Taxes on an MLP Held in a Tax-Deferred Account

The MLP rules limit this type of business organization primarily to the energy sector.
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Although investing master limited partnership works just like buying shares of stock in a corporation, an MLP investment isn't stock. As the limited partnership structure indicates, you become a limited partner and participate in the profits of the MLP company. However, owning MLP units in your IRA might pose some tax scenarios to be aware of.

Unrelated Business Income

An IRA account shelters taxable investment income from current taxation. If an IRA earns income not related to its purpose -- deferring investment income -- that income will be classified as unrelated business income. The unrelated business income only exists because of the tax-advantaged nature of the IRA. It is possible for an MLP to generate income that would be unrelated business income for an IRA and result in a tax issue for the account.

Thousand Dollar Exclusion

If you own an MLP in your IRA, the tax form from the company -- called a K-1 schedule -- will show how much unrelated business income your IRA earned from the investment for the year. If the total unrelated income earned by your IRA was less than $1,000, you have no tax issue. If your IRA earned more than the $1,000 deduction, unrelated business income tax must be paid on the earnings greater the reporting threshold.

IRA Pays Taxes Not You

If you earn more than the $1,000 of unrelated business income in your IRA, it is the IRA itself that must pay the tax. The custodian of your account should complete the tax form, calculate the tax due and file the taxes including a check drawn from the cash balance of your IRA account. If you see unrelated business income on the K-1 from an MLP in your IRA, you should contact the custodian and make sure they are aware of the situation. The custodian of your IRA may charge a fee for filing the unrelated business income tax return for your account.

Evaluating a UBIT Issue

The limited partnership business structure results in a pass-through of both income and deductions to investors. If you earn net income on an IRA-owned MLP investment, that money will be unrelated business income. However, it is very possible there will be little or no pass-through income from owning MLP units. The amount of unrelated income that results from a MLP investment is not related to the amount of dividends paid by the company. Unfortunately, it is impossible to determine whether you have an unrelated business income tax issue until you get the K-1. If your IRA MLP investment is not large, you will probably not have a UBIT problem.

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