Publicly Traded Partnership

A publicly traded partnership, also known as a PTP, is a type of limited partnership that is managed by two or more partners (individuals, other partnerships, or corporations) and traded consistently on an established securities market. It is funded by limited partners who bring capital but have no management responsibilities.

Further Defining a Publicly Traded Partnership – PTP

As per the U.S. Code, a publicly traded partnership can only participate in certain types of business activities. Examples are businesses concerning natural resources, such as petroleum, and transportation. According to Internal Revenue Code §7704(b), a partnership is publicly traded if the partnership’s interests are publicly traded on an established securities market or available for trade on a secondary market or its equivalent. Once the partnership is active, the partners need not pay state or federal levels of statutory corporate income tax.

Often, PTPs are either:

  • Master limited partnerships (MLPs), or
  • Limited liability companies (LLCs) that have elected to be taxed as a PTP

A master limited partnership is:

  • A limited partnership with a two-level structure
    • One tier of 1+ partners who manage the partnership
    • Second tier of a partnership owned at least partially by the traded partnership that operates the company and owns its assets

An LLC is:

  • A business entity with limited liability like a corporation but chooses whether to be taxed as a partnership or corporation
    • Has members rather than shareholders, unlike a corporation
    • All members can be managers, or there can be one manager only

Background

IRC Section 7704 is the main law defining PTPs and how to tax them. This section dates back to 1987. According to this section, publicly traded partnerships that receive at least 90 percent of their income from qualifying sources will not pay entity level tax and will follow a pass-through method to members for tax items. Thus, they keep their partnership tax treatment if they meet this 90 percent threshold.

If the publicly traded partnership does not meet this qualification, then it will be taxed as a corporation. This means paying corporate tax, and that partnership distributions are seen by the IRS as dividends subject to tax.

Partnership Interests will not be Considered to be Publicly Traded Under §7704(b) in the Following Circumstances:

  • This partnership isn’t actively participating in trading or recognizing the transfers that result
  • Trading isn’t a part of private transfers
    • Instead, there are transfers as per a qualifying agreement (redemption or repurchase)
  • Transfers occur through qualified matching services (digital or printed listing system that lists bid or asks for quotes to match sellers and buyers)
  • Partnership interest are doled out in a private placement, and there are under 100 partners
  • No trading occurs
    • Transfers are for less than 2% of partnership interests per year
    • Doesn’t include private transfers and transfers from qualifying agreements (redemption or repurchase) or qualified matching services

The Pros of Investing in Publicly Traded Partnerships

Firstly, a publicly traded partnership can steer clear of paying corporate-level taxes by meeting specific requirements. To qualify for a PTP statusthe partnership must make at least 90% of its income from qualifying sources, as per the United States IRS. Qualifiers include dividends, royalties, or interest.

Another benefit is that the partnership income is only subject to tax once, at the investor level. The publicly traded partnership provides the investor a Schedule K-1 yearly that shows their share of income, gains, losses, deductions, and credits. The investor then pays tax on the PTP-generated income at their tax rate. This is less than for publicly traded corporations, which are taxed twice; once for profits at the corporate level and again for dividends at the shareholder level.

Also, an investment in a publicly traded partnership is as fluid as ownership of a publicly traded stock. When an investor purchases units in a PTP then this person becomes a limited partner. Rather than being called shares, they are called units in a PTP. When selling PTP units, the partner’s taxable gain is the difference between the sale price the partners paid and the partner’s adjusted basis.

The Cons of Investing in Publicly Traded Partnerships

A downside is stress over Sales of PTP units. A few examples are:

  • Investors must track the basis for their publicly traded partnership investments
    • When the PTP units are sold, the investor will get two different documents; a Schedule K-1 and an end-of-year tax brokerage statement. The statement must be paid by the end of February while the tax deadline for PTPs is April 15
  • PTP filings can be extended to September 15 (extra five months)
    • Thus, the Schedule K-1 doesn’t come for another six months after that, and then there are issues with incorrecttax estimates and projections, investors might file their returns late, and there are possible penalties or interest accrued
  • Complex tax projections when there are several brokers
    • Partial sales of interests during the year can complicate the partner’s CPA when crafting tax projections
    • Base adjustments must be made to properly determine gain
    • Accounting fees increase because of tracking and reporting activities
  • Not enough diversification
    • Often PTPs invest in other PTPs, which means a reoccurrence of similar investments into oil, gas, etc.
    • This is a turn-off for investors looking for diversified investments
  • Allocated losses have minimal use for the unit holder
    • If a certain PTP has a loss, that loss can only offset earnings in the future from that same publicly traded partnership
    • This is unlike non-PTP passive actions, in which allocated losses can go toward offsetting earnings for other passive actions

Exception Not to Apply to Certain Partnerships Which Could Qualify as Regulated Investment Companies

Subsection (c) of U.S. Code Section 7704 does not apply to any partnership described in 851(a) if it is a domestic corporation. The exception though is if you are in a partnership that makes the buying and selling of commodities (aside from those in Section 1221(a)(1)), commodity options, futures, or forwards a main activity.

