Following the election, which left Washington’s existing structure intact, investors kicked sell-first-ask-questions-later into high gear regardless of the good economic data. As the prospect of further political gridlock took hold, the threat of higher investment taxes has dictated the past week of trading.
It’s clear that ordinary income taxes and taxes on dividends will be part of some grand deal to avoid the fiscal cliff. But I’m seeing a knee-jerk reaction to lighten up on just about everything — with stocks that pay 2% to 5% qualified dividends being punished most severely.
Tax-advantaged master limited partnerships (MLPs), however, are a safe bet and an entirely different story. MLPs are already the best-performing sector in the past decade and will continue to lead going into 2013. MLPs pay tax-free distributions, act as an excellent hedge against inflation and because they’re commodity-based, are best to own when risk of currency devaluation is high.
I’ve heard some chatter and hearsay about the tax structure of MLPs coming under scrutiny. Let me be one of the first to inform investors that such risk isn’t on the table in any tangible form at this time. The MLP sector came under particularly heavy selling pressure last week because of these rumors, but they are just that: unfounded and born out of speculation.
Last Friday, I spoke with Mary Lyman, executive director for the National Association of Publicly Traded Partnerships (NAPTP), and she laid out the current dialogue surrounding MLP taxation. The short version of the conversation is that MLP income in its current form and structure is safe from any new legislation.
At some point in the future, it could come under discussion as part of a more comprehensive tax policy reform, but nothing like that is happening now. Some of last week’s selling is also the result of early November being a common period of ex-distribution dates.
Notably, what is being discussed at the legislative level is the inclusion of renewable energy into the MLP structure, essentially expanding the role of this popular entity for capital-intensive businesses. Think of it as more of a “big tent” approach to the energy sector, which in turn would only help to protect the interests of the oil, gas and coal industries.
I find this piece of news to be quite bullish for the sector, and I hope the inclusion of renewables comes to pass.
I highly recommend to anyone interested in earning tax-free income through MLPs to spend some quality time on the NAPTP website. It provides answers to just about every question investors could have about MLPs regarding tax treatment, cost basis, types of businesses, owning MLPs in retirement accounts, the effect of unrelated business taxable income (UBTI) and a host of other very informative FAQs.
Take a visit, and know that when any new legislation arises that could affect the MLP sector, this organization will be first to make it known.
Bryan Perry is editor of Cash Machine, a newsletter focused on dividends and income investing.