Posted by: Simon Lack | March 9, 2013

MLP Investors Pay More Tax

Master Limited Partnerships (MLPs) are one of the more tax efficient income generating investments around, given that investors can deduct depreciation from their distributions and thereby defer portions of their tax liability until they sell. We’ve been running an MLP strategy for many years, directly invested in a portfolio of partnerships. This is the best way to own MLPs for high net worth clients.

Recently I’ve noticed a couple of articles discussing how much tax revenue the IRS forgoes through this treatment. A recent estimate from the non-partisan Joint Committee on Taxation put the figure at $1.2 billion annually.  It’s not much in the context of a $3.5 trillion budget, but still worth noting in case tax reform renders this a source of new revenue.

Another interesting development has been the strong growth of various funds (closed end funds, ETFs, ETNs) to hold MLPs for those investors unwilling to deal with K-1s. These vehicles give you a 1099, but the price you pay is a complete loss of the tax efficiency MLPs provide. 1099s come at a considerable cost. Nonetheless, these vehicles are growing strongly. Barrons noted their growth and listed funds that held in aggregate $22BN in MLPs, which is about 10% of the float adjusted market cap of the Alerian MLP index.

Although all these vehicles are only appropriate for smaller investors, their growth is performing a great service to people who continue to invest directly in MLPs and receive K-1s. Because the indirect investors are receiving their returns after tax, the tax loss to the U.S. Treasury is less than would otherwise be the case. Let’s hope that all these funds continue to grow, funded by smaller and less tax sensitive investors.


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