Fiscal Cliff Makes MLPs a Grand Bargain
By now we’re all familiar with the Fiscal Cliff – the wave of spending cuts and tax increases poised to come crashing onto our shores in the New Year.
There’s still a chance that a deal will be reached, but it’s hard to have faith in today’s politicians. So for now, you should hope for the best, but prepare for the worst.
To that end, I suggest investing in Master Limited Partnerships, or MLPs.
If you’re not familiar with the term, MLPs are particularly attractive investments in a low-yield environment – like the one we’re in today.
Unlike most companies, MLPs aren’t taxed at the corporate level. Money is only taxed when shareholders receive dividends. This privileged structure avoids the problem of double taxation that other companies face (when both revenue and dividends are taxed).
However, to avoid exploitation of this preferential status, Congress insists that a partnership’s revenue comes from a “qualified” source. Basically, this means income has to be derived from the natural resource or energy infrastructure businesses.
Additionally, the partnership is required to pass along the vast majority of its earnings to the partners (i.e. – shareholders).
Yet, even though MLPs are structured differently than traditional companies, their shares, or “units,” trade just like stocks. Only they usually yield about 7% to 9%.
Now, as the Fiscal Cliff approaches, many investors are selling dividend stocks. The rationale is that the tax rate on “qualified dividends” is set to rise from 15% to the level of “ordinary income” rates, which could be as high as 39.6%.
But what many investors don’t understand is that distributions from MLPs are already taxed at ordinary rates and don’t qualify for special qualified dividend status. So essentially, the selloff in dividend-paying shares has actually created a great buying opportunity.
Granted, the proposed increase to capital gains would affect MLPs, as this would impact your returns when you sell MLP units. But then again, that’s true of every investment subject to capital gains taxes, including common stocks.
Also, while pending changes to the tax code aren’t currently expected to meaningfully affect MLPs, that could always change. However, the government does have a very positive view of MLPs, which build infrastructure, transport our country’s resources, and create new facilities and jobs. So I don’t think MLPs will be targeted by budget hawks.
Indeed, Wells Fargo (WFC) analysts say there’s “a low probability” that MLP tax benefits will be affected.
In the coming weeks, we’ll take a closer look at some specific MLPs capable of providing both income and capital gains opportunities.
But for now, here’s a list of the highest-yielding MLPs on the market, so you can take a look for yourself…
And “the chase” continues,
Karim Rahemtulla
