially in excess of those interests not transferable.'3 2
It is clear that the MLP possesses the corporate characteristic of free transferability of interests. Units are traded publicly
on the exchange as are corporate stocks, and so unit holders
have more leeway to transfer their interests at will. 33 The
boundaries of this characteristic have changed since the days of
Larson and the days before the MLP. The IRS will be quick to
seize upon the opportunity to impute this corporate characteris34
tic onto the MLP.1
IV.
IMPACT
Depending on the MLP examined, the classification test
may or may not result in reclassification to an "association" status. There must be a determination as to how many associationcharacteristics are met by the MLP. The conclusion of the classification test results in two or three characteristics in favor of
association classification (centralized management, free transferability of interests, and, under some circumstances, limited liability) and one or two characteristics in favor of non-association
classification (continuity of life and, in some circumstances, limited liability). If an MLP meets the limited liability test, then a
131. Fisher, supra note 92, at 658 (TREAS. REG. § 301.7701-2(g)(1983)). See generally Peel, Definition Of A Partnership:New Suggestions On An Old Issue, 1979 Wis. L.
REV. 989 (examining the present regulations, describes how the Larson opinions have
forced consideration of their revision, and exploring legislative and regulatory possibilities for improving the present situation).
132. Fisher, supra note 92, at 658.
133. See supra note 17 and accompanying text (free transferability of units
allowed).
134. See supra note 120 (Larson possessed this quality by right of assignment; by
analogy an MLP needs no specified right); see also Tax Reform Fall Out, supra note 1
(classifying some types of MLP income as "active activity income", similar to corporate
dividend income, based on the theory that the MLP taxpayer-partner utilized the income from publicly traded entity shares).
But see Tax Report: A Special Summary and Forecast,supra note 84, at 1, col. 5
(1983). ABA committee head, Robert R. Casey, of Baton Rouge, La., stated that ownership (unit) transfers alone should not decide tax status. Id. Samuel Murry, of Arthur
Anderson and Co., related a common fear that corporate tax would later be applied to
other partnerships under this theory. Id.
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[Vol. 9:217
3-1 ratio would result and the MLP would be classified as an
association under Treasury Regulation section 301.7701. If an
MLP fails the limited liability test, then a 2-2 tie would result. A
resolution in favor of association status, when in a stalemate, is
to weigh each characteristic differently according to its importance to the entity itself and its distinguishability with respect
to partnership or association attributes. 3 5 Because the ability to
engage in the public trading of partnership interests is the distinguishing factor in the rise of the MLP as opposed to other
partnerships, this transferability factor should be weighed more
heavily when considering MLP tax consequences. 3 6 This right is
135. See BITTKER & T. EUSTICE, FEDERAL INCOME TAXATION OF CORPORATIONS AND
SHAREHOLDERS 2.04 (abr. ed. 1979). In 1977, amendments to the "association" classification regulations were proposed and quickly withdrawn in response to the Larson decision. Id. One feature of the proposed amendments worth noting, however, was the use of
a "resemblance" or a type of balancing test as opposed to the mechanical "preponder-
ance" of characteristics test used today. Id. Under the resemblance test, a two-two tie in
characteristics would not always result in a non-corporate entity for lack of preponderance. Id. If the corporate status predominates in one or more factors, the scale will tip in
favor of an association status. Id. This balancing approach allowed for more flexibility in
classifying associations. Id. See also Larson, 66 T.C. at 194 (Simpson, J., dissenting). The
purpose of the regulations is to decide if an entity "more nearly resembles" corporations
or partnerships. Id. The court should have considered other significant characteristics
which have any relevancy in making the judgment. Id. These other characteristics should
be added into the analysis when determining the outcome of the four main characteristics, or in the alternative, these characteristics should just be added to the overall analysis in general to tip the scales in favor of or against corporate status. Id. at 194-202. This
type of balancing test would be more rational and fair. Id.
136. See generally Note, supra note 116, at 570-72 (a limited partnership interest
is a security). Under the tests set forth in S.E.C. v. W.J. Howey Co., 328 U.S. 293 (1946)
and State Comm'n of Sec, v. Hawaii Mkt. Center Inc., 52 Hawaii 642 (1971), limited
partnership interests meet the requirements of a security; Note, supra note 116, at 57071. Limited partners invest funds in a common enterprise to earn profits through the
managerial efforts of others. Id. at 571. Limited partners provide value to the promoter
or general partner which is given at risk in order to build up the enterprise. Id. Limited
partners expect a return on investment but have no right to exercise control over the
management of the partnership. Id. Also, limited partners can enter into or withdraw
from the partnership after formation (U.L.P.A. § 1 Official Comment). Id. Furthermore,
the limited partner can freely transfer or assign her interest (6 U.L.A. §§ 19, 25(1)
(1969)) and need not even know the identity of her fellow investors (6 U.L.A. §§ 8, 19, 25
(1969)). Id. See also S.E.C. RELEASE No. 33-4877 (Aug. 8, 1967), 32 FED. REG. 11, 705
(1967) (the SEC agrees that a limited partnership interest should be treated as a security) and UCC § 8-102(1)(b) which provides in part:
[A] share, participation, or other interest in property or an enterprise of the
issuer or an obligation of the issuer which is (i) not represented by an instrument and the transfer of which is registered upon books maintained for that
purpose by or on behalf of the issuer;
(ii) of a type commonly dealt in on securities exchanges or markets; and
19881
MASTER LIMITED PARTNERSHIPS
an important attribute of the MLP, and it is also very similar to,
if not indistinguishable from, the trading of corporate shares.
