MLPs are limited partnerships (LP) that trade on the major exchanges just like any stock. Most of the MLPs we follow trade on the New York Stock Exchange NYSE); MLPs can be purchased easily through any discount or full-service broker at the same commissions you'd pay to buy any stock.

To qualify for MLP status, a partnership must receive at least 90 percent of its income from what the IRS calls "qualifying" sources; these include all sorts of activities related to the production, processing or transportation of natural resources like oil, natural gas and coal.

MLPs consist of two basic entities: LPs and a general partner (GP). But LPs don't actively manage or control the assets of the partnership. The actual day-to-day management of an MLP is a task performed by the GP.

However, some firms are structured as limited liability companies (LLC). These firms offer the same basic tax and yield advantages as MLPs; however, LLCs do not have a separate GP and LP but are run more like normal corporations.

MLPs raise capital by issuing units - the equivalent of shares in a common stock. When you buy an MLP, you're known as an LP unitholder. LP unitholders are entitled to cash distributions that come from the basic operation of the partnership business - basically, the cash flows received from running the business. But LPs don't actively manage or control the assets of the partnership.

The higher the quarterly distributions paid to LP unitholders (investors in the MLP), the higher the management fee paid to the GP. Also, relatively new, "young" MLPs pay little or no incentive distribution to GPs. But as cash flows and distributions rise over time, incentive distributions to GPs will rise as well. The structure of incentive distributions can make a big difference for unitholders

GPs typically are compensated for their services in two ways. First,most GPs also own LP units and receive cash flows just like any other unitholder. Second, GPs earn what's known as an incentive distribution - a sort of management fee that escalates based on a pre-set performance formula. Incentive distributions are typically based on the quarterly distribution paid to LP unitholders. The exact formula differs from MLP to MLP.

In most cases, MLPs should be held for long periods to get the full benefit of distributions. You're likely to be deferring 80 to 90 percent of your taxes for several years or perhaps indefinitely - a tremendous benefit for most investors.

Master limited partnerships (MLP) offer investors a simple value proposition: double-digit, tax-advantaged yields and strong recession-resistant growth potential.

The industry benchmark Alerian MLP Index compares favorably to the yields available on government bonds, BBB-rated corporate bonds, real estate investment trusts (REIT) and utilities. Of the companies in the Alerian MLP Index, 40% offer yields in the double-digits.

MLPs offer capital gains potential as well as allow investors to defer much of their personal income tax liability for years into the future or, in many cases, indefinitely.

Unlike regular corporations, MLPs don't pay any corporate-level tax. Instead, these partnerships pass through the majority of their income to investors in the form of regular quarterly distributions. Each investor is responsible for paying tax on their share of distributions received.

There are some big tax benefits to owning MLPs. Because of depreciation allowance, 80 to 90 percent of the distribution you receive from a typical MLP is considered a return of capital by the IRS. You don't pay taxes immediately on this portion of the distribution.

Instead, return of capital payments serve to reduce your cost basis in the MLP. You're not taxed on the return of capital until you sell the units. In other words, 80 to 90 percent of the distribution you receive from the MLP is tax-deferred. The remaining piece of each distribution is taxed at normal income tax rates, not the special dividend tax rate. But the piece taxed at full income tax rates is only 10 to 20 percent of the total distribution; there's still a huge deferred tax shield for unitholders.

This is simply a tax term; it doesn't mean that the partnership is literally giving you back your investment. Recall that MLPs are pass-through entities: For tax purposes only, it's as though unitholders generated the partnership's earnings for themselves. Net income generated by the MLP is allocated proportionally among individual investors. In addition to income MLPs are also able to pass-through other deductions and tax credits such as depreciation. It is these passed-through tax credits that generate tax-deferred return of capital.

That's actually only partially true. When you own an MLP you are considered to be earning income in every state in which that MLP operates. However, in most cases unless you own a large position in the MLP it's likely you will not have to file a return in every state or pay any state taxes outside your home state.

