Master Limited Partnership vs. Limited Partnership: Understanding the Key Differences

Erika Rasure is a globally respected expert in consumer economics, a dedicated researcher, and educator. As a financial therapist and transformational coach, she specializes in empowering women to confidently navigate investing.

Master Limited Partnership vs. Limited Partnership: A Modern Perspective

At its core, a partnership is a business entity owned by two or more individuals. Every partner contributes resources—whether property, capital, skills, or labor—in exchange for a share of profits and losses.

The main distinction between limited partnerships and master limited partnerships lies in their trading status and tax advantages. MLPs combine the tax benefits of limited partnerships with the liquidity of publicly traded securities.

Essential Insights

• Partnerships involve multiple owners and come in various forms.
• A limited partnership (LP) includes a general partner managing daily operations and a limited partner who is passive.
• General partners in LPs hold personal liability for business debts, unlike limited partners.
• Master limited partnerships (MLPs) are publicly traded entities offering tax benefits and shielding limited partners from debt liability.
• MLPs must derive at least 90% of their income from natural resource activities.

Understanding Limited Partnerships

In a limited partnership, there is at least one general partner who actively manages the business and assumes full personal liability for debts. This means if the business faces financial trouble, the general partner's personal assets could be at risk.

Limited partners contribute capital but do not participate in daily management, protecting them from personal liability and lawsuits. Their financial risk is limited to their investment amount.

However, if a limited partner becomes actively involved in operations, they risk losing their liability protection.

Since limited partners are passive, their earnings are not subject to self-employment taxes, offering a tax advantage in exchange for their limited role.

The Dynamics of Master Limited Partnerships

MLPs are unique business structures: publicly traded limited partnerships that offer investors liquidity alongside tax benefits. Limited partners enjoy protection from liability and receive income distributions typically derived from steady cash flows.

MLPs focus primarily on natural resource sectors such as energy pipelines, storage, commodities, or real estate, generating at least 90% of revenue from these areas.

These partnerships often secure long-term contracts and hedge prices, resulting in more stable returns and lower volatility compared to other investments.

Income is passed directly to unit holders, avoiding double taxation and allowing more capital to be reinvested in operations and growth.

The "master" refers to the general partner, usually holding around 2% ownership and managing daily operations. This partner benefits from performance incentives tied to increasing cash distributions, which are largely tax-deferred through depreciation.

MLPs typically offer yields above 5%, combining attractive returns with tax efficiency and reduced volatility. Upon selling shares, investors benefit from capital gains tax treatment rather than ordinary income tax.

One consideration is that many MLPs operate pipelines across multiple states, potentially requiring investors to file state taxes in several jurisdictions. Consulting a tax advisor is recommended to understand applicable exemptions.

Comparing Limited Partnerships and MLPs

Key differences include trading status, liability, tax treatment, and income sources, with MLPs providing enhanced liquidity and tax advantages tied to natural resource income.

Why Choose an MLP?

MLPs offer the advantage of distributions that avoid double taxation, often delivering superior returns compared to traditional bonds and stocks due to their favorable tax structure.

Identifying an MLP

Companies structured as MLPs typically disclose this in their legal filings. They must generate at least 90% of income from natural resource activities like mining or oil extraction.

Distinguishing LPs from LLPs

Unlike LPs where only the general partner manages operations and bears liability, Limited Liability Partnerships (LLPs) allow all partners to participate in management while limiting their personal liability.

Final Thoughts

While limited partnerships offer benefits, investing in an MLP adds the advantage of liquidity. This flexibility allows investors to access capital quickly when needed by trading MLP units on public markets.

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