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2013 SPECIAL
TAX EDITION
Sharing clear solutions on topics affecting our clients and their investors
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Understanding the Master Limited
Partnership Market and its Impact on
the Financial Services Industry
In the last five years, we have seen significant growth of Master
Limited Partnership (MLP) investments within both the mutual
fund and alternative investment sectors. Whether you are
interested in increasing your exposure to MLP investments
within your existing funds or are considering structuring a fund
that focuses primarily on MLPs, there are several factors that
should be considered. U.S. Bancorp Fund Services offers
consultative support and tax preparation services for multiple
fund structures that invest in MLPs.
Our Expertise in the MLP Market
U.S. Bancorp Fund Services developed an automated,
solution-oriented accounting approach over the last 10
years that allows us to provide full fund accounting, financial
reporting, and tax services for MLP investment funds. Our
comprehensive services are offered within mutual fund, hedge
fund, and C Corporation structures. We currently provide these
services for a substantive amount of MLP investment advisers
and will continue to be a leading full service administrator for
MLP fund structures as well as funds that may hold a nominal
amount of MLP investments.
General Characteristics of MLPs
MLPs are generally considered publicly traded partnerships (PTPs) that are sold on a primary or secondary
market or exchange where they are priced throughout an open day of trading, much like a typical corporate
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stock. PTPs are traded in units rather than in shares, but because of their corporate open market trading
characteristics, they can be classified as corporations for U.S. financial reporting and tax purposes.
The IRS allows MLPs that derive 90 percent or more of their annual gross income amount from passive
sources to be classified as Qualified Publicly Traded Partnerships (QPTPs). While PTPs that fail to qualify as
QPTPs are taxed as corporations for U.S. tax purposes, QPTPs are taxed as partnerships. Because QPTP
classification is based on an annual fiscal gross income test, MLP designation as a taxable corporation or
partnership can change, and therefore must be monitored. MLPs that are U.S. corporations for tax purposes
issue annual 1099 income reporting statements to their underlying investors, while MLPs taxed as partnerships
issue K-1 statements.
Currently, a significant portion of MLPs are classified as oil, gas, or other types of energy exploratory
companies. Per the National Association of PTPs (NAPTP), there has been significant growth in total U.S. MLP
structures over the past five years. See the illustration below for the current industry composite of MLPs.
For funds that invest in MLPs,
the NAPTP website also currently
lists within the financial services
industry 15 active open-end
MLP Funds and 25 closed-end
MLP Funds. There is also an
aggregate of 19 MLP exchange
traded fund (ETF) and exchange
traded note (ETN) structures.
In the current MLP industry
environment, a majority of energy
MLPs typically qualify on an
annual basis as QPTPs and are
therefore taxed as partnerships
rather than as corporations.
MLPs also generally make
quarterly cash distributions to
their underlying unit holders.
For the underlying investors that receive these distributions, only a small portion of the quarterly distributions
are generally designated on year-end reporting statements as taxable income distributions, while the remaining
portion of the taxable character is classified as return of capital (ROC) distributions. The ROC portion of these
distributions is generally considered a tax deferred attribute of MLP quarterly distributions. These significant
ROC distributions are due to favorable accelerated depreciation expenses for energy pipeline developments
and other U.S. tax credits that can be applied to offset MLP taxable income amounts.
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Some MLP analysts currently project these
investments to yield a return on investment
between a 5 to 7 percent range, which has
been very attractive to many investors given
the current lower annual yields within most
bond and other fixed income markets. The
MLP market within the United States continues
to expand as new pipelines are developed,
especially within the Permian basin, the Gulf
Coast region, and throughout our western
states. The United States is also expanding its
role as a net exporter of energy products to
many regions including Mexico and Western
Europe. Analysts have also noted recent
expansions in new energy markets including
shale, petro chemicals, and natural energy
sectors such as solar and windmill products.
All of these attributes noted within the MLP
energy sector suggest continued growth and
expansion within this market.
Special Accounting and Reporting Considerations for Investments in MLPs
Given their unique characteristics, the following considerations should be examined for MLP investments:
»» Most MLPs are taxed as U.S. partnerships and generate Schedule K-1s, which can create timing issues for
calculating and estimating taxable income with an investment fund’s fiscal year. Certain fiscal year-ends can
be elected that are more favorable if significant MLPs are held, and efforts may need to be made to estimate
K-1 income from MLPs through their prior annual K-1 income statements.
»» Recently proposed IRS regulations attempt to limit mutual fund exposure to MLP investments from 50
percent to 25 percent of total gross assets. As a result, there may be a trend for new MLP-focused funds to
be structured as C Corps and hedge funds.
»» MLP funds can generate ordinary income from a trade or business. This can greatly enhance state reporting
obligations and trigger in-depth analyses that must be performed at the state level.
»» Accounting systems for MLP investments must be designed to appropriately allocate K-1 income equitably
among multiple purchase lots held for the same MLP investment for calculating tax basis for each lot and
capital gains or losses from the sale of MLP lots.
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»» MLPs that are designated as corporations for
tax purposes can trigger a favorable Dividend
Received Deduction income tax reduction from
the quarterly distributions paid by MLP funds.
»» K-1 information received from MLPs must
be thoroughly reviewed in determining their
Earnings and Profits (E&P), which in turn may
impact reportable taxable income amounts
received from quarterly distributions.
»» The IRS passive loss limitation rules require an
analysis to be performed to ensure losses from
MLPs are recorded at the individual MLP level
and are not netted together at the MLP fund
level for tax purposes.
»» Because MLPs can generate ordinary income
from a trade or business, they may generate Unrelated Business Taxable Income (UBTI) to qualified
tax-exempt investors depending on the type of MLP fund investment structure.
»» MLPs must be reviewed annually to determine whether they qualify as QPTPs.
BUILDING ON FOUR DECADES OF INVESTMENT EXPERIENCE
With nearly 45 years of service distinction, U.S. Bancorp Fund Services combines industry-leading technology with high-quality
customer service to provide our clients with customized solutions. The core of our business model has relied on the passion and
experience our professionals bring to the office every day. With extensive industry tenure and knowledge encompassing every
type of mutual fund and alternative investment product and strategy, our professionals’ vision, combined with our sophisticated
technology, gives our clients the guidance, resources, and insight into the market they need to be successful.
Please contact your U.S. Bancorp Fund Services fund administrator, relationship manager, or Michael McMaster, U.S. Bancorp
Fund Services Tax Director (414-765-6871) for any further information regarding our full suite of services for MLPs.
This document is for general discussion purposes only and is not intended to be used or construed as tax advice, and cannot be
used by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable
state or local tax law provisions.
U.S. Bancorp Fund Services, LLC
615 East Michigan Street
Milwaukee, WI 53202
www.usbfs.com | 1.800.300.3863
U.S. Bank does not guarantee the products, services, or performance of its affiliates and third-party providers.
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