The Pros and Cons of Investing in Publicly Traded Partnerships

In recent years, Bartlett, Pringle & Wolf, LLP has seen an influx of clients who are investing in publicly traded partnerships (PTP). What are publicly traded partnerships? PTPs are business organizations that have two or more co-owners and are also traded on a public securities market such as the NYSE or NASDAQ. These co-owners can be individuals, other partnerships or corporations.

A share in a PTP is referred to as a unit and the shareholders are referred to as unit holders. When an investor decides to buy units in a PTP, he or she becomes a limited partner. A majority of PTPs engage in oil, gas and other energy-related businesses. Although investing in a PTP can seem very attractive due to its tax benefits, it can also create headaches due to reporting complexities and the uncertainty of future earnings. In this article, we will discuss some of the pros and cons of investing in PTPs.

Pros
By meeting certain qualifications, a PTP can avoid corporate tax treatment. To qualify as a PTP and avoid corporate taxation, 90% or more of the PTP’s gross income must consist of qualifying income. Examples of qualifying income include interest, dividends or royalties.

One of the largest advantages of investing in a PTP is that the partnership’s income is subject to only one level of tax, at the investor level. The investor will receive a Schedule K-1 annually from the PTP allocating the investor’s share of income, gains, deductions, losses and credits. At this point, the investor will then pay tax on the income received from the PTP at their tax rate. This is much more advantageous than investing in a publicly traded corporation, which is taxed at two different levels. Publicly traded corporations are taxed at the corporate level on profits and then once again at the shareholder level once dividends are distributed.

Another advantage of investing in a PTP is the liquidity of owning a publicly traded stock. When you sell your PTP units, your taxable gain is the difference between the sales price you paid and your adjusted basis. Cash distributions decrease basis and are commonly disbursed quarterly. Under the United States tax code, cash distributions are a return of capital and not taxed when received. If adjusted basis reaches zero, future cash distributions will be taxed as capital gains in the year received.

These pros can make investing into a PTP seem very desirable; however, you should also consider other factors before taking the plunge.

Cons
Headaches can occur upon the sale of PTP units. As stated earlier, your adjusted basis comes into play when your PTP units are sold. An investor’s initial basis is the price paid for the units and is then adjusted by the investor’s share of income and deductions received. If PTP units are sold at a gain, there is a division between taxing the gain at the preferential capital gain rate and the ordinary income rate. For these reasons, it is extremely important for investors to accurately track basis in their PTP investments. It should be noted that investment brokers rarely track shareholder basis for PTP investments, but an adjusted basis will be shown on the Schedule K-1 when all or some of the units are sold.

An investor will receive two different types of documents upon the sale of PTP units: a year-end tax brokerage statement as well as a Schedule K-1. However, it is important to note that these two documents are provided at different times of the year creating difficulties with tax planning, reporting and timely filing. Brokerage statements are due by the end of February, while PTPs have a tax deadline of April 15. Additionally, PTPs have the option to extend their filing deadline by five months to September 15. This can result in investors receiving their Schedule K-1s approximately six months after their brokerage statements! This may lead to problems such as inaccurate tax projections and tax estimates, possible late filing of investor’s returns, as well as potential interest and penalties.

Investors who purchase an array of PTPs can encounter a nightmare when it comes time to filing their tax returns. The PTPs are often held by different brokers and can have partial sales of interests throughout the year. This can create complexity for your CPA when they are preparing tax projections for you, as basis adjustments are necessary to correctly determine gain. This will result in higher accounting fees related to these tracking and reporting requirements.

Lack of diversification can be another problem with PTPs. Investors who are looking to purchase an interest in a PTP should know that PTPs often times invest in other PTPs. This can lead to a reoccurrence of investments into oil, gas and other energy-related businesses. This allocation may deter investors who are looking for a more diversified investment.

An important tax implication to note regarding PTPs is the availability to use the losses allocated to the unit holder. When a particular PTP incurs a loss, that loss can only offset future earnings from that same PTP. This is very different from interests in regular, non-PTP passive activities where allocated losses can be used to offset earnings for any other passive activity. This is one of the more significant current year tax issues. These losses can only be realized upon either income recognition from the PTP or complete disposition of the PTP units.

Conclusion
At first glance, investing in publicly traded partnerships seems like a worthwhile move as the returns on the stock exchange can appear very attractive. However, we can see that these investments lead to complications with tax reporting and can result in increased tax compliance costs. BPW recommends that you carefully consider the compliance costs associated with the PTP investment in balance with the investment potential and consult with your tax advisor before buying PTP units.

If you have any additional questions or concerns regarding publicly traded partnerships, please feel free to contact your BPW advisor at (805) 963-7811.