Various types of limited partnership structures are becoming increasingly popular in the US economy. Such entities are obliged to distribute most of their earnings, which has a number of implications for the sustainability of the firm and the economy.
The author observes that most newly created entities are structured as limited partnerships and have to distribute most of their earnings to benefit from the tax-advantaged status. A high payout rate comes with a number of risks related to the partnership structure (e.g., less transparency and protection for shareholders).
How Is This Research Useful to Practitioners?
Such relatively new company structures as master limited partnerships (MLPs) in the energy industry and business development companies (BDCs) have become popular in the US economy. These structures enjoy favorable tax treatment, which allows them to not pay corporate or federal tax but which is dependent on their passing through most earnings. Therefore, in contrast to a typical corporation, where retained earnings can be used to fund investment and growth, companies using these limited partnerships—sometimes called “distorporations”—must constantly acquire new capital to ensure their endurance.
The limited partnership structure seems to be an attractive investment vehicle because the average payout rate is two to three times greater than the dividend yield and because the tax benefits for unitholders allow them to avoid paying income tax. But such partnerships offer little transparency and protection for investors because few regulatory or shareholder rights apply.
The author questions whether IRS treatment that favors pass-through partnerships over standard corporations is beneficial for the long-term sustainability, productivity, and innovation of the US economy.
Clever limited partnership structures seem more effective and profitable than the standard corporation structure, which is burdened with the additional costs of taxes, regulatory requirements, and shareholder protection. But it is important to note that investors (i.e., limited partners) bear potentially large unsystematic risk and have little influence or control over the partnership.
Furthermore, if the policymakers attempt to regulate such legal structures and effectively close the tax loopholes that favor partnerships, the valuation of such structures may fall dramatically.