Investors seek three things: steady income, minimal risk, and tax avoidance. In order to achieve maximum yield on an investment, the canny market player will always try to find the strategy which will bring in high returns on their initial stake, and to reduce substantially the tax penalty if possible. There are some investments allowing this thanks to certain loopholes in the tax laws favoring long-term holdings. Among these are investments in Master Limited Partnerships.
What is a Master Limited Partnership? The MLP is a publicly traded limited partnership which combines the tax sheltering benefits of limited partnerships with the liquidity available to publicly traded stocks and bonds. These business organizations have become very common in the energy industry. MLPs provide and manage oil and gas pipelines, drilling operations, refinery services, transport, and logistical support.
How does the tax loophole work? An MLP legally exists as a collection of separate partners. Profits generated through an MLP are taxed only when the unitholders in the partnership receive dividends. Investments in an MLP are made through the purchase of publicly traded units rather than in shares. Where the tax advantage lies is in the mechanism of pass-through income. The MLP itself is not liable for corporate income taxes. Unitholders are each only liable for income taxes on their portions of the total earnings in the MLP. This insulates the investor from being “double-dipped”: having to pay both the corporate tax and personal income tax on stock earnings as well.
What makes an MLP particularly advantageous as a long-term investment? MLPs, like any publicly traded company, make dividend payouts to unitholders on a quarterly basis the same as with stocks. However, unlike the situation with stock shareholders, substantially large portions of the income distributions paid to the unitholders in an MLP are tax-deferred until the unitholder sells out of his or her holdings. The unitholder then pays only the lower capital gains tax rate instead of the higher income tax rates. Over the long-term, an MLP unitholder can avoid taxation on anywhere between 80 to 90% of all the earnings derived from the investment! And this is in addition to an investment index which has outperformed the S&P 500 through most of the last fifteen years on annual returns. Investors therefore may wish to head over here to learn more about the many advantages offered by investment in a Master Limited Partnership.