Master limited partnerships, the corporate structures favored by pipeline companies, are getting a close look from companies across the spectrum — and yield-starved investors are taking note.
Known in the finance world as MLPs, the partnerships throw off payments that are competitive with high-yield dividend stocks and junk bonds. But they operate in a completely different way.
First and foremost, MLPs allow investors to avoid the double-taxation effect of a normal dividend stock. In a typical dividend-paying company, earnings are taxed once at the corporate level and again as income to the shareholder.
The only way to avoid the hit is to hold dividend-payers in a tax-deferred or tax-free account — not much help for retirees seeking income now. With Treasury yields scraping bottom and bond prices at correspondingly risky highs, seniors today get the worst of both worlds: low current income and high risk.
Meanwhile, MLPs pay distributions that equal a yield of nearly 7 percent, compared to 2.2 percent for the stock market as a whole and well under 2 percent for 10-year bonds. As the “fiscal cliff” looms over Congress, few doubt that change is coming fast.
"Investors have this thirst for income," Maury Fertig, CIO of Relative Value Partners in Northbrook, Ill., told DailyFinance.com. "For someone who wants income, but realized the bond market is not there, if they're willing to take a little risk, they're constructing a scenario where they can dip a toe in the market."
MLPs pay out their income directly to investors, who are considered partners in the venture. As such, they are taxed at income rates. As long as dividend payments remain at favorable tax rates, there’s little reason to make the switch. But if the Bush tax cuts expire, dividend income tax rates go back up to income-tax levels — perhaps as high as 43 percent.
Under those conditions, MLPs start to look like a better deal. Part of the reason is taxes. Held over the long term, MLP distributions lower your tax basis, since the payments count, in part, as a tax-deferred return of capital.
“We have the most MLP initial public offerings ever in registration, waiting to go public,” Hinds Howard, chief investment officer of Guzman Investment Strategies, an MLP-focused investment adviser, told the San Antonio News-Express.
Howard added that 14 energy companies have registered proposed MLPs with the SEC and two companies already have gone public. That’s a big increase, he said, since there are only about 100 MLPs today. Of those, 85 are in the energy business.
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