The overarching benefit to holding master limited partnership (MLP) assets is the high income steam ...
APL: Taxes and the Toll-Road Business
04/08/2014 11:00 am EST
Master Limited Partnerships are a part of the oil and gas and energy industry that has been exploding in recent years, says Matthew Skelly, Head of Investor Relations at Atlas Pipeline Partners, who explains what they are and how they relate to federal and state taxes.
Master Limited Partnerships (MLPs) came around in the early 1980s. The government created this form of company to foster energy infrastructure build-out in this country. Master Limed Partnerships were created as a way to not charge any of these companies corporate income tax, which, in turn, allowed the companies to take their cash flow and pay investors, and reinvest, and build pipelines, plants, as well as to produce oil and gas.
That's kind of how this whole asset class came about. Master Limited Partnerships don't pay corporate income tax. That way, these MLPs essentially pass the savings through to the distribution, or dividend; that's how MLPs are able to pay such high yields on their units (stocks).
There were 21 new MLPs created in 2013 alone. There are probably between 80 and 90 different MLPs currently that are publically traded. So the choices for MLP investors keep getting wider and wider as a direct result of the energy resurgence in this country.
Companies in the pipeline portion of the energy sector are the types of businesses you traditionally think of, when you think of MLPs. These MLPs follow a “toll-road business model.” Much like with a toll on a highway, the more cars that pay the fee, the more cash is raised. Pipelines are very much the same way, volumes of natural gas and liquids flow through pipe, and the Pipeline MLP just collects a fee from the drilling customers.
And that's what you want in an MLP. You want steady, predictable cash flow, because the MLP is on the hook to pay a distribution to their investors every quarter. People invested in MLPs are invested because of the distribution, because of the yield (not to mention a potential rising stock price!). It is great income, so you want to make sure that cash flow is as predictable as possible, because of that distribution that is expected every quarter.
However, when it comes to investing in MLPs, there are some state and federal tax considerations that come into play. MLPs are considered partnerships, not corporations, so an investor will get a K-1 tax form at the end of the year. It's just one extra form that the investor files with his federal taxes, basically saying that he's part of a partnership. It will show how much an investor has gotten in distributions, and that is usually considered a return of capital against his purchase price, provided the cost basis has not gone to zero (cost basis is reduced by the distribution). Every time an investor gets a dividend, or distribution, his cost basis decreases from what he paid in. Basically, it's tax-deferred and an investor doesn't really have a tax obligation until his basis gets to zero, which could be for quite some time.
In regards to state taxes, the MLP investor is getting cash flow from various states in the form of a distribution, or dividend, and therefore, he/she has to file state taxes in the states in which the MLP operates. This can be cumbersome if invested in a large MLP that operates in multiple states.
However, our midstream MLP only operates in just three states. Atlas Pipeline Partners (APL) only operates in Oklahoma, Kansas, and Texas. And Texas has no state taxes. So, an Atlas Pipeline investor may only have to file, potentially, in Oklahoma and Kansas.
Please note neither Atlas Pipeline Partners nor Matthew Skelly gives tax advice and this article should not be taken as such. It is for informational purposes only. Please contact a tax advisor as MLPs may not be suitable for all investors.
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