A master limited partnership (MLP) is a business structure that trades on a public stock exchange like a regular stock but is organized as a limited partnership instead of a corporation. This structure lets MLPs avoid corporate income tax entirely, passing profits directly to investors, who then pay taxes on their individual returns. MLPs are most commonly found in the energy and natural resources sector, and they’re known for paying relatively high quarterly distributions to investors.
How MLPs Are Structured
Every MLP has two types of partners. The general partner manages day-to-day operations and makes business decisions. The limited partners are the investors who buy units (the MLP equivalent of shares) on public exchanges and provide the capital that funds the business. Limited partners have no role in management, which is why they’re sometimes called silent partners. In return for their investment, limited partners receive periodic cash distributions, typically paid quarterly.
The general partner’s compensation is tied to the partnership’s performance, which in theory aligns their interests with the limited partners. Many MLPs also have an “incentive distribution rights” structure that gives the general partner a larger slice of distributions as total payouts to limited partners grow past certain thresholds.
The 90 Percent Income Rule
Not every business can operate as an MLP. Under Section 7704 of the tax code, a publicly traded partnership is normally treated as a corporation for tax purposes, which would eliminate the pass-through tax benefit. Congress carved out an exception: if at least 90% of the partnership’s gross income is “qualifying income,” it keeps its partnership tax status.
Qualifying income includes revenue from the exploration, development, mining, production, processing, refining, transportation, or marketing of minerals and natural resources. That’s why nearly all MLPs operate oil and gas pipelines, process natural gas, store petroleum products, transport coal, or manage timber. Real estate income also qualifies. A company earning more than 10% of its revenue outside these categories cannot maintain MLP status.
How MLP Distributions Are Taxed
Because MLPs are partnerships, they don’t pay corporate tax. Instead, all income, deductions, gains, and losses flow through to each limited partner’s individual tax return. This is reported on a Schedule K-1 (Form 1065), which the MLP sends you each year instead of the 1099 forms you’d get from a regular stock. You don’t file the K-1 with your return, but you use the information on it to complete your taxes.
MLP distributions work differently from stock dividends. A large portion of most MLP distributions is classified as a return of capital rather than ordinary income. Return-of-capital payments aren’t taxed immediately. Instead, they reduce your cost basis in the investment. You eventually pay tax on that deferred amount when you sell your units, as capital gains. This deferral is one of the main reasons income-focused investors find MLPs attractive.
The trade-off is complexity. K-1 forms often arrive late in tax season, sometimes in March or even April, which can delay your filing. If the MLP operates in multiple states, you may have small amounts of income allocated to those states, potentially creating state filing obligations you wouldn’t have with ordinary stocks.
The Qualified Business Income Deduction
MLP investors have been eligible for an additional tax break under Section 199A: a deduction equal to 20% of qualified publicly traded partnership income. This effectively lowers the tax rate on MLP income. However, this deduction applies only to tax years beginning after December 31, 2017, and ending on or before December 31, 2025. Unless Congress extends it, the 20% deduction will not be available for the 2026 tax year and beyond, which would increase the effective tax burden on MLP distributions.
MLPs in Retirement Accounts
Holding MLPs inside an IRA or Roth IRA sounds like a way to simplify or eliminate the tax burden, but it can backfire. MLP income inside a retirement account is classified as unrelated business taxable income (UBTI). If UBTI from an MLP exceeds $1,000 in a year, the amount above that threshold is taxable, even inside a Roth IRA that would normally shelter all gains from taxes. The IRA custodian would need to file a separate tax return (Form 990-T) for the account and pay the tax from account funds.
This doesn’t mean you can never hold MLPs in a retirement account. Small positions that generate less than $1,000 in annual UBTI generally won’t trigger the tax. Some investors who want MLP exposure in retirement accounts use MLP-focused mutual funds or exchange-traded funds instead, since those are structured as corporations or regulated investment companies and handle the tax issue at the fund level, though they come with their own fees and tax characteristics.
Who Typically Invests in MLPs
MLPs appeal most to investors looking for current income. Because partnerships must distribute most of their cash flow to maintain their structure, MLP yields are often significantly higher than what you’d find from traditional dividend stocks. Retirees and other income-oriented investors are drawn to both the yield and the tax deferral that comes with return-of-capital distributions.
The concentration in energy infrastructure means MLP investors are taking on sector-specific risk. Pipeline companies depend on the volume of oil and gas flowing through their systems, which ties their performance to commodity prices and energy demand. Interest rate changes also affect MLPs, since rising rates make their yields less attractive relative to bonds and increase borrowing costs for capital-intensive pipeline projects.
If you’re considering MLPs, the key factors to weigh are the higher yield and tax deferral on one side, and the K-1 complexity, potential state filing headaches, sector concentration, and UBTI complications in retirement accounts on the other. For taxable brokerage accounts where you’re comfortable with the energy sector and don’t mind the extra paperwork, MLPs can be a useful income-generating piece of a portfolio.