Definition
A Master Limited Partnership (MLP) is a business that trades on a stock exchange like a normal company but is legally organized as a partnership rather than a corporation. When you buy an MLP you are not buying "shares" — you are buying units, and you become a limited partner (a part-owner) in the business.
The vast majority of MLPs operate in the energy sector, and most of those are in the midstream part of the industry: the pipelines, storage tanks, processing plants, and terminals that move oil, natural gas, and refined products from where they are produced to where they are used. This is a deliberate part of the design — U.S. tax law only lets a partnership trade publicly and keep its special tax status if roughly 90% of its income comes from qualifying sources, and natural-resource activities like pipelines are on that approved list.
The single most important feature of an MLP is that it is a pass-through entity. A regular corporation pays corporate income tax on its profits, and then shareholders pay tax again on the dividends they receive — the classic "double taxation." An MLP pays no corporate tax at all. Instead, all of its income, deductions, and credits flow straight through to the unitholders, who report their share on their own tax returns. Because that first layer of tax is gone, MLPs can distribute a large share of their cash flow to investors, which is why they are known for high distribution yields — often in the mid-to-high single digits.
MLPs typically own long-lived, fee-based infrastructure. A pipeline collects a toll for every barrel or cubic foot that passes through it, often under long-term contracts, so the cash flows tend to be steadier than the underlying commodity price. That toll-road profile is a big part of the appeal for income investors.
Why It Matters
For an income investor, MLPs are attractive for an obvious reason — the yields are high and the distributions have historically grown. But the trade-off is complexity, and it shows up mainly at tax time.
When you own an individual MLP, you do not receive the familiar Form 1099 that a brokerage sends for stocks and ETFs. Instead, the partnership sends you a Schedule K-1. A K-1 reports your allocated share of the partnership's income, deductions, and other items. It is longer, arrives later in tax season (sometimes in March, occasionally with corrections afterward), and can require filing in multiple states if the partnership operates across state lines. Owning several MLPs means several K-1s. None of this is unmanageable, but it is a real chore that many investors underestimate.
The second thing that matters is how the distributions are taxed. A large portion of an MLP's cash distribution is usually treated as return of capital rather than as taxable income. Thanks to depreciation on all that pipeline infrastructure, the partnership's reported taxable income is often much smaller than the cash it pays out. The result is a distribution that is largely tax-deferred: instead of being taxed as income the year you receive it, it lowers your cost basis in the units. You do not escape the tax forever — it generally resurfaces as a larger capital gain when you sell — but you defer it, sometimes for many years. This is the same mechanism covered in our return of capital article, just applied at partnership scale.
The third thing that matters — and the one that trips up the most investors — is retirement accounts. Because an MLP is a pass-through business, holding one inside a tax-advantaged account like an IRA can generate Unrelated Business Taxable Income (UBTI). If your IRA's total UBTI across all holdings exceeds $1,000 in a year, the IRA itself may owe tax and have to file a return — which defeats much of the point of using a tax-sheltered account. This is why raw, individual MLPs are considered awkward IRA holdings, and why a whole category of MLP funds exists to solve the problem.
Example
Say you buy 1,000 units of a midstream MLP such as EPD at $28.00 per unit, a $28,000 cost basis, and over the year it pays $1,960 in cash distributions (a 7% distribution rate). Here is roughly how the pieces fit together (illustrative numbers):
- Of that $1,960, suppose only $360 is characterized as taxable income on your
K-1 and the remaining $1,600 is return of capital.
- The $360 is reported on your return for the year.
- The $1,600 of return of capital is not taxed now. Instead it lowers your
basis: $28,000 − $1,600 = $26,400, or $26.40 per unit.
Carry that forward for several years and your basis keeps stepping down. When you eventually sell, your taxable gain is measured against that reduced basis, so the deferred amount comes back as capital gain — and a portion tied to depreciation may be taxed at higher ordinary-income "recapture" rates rather than the long-term capital-gains rate.
Now compare that with holding an MLP fund instead. The table below contrasts owning an MLP directly with owning a diversified MLP ETF like AMLP (an index fund) or MLPI (an options-overlay income fund). Numbers and treatments are illustrative and simplified:
| Feature | Individual MLP (e.g. EPD) | MLP ETF (e.g. AMLP, MLPI) |
|---|---|---|
| Tax form you receive | Schedule K-1 | Standard 1099 |
| Filing complexity | Higher; possible multi-state | Lower; like any ETF |
| IRA-friendly? | Awkward — can create UBTI | Yes — no K-1, no UBTI |
| Distribution treatment | Often heavy return of capital | Often return of capital, but simpler reporting |
| Structure drag | None (you own the asset directly) | Fund-level corporate tax on MLP-heavy ETFs |
The fund route trades one problem for another. It removes the K-1 and UBTI headaches, but it adds a structural cost that individual ownership does not have — covered in Common Mistakes below.
The Fund Workaround: MLP ETFs and ETNs
Because so many investors want MLP income without the K-1 and UBTI baggage, issuers created wrapped products. There are two main types, and the difference matters.
