What are the disadvantages of using MLPs?

The Hidden Costs of MLP Investments

Master Limited Partnerships (MLPs) have long been praised for their tax efficiency, especially in the energy and infrastructure sectors. They offer attractive yields and pass through income directly to investors, avoiding the double taxation typical of traditional corporations. But beneath the surface, there are several disadvantages that can catch unprepared investors off guard.

One of the biggest drawbacks is tax complexity. While MLPs don’t pay corporate income tax, investors receive a Schedule K-1 instead of a standard 1099 form. This document details each investor’s share of the partnership’s income, deductions, and credits, and can make tax filing significantly more complicated—especially for those with multiple investments.

Another hidden burden comes from state tax obligations. Since MLPs often operate across several states, investors may be required to file state tax returns in each of those jurisdictions. This means someone living in California could end up filing tax forms in Texas, Louisiana, and North Dakota, just to report their allocated portion of MLP income. Even if the tax owed is minimal in each state, the administrative hassle and potential filing fees add up.

Furthermore, holding MLPs in retirement accounts like IRAs can trigger Unrelated Business Income Tax (UBIT), creating unexpected tax liabilities. This can erode returns and complicate tax planning for long-term investors.

While MLPs can be a powerful tool for income-focused portfolios, the benefits come with trade-offs. The tax reporting burden, multi-state filing requirements, and IRA complications mean these investments aren’t for everyone. Investors should weigh the yield against the paperwork—and possibly consult a tax advisor—before diving in.