These days, the only thing better than getting solid income
from your stocks is getting solid,
income from your stocks. Thanks to a recent ruling from the IRS,
a number of companies may be able to take advantage of a
favorable tax status once reserved solely for energy and natural
Later in this article, I'll get into the technical nature of
the IRS decision and what it means for investors. First, though,
let's take a look at the type of investment at issue: the
master limited partnership
Master of their domain
In their search for greater income, investors have discovered a
number of previously obscure types of assets that emphasize
distributions to shareholders. Mortgage REITs and business
development companies, for instance, offer impressive yields that
in many cases top the 10% mark, due to the requirement that they
pay out the bulk of their net income in distributions to
But in many ways,
master limited partnerships
give investors an even better deal. Because of their status as
partnerships, MLPs tend to make big distributions to their
unitholders. Yet because of the nature of the business in which
most MLPs operate, a good portion of those distributions qualify
as tax-free return of capital rather than ordinary income. That
doesn't mean that investors avoid tax forever, as the IRS usually
recaptures the return-of-capital tax break when investors sell
their MLP units. During the interim, however, investors enjoy
deferral on their distributions.
Even better, MLPs avoid corporate-level income tax. That
leaves these companies with more income to distribute back to
Opening the doors
In order to qualify as a master limited partnership, a business
has to fall into certain IRS-approved categories. The section of
the tax law dealing with MLPs describes businesses whose "income
and gains [are] derived from the exploration, development, mining
or production, processing, refining, transportation ... or the
marketing of any mineral or natural resource (including
fertilizer, geothermal energy, and timber)."
That definition clearly allows fertilizer maker
qualify as an MLP
. But for the most part, MLPs tend to be pipeline or other
midstream energy companies.
Last week, though, the IRS ruled that a certain type of
business known as "steam cracking" could qualify for MLP status.
Because the process involves taking natural gas liquids and
refining them into specialty chemicals known as olefins, the IRS
found that the income from such businesses could count as MLP
income if the business were properly structured.
The IRS decision is good news for two groups of companies. As a
blog post discussed on Friday, the move appears to validate the
) to move an olefin processing facility into
its affiliated MLP
More important, though, the decision could allow a set of
chemical companies to create brand-new MLPs. Last Tuesday, shares
) , and
) all rose sharply along with many of their peers, with gains
especially concentrated on those companies that would be best
suited to spin off existing facilities into an MLP structure.
Investors could benefit in two separate ways from such a move.
In addition to the tax benefits described above, analysts point
to the fact that MLPs have tended to trade at higher multiples to
operating income than what chemical companies typically fetch. If
companies spin off MLPs and their share prices rise, then
shareholders who hang on to spun-off shares will reap big
Keep your eyes on the IRS
With the U.S. government still hurtling toward the fiscal cliff
with no relief in sight, it's nice to see the IRS giving
news for a change. The thing that
investors need to remember is that even if taxes aren't usually
the only reason to make an investment, changes that give
investors new benefits can often be significant enough to move a
stock. It's essential to watch and see when big tax changes
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Tune in every Monday and Wednesday for Dan's columns on
retirement, investing, and personal finance.
You can follow him on Twitter @DanCaplinger.
Fool contributor Dan Caplinger has no positions in the stocks
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