Taxes on an MLP Held in a Tax-Deferred Account

by Mike Parker

A master limited partnership, sometimes referred to as an MLP, is a business structure that allows attractive tax benefits to flow through to the partners, who are sometimes referred to as unit holders. While it is possible to hold MLP units in a tax-deferred account, this can result in certain tax consequences.


An MLP is a business structure that operates with two levels of ownership: general partners and limited partners. The general partners provide the management oversight for the partnership's day-to-day operation, while the limited partners provide the investment capital. Only companies that earn at least 90 percent of their income from specific activities including dividends and interest, or gains from real estate, commodities, commodity futures or mineral or natural resources, may use the MLP business structure.

Tax Advantages

The partnership structure of an MLP provides for certain tax-advantaged distributions to be passed down to the individual unit holders, without creating a tax liability at the partnership level. This provides the unit holders with means of sheltering some of their otherwise taxable income by using their share of the partnership's depreciation and other tax deductions.

Tax-Deferred Accounts

There are a number of different types of tax-deferred accounts, including traditional individual retirement accounts and 401k accounts. These accounts allow you to set aside a certain amount of money toward your retirement. Tax-deferred accounts may allow you to take a tax deduction for the amount you contribute to the account, and all funds in the account are allowed to grow without incurring a tax liability until you withdraw them, usually after you reach retirement age, when you will presumably be in a lower tax bracket.

Tax Considerations

There is no Internal Revenue Service prohibition against holding units of an MLP in your tax-deferred account, but since a tax-deferred account eliminates any current tax obligation on income produced by investments in the account, you will lose the tax benefits of distributions from the MLP. Withdrawals from your tax-deferred account are typically taxed as ordinary income, regardless of how those funds were earned, so you may actually end up paying income taxes on funds from the MLP that would have otherwise provided a tax deduction. You may also be subject to Unrelated Business Income Tax if your share of the partnership's distribution exceeds IRS limitations on such income, which was $1,000 for the 2011 tax year.

About the Author

Mike Parker is a full-time writer, publisher and independent businessman. His background includes a career as an investments broker with such NYSE member firms as Edward Jones & Company, AG Edwards & Sons and Dean Witter. He helped launch DiscoverCard as one of the company's first merchant sales reps.