An MLP ETF such as AMLP holds a basket of MLPs directly. It issues a single 1099 to you and shields you from UBTI, so it can sit comfortably in an IRA. But there is a catch: because a fund holding more than 25% of its assets in MLPs cannot itself qualify as a pass-through regulated investment company, these ETFs are structured as C-corporations and pay corporate tax at the fund level on their gains. That built-in tax can create a meaningful drag on total return over time, especially in strong-up markets — the fund's net asset value grows more slowly than the underlying index because a deferred tax liability accrues inside the fund.
A newer variation is the option-income MLP ETF, such as MLPI, the NEOS MLP High Income ETF. Like AMLP it is a true ETF — you get a standard 1099, no K-1, and no UBTI — but instead of simply tracking an index it layers an options overlay on its MLP exposure to target high monthly income. That extra distribution comes with the usual option-income trade-offs: capped upside in strong markets and a payout that can include option premium and return of capital rather than pure pass-through income.
A third structure exists too: some MLP products are exchange-traded notes (ETNs) — not funds at all, but unsecured debt notes issued by a bank that promise to pay the return of an MLP index. Because an ETN holds no MLPs directly, it sidesteps both the K-1 and the fund-level corporate tax, so it can track its index more tightly. The trade-off is credit risk: if the issuing bank fails, the note can become worthless regardless of how the underlying MLPs perform. ETNs also have their own distribution and tax quirks — check the structure before assuming any "MLP fund" is actually a fund.
Rule of thumb: individual MLPs give you the purest exposure and the biggest tax-deferral benefit, but a K-1 and IRA complications. MLP ETFs and ETNs hand you a clean 1099 and IRA-friendliness in exchange for a structural cost — corporate-tax drag (ETF) or issuer credit risk (ETN).
Common Mistakes
- Assuming an MLP is a stock. It is a partnership. That single fact drives the
K-1, the UBTI issue, and the return-of-capital tax treatment. Treating a unit like a share sets you up for tax-time surprises.
- Buying a raw MLP inside an IRA without thinking about UBTI. A large MLP
position in a tax-sheltered account can generate UBTI above the $1,000 threshold and force the IRA to file and pay tax — quietly eroding the tax shelter you were trying to use.
- Confusing an MLP ETF's yield with the underlying MLPs' yield. The
fund-level corporate tax in an ETF like AMLP means its long-run total return can lag the index it tracks. The headline distribution rate doesn't capture that drag.
- Ignoring ETN credit risk. An ETN's tight index tracking looks like a free
lunch until you remember you are holding the unsecured IOU of a bank, not a pool of real pipelines.
- Expecting qualified-dividend tax rates. MLP distributions are not
qualified dividends. They are a mix of return of capital and pass-through income with their own rules — do not assume the preferential dividend rate applies.
- Underestimating the paperwork. Several individual MLPs mean several K-1s,
sometimes arriving late or with corrections, and potentially state filings. Many investors move to a fund purely to escape this.
FAQ
What is a Master Limited Partnership (MLP)?
An MLP is a business that trades on a public exchange but is legally a partnership rather than a corporation. Investors buy "units" and become limited partners. Most MLPs are energy-infrastructure companies — especially midstream operators that own pipelines, storage, and processing assets. Because a partnership pays no corporate income tax, MLPs can pass most of their cash flow through to unitholders, which is why they are known for high distributions.
Are MLP distributions taxed?
Usually only partly, and often not right away. A large share of a typical MLP distribution is characterized as return of capital, which is not taxed the year you receive it — instead it lowers your cost basis and defers the tax until you sell. The remaining portion flows through as taxable income on your K-1. When you eventually sell, the deferred amount generally comes back as a gain, part of which may face higher "recapture" rates. This is educational information, not tax advice — confirm your own situation with a qualified tax professional.
Can I hold MLPs in an IRA?
You can, but individual MLPs are generally awkward inside an IRA. Because an MLP is a pass-through business, it can generate Unrelated Business Taxable Income (UBTI). If your IRA's total UBTI tops $1,000 in a year, the IRA itself may owe tax and have to file a return — undercutting the tax shelter. Many investors who want MLP exposure in a retirement account use an MLP ETF instead, which issues a 1099 and does not pass UBTI through to you.
What is a K-1 and why do MLPs use one?
A Schedule K-1 is the tax form a partnership sends to its partners, reporting each partner's share of income, deductions, and other items. Because an MLP is a partnership rather than a corporation, it issues a K-1 instead of the Form 1099 you get from stocks and ETFs. K-1s tend to arrive later in tax season, can be more complex, and may require filing in multiple states if the MLP operates across state lines.
What is the difference between an MLP ETF and an MLP ETN?
An MLP ETF (like AMLP, or the options-overlay income fund MLPI) actually holds MLP exposure and issues you a 1099. A fund that keeps more than 25% of its assets in MLPs is taxed as a C-corporation, so a fund-level corporate tax can drag on returns. An MLP ETN is an unsecured debt note from a bank that promises an MLP index's return; it tracks the index more closely and avoids the fund-level tax, but carries the credit risk of the issuing bank.
Are MLP distributions qualified dividends?
No. MLP distributions are not qualified dividends and do not receive the preferential qualified-dividend tax rate. They are a mix of tax-deferred return of capital and pass-through partnership income, each with its own treatment reported on your K-1. If qualified-dividend tax treatment is important to you, compare how MLPs stack up against other income sources — see our qualified dividends article — and confirm specifics with a tax professional.