The investment seeks investment results that are usually consistent with the price and yield performance of its underlying index, the Alerian MLP Infrastructure Index (before fees and expenditures). In most cases, the fund will invest at least 90% of its total assets in securities that make up the underlying index. Energy infrastructure MLPs that derive the majority of their cash flow from the transportation, storage, and processing of energy commodities make up the underlying index. It isn’t well-balanced.
What is Alerian MLP, exactly?
Alerian is an independent corporation established in Dallas, Texas that delivers transparent master limited partnerships (MLP) and energy infrastructure benchmarks and analytics. Industry professionals use the flagship Alerian MLP Index (AMZ) to evaluate relative performance.
Alerian reported that total assets of exchange-traded products connected to the Alerian Index Series exceeded $13 billion as of September 30, 2015.
Is it wise to invest in Alerian MLP?
All exposure to AMLP has been liquidated above $35. It’s an excellent location to enter a trade when it’s closer to $30. In the short run, buying falls and selling rallies should be profitable. The most that can be gained is about $40.
What’s the matter with Amlp?
Because it invests primarily in MLPs, the Fund is not qualified to be treated as a regulated investment company under current legislation. For federal income tax reasons, the Fund must be treated as a regular corporation.
Because corporate taxes can be rather high, this is a substantial disadvantage for the fund and its investors. In the past, AMLP had to pay an effective corporate tax rate of 12-14 percent, reducing overall shareholder returns by the same amount. Due to recent corporate tax cuts and the fund’s large losses from prior years, the fund’s effective tax rate will most certainly reduce in the future, but the situation is still far from ideal.
On the plus side, AMLP investors don’t have to fill out a complex K-form, and the fund’s dividend is mostly made up of tax-deferred return of capital distributions. Taxes are higher when there is more turnover, which includes when MLPs convert to corporations and the fund drops them from its holdings.
The AMLP is simply too inefficient as a tax-deferred investment instrument. By investing elsewhere, most investors would pay significantly lower taxes and, as a result, enjoy significantly higher total shareholder returns.
AMLP’s corporate/tax structure also makes things difficult for the investment manager, and it’s largely to blame for the fund’s 0.85 percent expense ratio. Although the majority of funds in this industry subsector are somewhat expensive, two of them, MLPA and MLPX, are much less expensive:
The extremely high costs charged by AMLP are, in my opinion, a deal breaker. Index funds are rarely this expensive, and it makes little sense to pay too much for passive management, especially given AMLP’s limited holdings. As we will see shortly, the fund’s exorbitant costs simply serve to reduce total shareholder returns.
What are the taxes on Alerian MLP?
Michael Akins, Vice President of Product Risk Management & Portfolio Analytics at ALPS Advisors, Inc., and Daniel Franciscus, Senior Investment Analyst at ALPS Advisors, Inc., will take over day-to-day management of the Fund on July 1, 2011.
The ALPS ETF Trust (the “Trust”) will only issue and redeem Shares at NAV in significant quantities known as “CreationUnits” or multiples thereof. 50,000 Shares make to a Creation Unit. The deposit or delivery of in-kind securities and/or cash constituting a significant replication, or arepresentation, of the securities covered in the Index is the consideration for purchasing Creation Units of the Fund. The majority of Creation Unit redemptions are for cash.
Individual shares of the Fund can only be bought and sold through brokers on the secondary market. The Fund’s shares are traded on NYSE Arca, Inc. (“NYSE Arca”) under the symbol “AMLP,” and because the Fund’s shares will trade at market prices rather than NAV, they may trade at a price higher or lower than NAV.
Taxable distributions from the Fund will be taxed as ordinary income in most cases. For tax purposes, a portion of the Fund’s dividends is expected to be considered as a return of capital. Return of capital distributions are not taxable to you, but they do diminish your Fund Shares’ tax basis.
How do MLPs function?
A master limited partnership (MLP) is a publicly listed limited partnership that operates as a commercial enterprise. They combine the tax advantages of a private partnership (earnings are taxed only when distributions are made to investors) with the liquidity of a publicly traded firm.
What happens when an MLP is sold?
When an MLP is sold, any loss carryovers for that MLP become deductible for the next year. Those losses can then be used to offset other types of revenue, such as ordinary or capital gain income, as well as income from other MLPs.
Is it wise to invest in MLP ETFs?
With the Global X MLP ETF, investors may get the best of both worlds: upward potential and downside protection (MLPA). MLPA provides investors with the following benefits: MLPs are known for paying high yields to investors since they do not have to pay corporation income taxes.
Is it possible to invest in AMLP using an IRA?
Many investors wonder if they may participate in MLPs through their retirement accounts, such as IRAs, 401(k)s, and other plans that allow them to generate tax-deferred income. MLPs are enticing to investors who want to build up their retirement accounts since they pay out regular cash distributions.
