Uncovering the Intricacies of Master Limited Partnerships: A Primer (2014)

Many of you have probably heard of master limited partnerships (MLPs), but our experience is that few management accountants have anything but a cursory knowledge of these investment vehicles. We suspect, too, that even many finance personnel have little more than a vague understanding of the intricacies of MLPs. In an effort to demystify them as an investment vehicle, we have endeavored to provide a descriptive account of MLPs: what they are, how they are organized and managed, how these entities (and their unit-holders) are taxed for U.S. income tax purposes, the primary lines of business in which MLPs operate, and the relevant risks and benefits of investing in these vehicles. Given the broadened role of accounting and the blurring of the lines of demarcation between accounting and finance functions, this information should be of interest to a wide array of management accounting professionals--both as a personal investment option and from the standpoint of the management accountant's role as a member of an organization's finance team. Legal Structure of MLPs An MLP is the more common term used to describe a publicly traded partnership (PTP). An MLP can be organized either as a limited partnership (LP) or as a limited liability company (LLC) choosing partnership taxation. Shares of ownership in these entities are referred to as units, which are traded on a stock exchange, such as the New York Stock Exchange (NYSE), NASDAQ, or one of the regional exchanges in the United States. Owners of units are referred to as To qualify for treatment as a partnership for U.S. federal income tax purposes, at least 90% of the partnership's gross income must be derived from As defined in [section]7704(d) of the U.S. Internal Revenue Code (IRC), qualifying income includes: * Interest, dividends, and capital gains; * Rental income and capital gain from the sale of real estate; * Income and capital gains derived from exploration, development and production, mining, gathering and processing, refining, compression, transportation, storage, marketing, distribution (but not retail sales, except for propane) of minerals, fertilizer, geothermal energy, timber, industrial carbon dioxide, biofuel, crude oil, gasoline, and other petroleum products; * Income from commodity investment or futures, forwards, or options with commodity as underlying assets; and * Capital gains from the sale of assets used to generate the above income. Because ownership units in MLPs are publicly traded, they offer the liquidity of corporate investments, such as stocks and bonds. Since they are partnerships, however, MLPs are not treated as separate entities for federal (and, in most cases, state) income tax purposes. Instead, MLPs are considered pass-through entities, which means that they pay no corporate taxes and that their income passes through to individual partners (unit-holders) who pay income taxes at their individual levels. MLPs also pass through their depreciation and depletion deductions to their unit-holders. Most MLPs provide regular cash distributions, although some can also use the cash for their own growth opportunities (e.g., by acquiring additional pipelines and/or storage facilities). There are approximately 120 MLPs traded in the United States, with a total market value of approximately $420 billion. (1) As shown in Figure 1, the majority of these entities are in the energy (oil and gas) sector. Financial analysts and corporate executives often separate the energy supply chain into upstream business (exploration and production), midstream business (transportation of oil and gas), and downstream business (delivery of final refined products, such as diesel and gasoline, to customers). As Figure 1 shows, most MLPs operate in the midstream sector of the oil and gas supply chain. Table 1 provides a list of the five largest MLPs, in terms of market value, as of the date of this writing. …