Qualifying Income for Purposes in This Section

Under U.S. IRS Code Section 7704, qualifying income means:

  • Interest
  • Gains from sale
  • Dividends
  • Real property rents
  • Other real property disposition
    • Such as property outlined in Section 1221(a)(1)
  • Income and gains from the following:
    • Mining, exploration, development, refining, transportation or marketing of natural or mineral source, fuel transportation or storage (as defined in Section 6426 Subsection (b), (c), (d) or (e)),industrial source CO2, or biodiesel fuel (as defined in Section 40A(d)(1))
    • Mineral or natural resource means any item with which a deduction for depletion is grantable under Section 611, but it cannot include any item outlined in Section 613(b)(7)’s subparagraph (A) or (B)
  • Gains from the sale or disposition of a capital asset or property defined in Section 1231(b) that was being held to produce income described in the above bullet points
  • Commodity income and gains, or futures, options, and forwards from commodities, provided the partnership meets the definition in the Section (c)(3)’s second sentence

Certain Interest Not Qualified

Interest will not be seen as qualifying income if (1) this interest comes from financial or insurance business, or if (2) this interest is excluded from the “interest” described in Section 856(f).

Real Property Rent

Real property rent refers to amounts that would meet the requirements as real rent, as per Section 856(d), if:

  • This section were applied without considering paragraph (2)(c), regarding guidelines for independent contractors, and
  • Stock owned by or for a partner wouldn’t be thought of by the partnership as owned under Section 318(a)(3)(A) unless at least 5% of the value of the interests in this partnership are owned by and for this partner (direct or indirect ownership)

Certain Income Qualifying Under Regulated Investment Company or Real Estate Trust Provisions

Qualifying income also refers to any income that would qualify under Section 851 (b)(2)(A) or 856(c)(2).

Special Rule for Determining Gross Income from Certain Real Property Sales

If your real property, which meets the definition of 1221(a)(1), sells or another disposition occurs, the gross income will not be reduced by inventory costs.

Inadvertent Terminations

  • Gross income rules defined in Section 7704 Subsection (c)(2) are not met by the partnership
  • The Secretary of State finds that this failure was inadvertent
  • Within a reasonable time of finding this failure, steps were made to ensure the partnership meets gross income regulations, and
  • The partnership agrees to make these changes, including adjustments to partners, or to pay the relevant sums, if required by the Secretary of State, with regard to this time, then each entity will be seen as continuing to meet the gross income requirements for the specific period

Effect of Becoming Corporation

Right from its first day, a partnership receives treatment as a corporation, as per Subsection (f) of Section 7704. This means that a partnership is treated as transferring all assets to a freshly created corporation in return for corporation stock and giving out this stock to the partners in liquidation of their partnership interests.

Exception for Electing 1987 Partnerships

As per § 7704(g) of the Internal Revenue Code, an electing 1987 partnership is an exception to Subsection(a), which applies to a PTP being treated as a corporation. This (g) Subsection, therefore provides grandfathered publicly traded partnerships to remain exempt from Section 7704. The term “partnership” is defined by Section 10211(c)(2) of the 1987 Revenue Reconciliation Act.

But this only applies if Subsection (a) was not applied to this partnership for all of its previous taxable years, starting post-December 31, 1987, and before January 1, 1998. The partnership must also elect the application of this (g) Subsection and consent to applying the tax required with paragraph (3) for its first taxable years (starting post-December 31, 1987). For a partnership choosing treatment as a 1987 partnership, it will stop being treated as such when there is a new line of business for this partnership, and this treatment will stop on the first day after December 31, 1997, that the new line commences.

Additional Tax on Electing Partnerships

Under Part III of U.S. IRS Code Section 7704, an electing partnership must pay every taxable year a 3.5% tax on the gross income from all active trades and business that the partnership conducts. The partnership cannot deduct this tax. As per§ 705(a)(2)(B), a partner in an electing partnership must lower the adjusted basis of their partnership interest by a fair share of the 3.5% tax that the partnership pays.

Election

Part IV of Section 7704 of the Internal Revenue Service Code governs elections. An election and consent under this part of the section will apply to the taxable years that it’s done for and will apply to all taxable years from then on, unless the partnership revokes this. If a revocation is made without the Secretary of State’s consent then it cannot be reinstated.