You Can, But…
Yes, MLPs can be invested in through IRAs, 401(k)s, and other qualified retirement accounts just like any other traded security. Nothing in the federal tax code or pension legislation prevents them from doing so. However, there are some particular factors you should assess carefully and speak with a competent tax counsel before adding MLPs to your retirement account.
To begin, keep in mind that one of the main reasons individuals buy MLPs is for the tax benefits, which include tax-deferred distributions and the opportunity to deduct depreciation and other deductions from taxable income passed through from the MLP. However, because income in a retirement account is already tax-deferred, the tax benefits of an MLP are effectively “wasted.”
More crucially, holding MLPs in a retirement account can result in the account paying tax, contrary to popular belief.
Unrelated Business Income Tax
The tax code has a notion termed “unrelated business income tax” (I.R.C. 511-514). (UBIT). Tax-exempt organizations and retirement accounts must pay tax on “unrelated business taxable income” (UBTI) revenue from a business that is not related to their exempt purpose under the UBIT rules (a university operating a business that had nothing to do with education would be an example).
When your IRA invests in an MLP, it becomes a limited partner in that MLP, just like if you had invested personally. Because an MLP, like all partnerships, is a pass-through company (no tax is paid by the partnership; all tax items flow through to the limited partners/shareholders, who pay tax on their share), the tax code treats the partners as if they were generating the MLP’s revenue directly. As such, the IRA or other account is considered to be “earning” its share of the MLP’s business profits as a partner in the MLP. Because the MLP’s activity is unrelated to the tax-exempt purpose of the retirement account, the IRA’s part of the MLP’s income is classified as UBTI and taxed accordingly.
The tax is due on the retirement account’s share of the MLP’s taxable business income, minus the retirement account’s share of depreciation and other business deductions, as stated on the K-1 form (not on the quarterly distributions). A line on the K-1 indicates how much UBTI the MLP is going through. The tax rate is currently 37 percent, which is the highest for a trust. The first $1,000 of UBTI from all sources is tax deductible; beyond that, the retirement account will due tax.
If there is tax owed, a Form 990-T must be completed, as well as quarterly anticipated income tax payments. The way a retirement account trustee prepares and files the Form 990-T, as well as how the tax is paid, may differ. The trustee may file the return and pay the tax with funds from the retirement account in specific instances. In some cases, you may be obliged to file the proper paperwork and pay the tax as the account owner. As a result, before investing, investors should study information on UBTI and Form 990-T on the website of their retirement plan trustee.
Should I Hold MLPs in my Retirement Account?
Investment advisors that follow MLPs have differing opinions on whether or not they should be included in a retirement account:
Some analysts believe that an MLP should not be held in a retirement account. Because tax benefits are such an important component of MLPs, they believe that this investment should be made in a taxable account where the benefits can be reaped. They also believe that putting MLP investments in an account that is subject to UBIT reduces the return and adds unnecessary complexity.
Others say that because MLP revenue is mainly offset by deductions such as depreciation, taxable income for many retirement accounts may fall below the $1,000 UBTI threshold. They also believe that the MLP’s income component is the most important advantage, and that even if the retirement account must pay tax, the cash distributions will still give an attractive after-tax return. After assessing their priorities, contacting their tax and investment experts, and crunching the numbers on the MLPs that interest them, investors must make this decision for themselves.
Other Alternatives for Retirement Accounts
If the threat of UBTI makes you hesitant to invest directly in MLPs for your retirement account, there are other options that will provide many of the same benefits without the negative tax effects. There are now several closed-end and open-end mutual funds that invest in MLPs and distribute MLP income to their investors as dividends. Furthermore, certain MLPs can be purchased through publicly traded affiliates that are taxed like corporations. If you want to add income to your retirement account but don’t want to risk UBTI, these are some possibilities to explore.
Additional Resources
- Tax on Unrelated Business Income of Exempt Organizations, IRS Publication 598 (partnerships are discussed on page 13).
- Unrelated Business Income Tax, section 511-514 of the Internal Revenue Code (rule for partnerships is in section 512).
This page’s content is provided solely for educational purposes and should not be considered as tax or investment advice. Regarding your specific case, seek the advice of an experienced counsel.
Are MLPs worth the money?
MLPs have a lower cost of ownership than conventional company equities since dividends aren’t taxed twice. In fact, when unitholders receive cash distributions, they are not taxed at all, which is highly enticing.
However, the longer an MLP is kept, the lower its cost basis becomes, increasing the tax liability when units are sold. One option is to leave the MLP as part of your estate to your heirs. Even if you don’t go this route, the cash dividends from an MLP usually outweigh the taxable income.