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Legislation Expands the Definition of MLP Qualifying Income

Energy Law Update

October 13, 2008

Qualifying Income Now Includes Income from the Transportation or Storage of Certain Renewable and Alternative Fuels and Activities Related to Industrial Source Carbon Dioxide.

On October 3, 2008, the President signed into law the Energy Improvement and Extension Act of 2008 (the "Act").  The Act expands the definition of qualifying income found in Section 7704(d) of the Internal Revenue Code (the "Code") to include the transportation or storage of certain renewable and alternative fuels and activities involving industrial source carbon dioxide.

Under the general rule of Code Section 7704(a), publicly traded partnerships (commonly referred to as "master limited partnerships" or "MLPs") are treated as corporations for federal income tax purposes.  However, if at least 90% of an MLP's gross income for each taxable year consists of "qualifying income," the MLP will be treated as a partnership for federal income tax purposes.

The definition of qualifying income generally includes interest (other than interest derived from a financial or insurance business), dividends, real property rents, gain from the sale of real property, income and gains from natural resource and mineral activities, and gain from the sale of assets held for the production of qualifying income.  Prior to the Act, the statutory definition of qualifying income had not been expanded since Code Section 7704 was enacted in 1987.

The portion of the qualifying income definition related to natural resource and mineral activities, contained in Code Section 7704(d)(1)(E), is of particular importance to the many energy MLPs that exist today.  In that regard, the Act amended Code Section 7704(d)(1)(E) so that qualifying income now includes the following: 

income and gains derived from the exploration, development, mining or production, processing, refining, transportation (including pipelines transporting gas, oil, or products thereof), or the marketing of any mineral or natural resource (including fertilizer, geothermal energy, and timber), industrial source carbon dioxide, or the transportation or storage of any fuel described in subsection (b), (c), (d), or (e) of section 6426, or any alcohol fuel defined in section 6426(b)(4)(A) or any biodiesel fuel as defined in section 40A(d)(1)

The fuels described in the Code Sections referenced in amended Code Section 7704(d)(1)(E) include the following:

  • alcohol fuel mixtures and biodiesel mixtures (Code Sections 6426(b) and 6426(c));
  • alternative fuels, including liquefied petroleum gas, P Series Fuels, compressed or liquefied natural gas, liquefied hydrogen, liquid fuel derived from coal through the Fischer-Tropsch process, and liquid fuel derived from biomass (Code Section 6426(d));
  • alternative fuel mixtures (Code Section 6426(e)); 
  • alcohol, including methanol and ethanol, but not including alcohol produced from petroleum, natural gas, or coal, or having a proof of less than 190, (Code Section 6426(b)(4)(A)); and 
  • biodiesel (Code Section 40A(d)(1)).

The amendment to Code Section 7704(d)(1)(E), which became effective on October 3, 2008, represents an important expansion of the types of activities that generate qualifying income and should stimulate investment by MLPs in various infrastructure projects, including carbon dioxide and ethanol pipelines.