Schedule K-1 – 1065 Publicly Traded Partnership

As per Schedule K-1, the passive activity limits apply separately for things from every PTP, except credits for low-income housing and rehabilitation. Also, a publicly traded partnership’s net passive loss cannot be deducted from other passive income. Instead, a passive loss for the PTP is suspended and goes forward to apply against passive income from this PTP in forthcoming years.

If the income of a partner from the PTP is totally disposed of, then the full unused losses are allowable in the year it is disposedof. A PTP’s passive income is not reported on Form 8582, nor are losses or gains. The following rules are useful for determining what to report on the form or schedule from your partnership’s income, gains, and losses on passive activities during the tax year on the owned PTP.

Begin by tallying up the present year’s income, losses, and gains, and any previous year’s unallowed losses to determine if the partner has a total gain or loss from the publicly traded partnership. Provide only the same type of income and losses the partner could include in the net income or loss from non-PTP passive activities.

If the partnerhas a gain overall:

  • The net gain part is considered nonpassive income
    • Calculate the net gain by subtracting total losses from the total gain
    • Report the net gain amount on form or schedule as nonpassive income; report the rest of the income as passive income; report total losses as passive loss
  • Declaring non-passive income is important because:
    • This amount is included in the modified adjusted gross income used to determine Form 8582’s special allowance (for actively participating in non-PTP rental estate actions)
    • It is part of your investment income when determining deductions for investment interest expenses on Form 4952

If you find an overall loss as a partner:

  • The losses are allowable, with the max dependent on the income amount
    • The excess loss carries forward to a future year when you have income to offset it
    • This only applies if you did not give your full interest from the PTP to an outside person in a fully taxed deal during that tax year
    • Report it as a passive loss on the same schedule or form you regularly use
  • If, however, you gave your PTP full interest to an outside person in a completely taxable deal during that tax year then your losses related to the activity for the year are not restricted to passive loss rules
    • In this case, report the income and losses on the normal forms and schedules; you can include the previous year’s disallowed losses too

Form 1065

This particular form is a tax document for reporting profits, deductions, and losses for partnerships. As per the Internal Revenue Service, a partnership contains at least two people who participate in a business or trade together. Each of these people offers something toward the partnership, whether it be assets, money, or skills, and the partners expect to get a profit or loss as a result.

Your partnership must submit Form 1065 (as much all LLCs) and also Schedule K-1 for each partner in it. The Schedule shows the profit percentage for each partner at the start of the reporting period and also at its end. For a non-profit religious organization, Form 1065 must be filed; you must declare income and losses on it.This form contains a lot of information about annual finances for a partnership. It contains expenses and deductions. Common expenses are employee salaries, rent, interest on business loans, and outstanding debts.

Completing the form involves using details from Form 4562, Form 1125-A, and Form 4797, as well as copies of any 1099s that the partnership issues. The filing process may also involve the following forms: 8893 (Election of Partnership Level Tax Treatment), 3520 (Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts), and Form 8918 (Material Advisor Disclosure Statement), 114 (Report of Foreign Bank and Financial Accounts Disclosure Statement).For a farming partnership, you may also require Form 1040.

Income Tax

A look at the 1065 form though will only tell you about the financial picture of the partnership. As Form 1065 does not show the amount of tax owed by a partnership, partners must also declare their share of the income of the partnership on their individual tax returns. The partners are required to pay this income tax.

Articles of Partnership

This is:

  • A formal agreement in document form between parties wanting to enter a business agreement to combine resources and labor
    • In which all owners have the equivalent responsibility for the business liabilities
    • Are allowed business assets as per the previously-approved percentages
  • Legally binding
  • Helps avoid and solve discrepancies between partners by clarifying the terms of partnership
  • Typically include:
    • Partnership’s name
    • Company purpose
    • Physical location
    • Partnership’s term
    • Original capital contribution by each partner
    • Percentage of interest for each partner
    • How to distribute profits
    • How to distribute salaries, if relevant
    • How/when partnership rights are transferable or for sale
    • Other details of the business procedure

Schedule K-1

This tax document is useful for reporting the partnership’s profits, dividends, and losses. Each partner receives a Schedule K-1 and includes it in their individual tax returns. For an S corporation, report the transactions via the1120S, unlike for a PTP that reports these activities on Form 1065. When not filing a personal tax return, the financial details are on each partner’s Schedule K-1 go to the IRS with Form 1065. Partnership-generated income is part of a partner’s other income sources that are reported on Form 1040.

Basic Calculation

A requirement of Schedule K-1 is that the partnership must track each partner’s investment in the business entity, which is called the basis. What makes the basis for a partner go up are capital contributions and the partner’s share of the income share. The basis decreases with partner’s withdrawals and the partner’s share of any losses.

Pay attention to basis calculation as it must be declared on Schedule K-1, within the part on the capital account analysis of the partner. When the basis balance is zero, any extra payments that the partners receives are taxed as regular income.

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