Many key States in which MLPs operate don't have State income taxes at all. Examples include Texas and Wyoming, both States where MLPs are extremely active. Most others have minimum income limits; unless you have income from the MLP above that limit you're not required to file State taxes.

Also, since most MLPs operate in multiple States, the share of income allocable to each individual State is quite small; typically only investors with large holdings will need to file. The following link offers a table showing tax rates and exemptions for all US states and the District of Columbia: http://www.taxadmin.org/fta/rate/ind_inc.html. Of course, the exact amount of income allocable to each individual State is included in your K-1 form.

There are a handful of closed-end funds trading on the major exchanges (typically the NYSE) that invest exclusively in MLPs.The benefit of buying these funds is that all of the K-1 forms and cost-basis calculations are handled by the fund manager; fund holders simply receive a form 1099 at tax time. In these cases, all the income passed through from the MLPs held in the fund is considered dividend income. You pay taxes on these distributions as you would for any other dividends.

You should be very careful when selecting an MLP fund; they aren't all the same. Some MLPs closed-end funds charge expense ratios of less than 1 percent while others charge 1.5 to 2 percent.

It's also important to pay careful attention to the actual MLPs that are held in these funds. Some managers are creative in taking advantage of new MLP issues and getting in on new initial public and bond offerings, while others are basically a proxy for the Alerian index.

Because MLP distributions aren't dividends, MLP unitholders don't get a Form 1099 at tax time. Instead, unitholders receive a form K-1 - a standard partnership form that's typically mailed to unitholders in March.

High splits are incentive distributions and should be an important consideration when investing in MLPs. Though each MLP has a different formula for calculating splits, the higher the split, the less cash there is to pay distributions to investors in the MLP. High splits also reduce the amount of cash available to service debt, make acquisitions and for general capital expenditures. High splits to GPs can make it more expensive for an MLP to borrow money to fund expansion.

When natural gas is first produced, it's called "wet" or "rich" natural gas. Wet gas is composed primarily of methane, but it also contains a number of other hydrocarbons known as natural gas liquids (NGL). Examples of NGLs include propane, ethane and butane.

Once NGLs are separated from the natural gas stream, the remaining gas is called dry natural gas. Dry natural gas is then injected into the pipeline system for transport to consumers or power plants. The removal of NGLs from the gas is known as natural gas processing.

Contrary to popular belief, most have little real exposure to commodity prices. That's because the most common business line for MLPs is the ownership of midstream energy assets such as pipelines, storage facilities and gas processing facilities. For the most part, MLPs don't actually take ownership of the commodities they transport, store and process but are simply toll-takers, earning a fee based on volumes moved.

While the following are examples of business types owned by MLPs, they are by no means the complete list of asset types owned by them.

Gathering Pipelines: Small diameter pipes that connect a single well or a group of wells to processing facilities and eventually to the national interstate pipeline grids.

Gas Processing/Fractionating: The removal of natural gas liquids (NGLs) from the gas is known as natural gas processing. The various hydrocarbons in NGLs can also be separated in a process known as fractionation.

Refined Product Pipelines: Refined product pipelines carry petroleum-based products like gasoline, diesel and jet fuel from refineries to terminals for distribution. Oftentimes, refined product pipelines are dedicated to a particular refinery.

Gas and Crude Storage: Gas storage facilities charge a competitive fee based on the volume of gas stored. Alternatively, sometimes, MLPs owning storage facilities will lease out a portion of their capacity for pre-set fixed fee on a longer-term basis.

Coal Properties: MLPs own coal-producing lands but don't actually mine for coal. The land is leased out to miners that pay a royalty fee based on the value of coal they produce.

Interstate Pipelines: Interstate pipelines are heavily regulated by the government. These pipelines offer stable regulated returns. But because fees are based on volume, profitability varies with demand for oil or gas transport.

Upstream Operations: Since early 2006, there has been a growing list of MLPs involved in upstream operations - the actual production of oil and natural gas. Some of the heftiest yields of all are available in upstream-focused MLPs.

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