What it means
A normal partnership is not taxed itself; its profits pass through to the partners, who pay tax on their own share. A publicly traded partnership works the same way, except that the partners are investors who buy and sell units on an exchange.
Tax law in the United States limits who may enjoy that treatment. A partnership whose units are publicly traded is generally taxed as a corporation unless at least 90% of its gross income is qualifying income, which includes items such as interest, dividends and income from natural resource activities.
Investors in these structures normally receive a form showing their share of income, deductions and credits, rather than the usual dividend statement. That can make tax filing more complex, and it can create obligations in more than one state.
Companies choose the structure because it avoids tax at the entity level, which allows more cash to be paid out to unit holders. The trade-off is complexity, a narrower group of eligible investors and a need to keep income within the qualifying categories.
Some pension funds and tax-exempt investors avoid these units because the income can create unwanted tax reporting. The nuance is that PTP can mean other things in other contexts, such as pay to play or peak to peak.
In finance and tax discussions, though, it normally means the partnership structure. Liquidity is a further difference from private partnerships.
Units can be sold on the exchange at any time, so investors do not have to wait for the partnership to wind up, although the price can fall as well as rise.
In practice
Real-world examples.
Example
A pipeline operator organised as a PTP pays most of its cash flow to unit holders each quarter. Because the entity pays no corporate income tax, the investors report their share of income on their personal returns.
Example
A tax adviser reviews a fund's holdings and finds two PTPs. She warns the client that the paperwork will arrive later than usual and may include income reported in several states.
Example
A finance director of an energy company considers converting a subsidiary into a PTP. The model shows higher payouts but also the risk that a change in business mix could push qualifying income below 90%. The director asks tax counsel for a written view before the board votes.
Formula
Calculation
Qualifying income ratio = qualifying income / gross income, which must be at least 90%
Suppose a pipeline partnership has gross income of $20,000,000, of which $18,600,000 comes from transporting natural resources and interest. The ratio is 18,600,000 / 20,000,000 = 0.93, or 93%. That is above the 90% test, so the partnership keeps its pass-through treatment. If qualifying income fell to $17,000,000, the ratio would be 17,000,000 / 20,000,000 = 85%, which would fail the test.Case study
Seen in the real world.
Ridgeline Midstream Partners is an illustrative, fictional company that moves natural gas through pipelines under long-term contracts. It is organised as a publicly traded partnership, and its units trade on a stock exchange.
When the company began to earn income from a new equipment leasing business, the finance director calculated the effect on the qualifying income ratio. The estimate showed that leasing income would be about a tenth of total revenue within two years. The new activity would have lowered qualifying income close to the 90% line.
The board decided to hold the leasing business in a separate corporate subsidiary so the main partnership stayed within the test. The finance team now measures the ratio every quarter, with an early warning if it drops below 93%. The illustrative lesson is that the structure delivers tax benefits only while the income stays in the right categories.
Watch out
Common mistakes.
- Treating PTP units like ordinary shares for tax purposes, when investors receive a partnership tax form and must report their share of income.
- Assuming the structure is available to any business, when the 90% qualifying income test limits it to certain activities.
- Ignoring the possibility of state tax filings, which can arise in each state where the partnership operates.
Questions
People also ask.
What is the difference between a PTP and a master limited partnership?
A master limited partnership is the common name for a PTP, and the two terms are often used interchangeably.
Why do PTPs pay high distributions?
They avoid tax at the entity level and so can pay out a large share of cash flow, although payouts are not guaranteed. The level of payout depends on the partnership's earnings and its agreement with unit holders.
What happens if a PTP fails the income test?
It is generally taxed as a corporation, which removes the pass-through benefit. Unit holders may then face a lower payout because the entity must set aside money for tax.
From the founder's library
Take it further with the book.
Build your financial confidence beyond this definition. Shihan's full-length guide, Accounting Fundamentals, takes the same plain-English approach and turns it into a complete, practical playbook for non-finance managers, business owners and students - with chapter-end quiz answers and presentation slides included.
25% off with code MMHQ25, applied at checkout. Priced in USD - checkout may show the equivalent in your local currency.
View the book and save 25%Related