Senate Agrees to Exempt MLPs from the Wage Cap and Increases the Pass-through Deduction to 23 Percent

By Stuart E. Leblang Michael J. Kliegman, and Amy S. Elliott

The amended version¹ of the Tax Cuts and Jobs Act (TCJA) that passed 51-49 in the Senate December 2, 2017, contains a special rule that gives all master limited partnership (MLP) investors the full benefit of a now increased 23 percent deduction (it was originally 17.4 percent) without limiting it by the investor’s share of the Form W-2 wages paid out by the MLP.

• If the Senate’s pass-through deduction mechanism is agreed to by both chambers in conference, then instead of paying a rate of 38.5 percent (for those in the top income bracket), MLP unitholders will only have to pay a 29.6 percent effective rate of tax (lower for those in lower income brackets) on their share of the MLP’s income.² 
• On the other hand, if the House’s special 25 percent pass-through rate wins the day, then instead of having to pay a top rate of 39.6 percent (as the top income bracket in the House bill is subject to a higher rate of tax), passive MLP unitholders will only have to pay a 25 percent effective rate of tax on their share of an active MLP’s income.

The MLP wage cap exemption that made it into the Senate-passed bill is the same as what we wrote about in our November 30 memo, “Seeking Parity with REITs, Lawmakers Want MLPs to Get Exemption from Pass-through Deduction Wage Cap.” While we cited amendment No. 1627 ³ , it was the same as amendment No. 1715 ⁴ , which was the one reportedly included in the manager’s amendment (No. 1855) introduced by Senate Majority Leader Mitch McConnell (R- KY).  The provision adds qualified publicly traded partnership (PTP, the tax term for an MLP) income to the types of qualified business income to which the wage cap does not apply, including certain real estate investment trust (REIT) dividends and cooperative dividends.

Although it was reported ⁵  that amendment No. 1715 would have extended the 23 percent pass- through deduction for all income from PTPs (even for financial PTPs and even if the income is not otherwise qualifying under Section 7704), this is false.  The Senate bill does nothing to change the fact that investment management fees received by a PTP do not constitute qualifying income for purposes of the PTP rules and therefore would still need to be blocked. ⁶ 

^{[1] https://www.budget.senate.gov/imo/media/doc/TAX%20SUBSTITUTE.pdf}

^{[2] For purposes of this article, we will not address the impact of the 3.8 percent net investment income tax, if applicable, and the impact of the repeal of the state and local income and sales tax deduction on individuals.}

^{[3] See page 62-63 of https://www.congress.gov/crec/2017/11/29/CREC-2017-11-29-pt1-PgS7408.pdf}

^{[4] https://www.congress.gov/congressional-record/2017/11/30/senate-section/article/S7568-1}

^{[5] Keefe, Josh, Dec. 1, 2017, “Tax Bill Adds New Deduction For Blackstone CEO and GOP Donor Schwarzman,” International Business Times (http://www.ibtimes.com/political-capital/tax-bill-adds-new-deduction-blackstone-ceo-gop-donor-schwarzman- 2622738); the article was later updated to make clear that the relevant amendment was not included in the Senate-passed bill.}

^{[6] As Victor Fleischer, professor at the University of San Diego School of Law, finally concluded on his Twitter feed December 1:  “The oil and gas MLP managers and investors get a 23 [percent] deduction and will pay, at most, 29 [percent] tax rate.  [Private equity] and hedge funds still have [to] rinse their ordinary income through a Delaware blocker [corporation], as they currently do.” In addition, the Senate bill does not extend the 23 percent pass-through deduction (new tax code Section 199A) to income from financial PTPs, because “qualified items of income” that are effectively connected with a “qualified trade or business” generally would not include investment management fees.}