Section 7704 of the Internal Revenue Code (I.R.C.), enacted in 1987, is the key law defining publicly traded partnerships and their tax treatment. The essence of section 7704 is simple: publicly traded partnerships which derive at least 90% of their income from qualifying sources will retain partnership tax treatment—i.e., they will pay no entity level tax and all tax items will flow through to the partners. All other partnerships which are publicly traded will taxed as corporations, paying a corporate tax, with partnership distributions treated as taxable dividends.
What is a Publicly Traded Partnership?
- A publicly traded partnership (PTP) is a partnership, usually a “master limited partnership,” or a limited liability company that has chosen to be taxed as a partnership, which is publicly traded.
- A master limited partnership (MLP) is a limited partnership which is part of a two-tier structure. A limited partnership has one or more general partners (they may be individuals, corporations, or other partnerships) which manage the partnership, and limited partners, which provide capital to the partnership but have no role in its management. The second tier is the operating partnership, a partnership owned entirely or almost entirely by the traded partnership which actually operates the business and owns its assets.
- A limited liability company (LLC) is an entity offering the limited liability of a corporation, but with the choice of whether to be taxed as a corporation or partnership. There are no shareholders. The owners are called “members.” All members may be managers, or one or more members may be designated managers by written agreement.
- Under I.R.C. §7704(b), a partnership is publicly traded if interests in the partnership are:
- Partnership interests will not be considered to be publicly traded under §7704(b) in the following circumstances:
- The partnership does not either actively participate in trading or recognize the resulting transfers.
- Private transfers not involving trading. This includes transfers under a qualifying redemption or repurchase agreement.
- Transfers through qualified matching services—a computerized or printed listing system listing bid and/or ask quotes in order to match sellers with buyers.
- All interests in the partnership were issued in a private placement and the partnership has no more than 100 partners.
- There is not actual trading—i.e., no more than 2% of partnership interests are transferred each year (not counting private transfers and transfers through qualifying redemption and repurchase agreements or through matching services).
Additional detail is provided in Treasury regulations, 26 CFR §7704-1.