The characteristic of centralized management should be afforded less weight due to the ambiguities surrounding the term
"proprietary interests."""7 There is a tenuous distinction between corporate management, and its interests in the business
and partnership management and its interests in the business.
As a result of the differing weight allocations, the MLP should
fall on the side of an association for tax purposes and thus serve
the interests underlying the new tax policy." '
V.
CONCLUSION
Concern over the growth of the MLP and the consequences
thereof is forcing Congress to take measures to curb the MLP's
effects on the economy. 139 Treasury officials believe that the
(iii) either one of a class or series or by its terms divisible into a class or series
of shares, participations, interests or obligations.
Id. See generally Note, Recognizing The Unique Status of Additional Named Insureds,
53 FORDHAM L. REV. 125 (1984-1985) (enlargement of the definition of securities). Connecticut and New York have enacted such a provision in Article 8 of their commercial
codes to enlarge the definition of security to include "uncertified Securities," or simply,
securities not represented by share certificates. CONN. GEN. STAT. ANN. § 42a-8-102 (West
Supp. 1987), N.Y. U.C.C. § 8-102 (McKinney Supp. 1987). Only California has specifically excluded the limited partnership interest from the definition of uncertified securities. CAL. COM. CODE § 8102(1)(b)(iv) (West Supp. 1987).
137. See supra notes 106-108 (differing views on the definition of proprietary interests and the activity it encompasses).
138. See Tax Reform Fall Out, supra note 1 (revenue buildup of $23.4 billion acquired from those who can best afford stepped-up taxes).
139. Id. See generally Tax Lawyers Tell ABA Conference Not To Expect Subchapter C Legislation Any Time Soon, Daily Tax Report (Apr. 14, 1987) (LEXIS,
Fedtax Library, BNA Daily Tax Report frm file). Treasury officials, tax lawyers, and
conference participants agreed by eliminating the General Utilities doctrine and ending
capital gains preference while increasing the tax burden of corporations relative to individuals. Id. The 1986 Act is pressuring corporations to organize themselves as subchapter
S firms, sole proprietorships or partnerships. Id. Donald Schapiro, of Barretts, Smith,
Schapiro, Simon & Armstrong, warns that the IRS should give guidance on MLPs and
"restrict the tax benefits available to them before they become 'institutionalized'." Id.
This would avoid situations where taxpayers entering into MLP transactions, without
the benefit of IRS guidance, are unfairly penalized for interpretations ultimately determined incorrect by the IRS. Id. But see Tax Official Takes Aim, supra note 85. Efforts
by the Treasury Department to limit the tax planning benefits of MLPs by treating
them differently from traditional limited partnerships with respect to the passive loss
regulations and other new tax reform provisions, will probably be squashed by the
courts. Id. It would be especially difficult to justify a decision to uphold such limitations
in the area of real estate since the law treats all rental real estate as a passive activity.
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[Vol. 9:217
popularlity of the MLPs will continue to thrive and their avoidance of the corporate tax will threaten the income tax revenue
base. "14 0 This would negate the purpose behind the Tax Reform
Act's corporate provisions to increase the treasury's revenue to
$23.4 billion.""
This concern should lead to the reclassification of the MLP
as an association to be taxed as a corporation under the new
Internal Revenue Code. 142 Free transferability of interests
should be the key factor involved, with strong public policy and
economic concerns promoting reclassification as well. But until
this reclassification occurs the MLP will continue to flourish and
business entrepreneurs, investors, and wily taxpayers will continue to take advantage of Master Limited Partnerships.
Suzanne B. Sutton
Id. "A decision treating rental real estate activity as other than passive would fly
squarely in the face of tradition and would be difficult to justify as being a rule 'necessary and appropriate' for the IRS to issue." Id. See also Tax Lawyers Tell ABA Conference Not To Expect Subchapter C Legislation Any Time Soon, Daily Tax Report (Apr.
14, 1987) (LEXIS, Fedtax Library, BNA Daily Tax Report frm file). A former treasury
assistant secretary for tax policy stated that it would not be worth the political capital
for legislators to push for reform of the corporate tax law at this time. Id.
140. Tax Lawyers Tell ABA Conference Not To Expect Subchapter C Legislation
Any Time Soon, Daily Tax Report (Apr. 14, 1987) (LEXIS, Fedtax Library, BNA Daily
Tax Report frm file) (projected returns from new tax laws equalled $23.4 billion).
141. Id.
142. See Tax Official Takes Aim, supra note 85. According to Treasury officials the
MLP issue is still under consideration. Id. The issue will be addressed later in the 1986
corporate tax changes reviewing process. Id.