Master limited partnerships, or MLPs, generally offer investors yields of about 8% or more. They can do so by operating as pass-through entities — meaning that their earnings go back to shareholders.
While C corporations get a break in their future tax level with Congress’ passing of recent legislation (to 21% down from 35%), there have been concerns about how MLPs would be affected by the reforms and what these changes would mean for MLPs in the year ahead.
Raymond James’ energy analysts — which include Darren Horowitz, Justin Jenkins, J.R. Weston and Tom Murphy — recently addressed these issues in note to investors.
The new tax law provides “MLP unitholders with eligibility to receive the full 20% deduction for pass-through income off their individual tax rates without being subject to the wage limitation (as before, cash distributions would remain untaxed),” they explained.
On the other hand, the lower corporate tax rate is “a slight-to-moderate negative for MLPs, as the magnitude of relative cost of capital advantage [for MLPs] over C-corps may somewhat diminish,” according to Horowitz and his colleagues.
More Ups Than Downs
Individual MLP investors, the Raymond James analysts believe, “should generally benefit from lower individual ordinary income tax rates, which will move closer to the rates on dividend income (which are staying unchanged at 15% or 20%, depending on income).”
While the shifts in individual rates are less significant than those affecting corporations, some taxpayers in the current 28% and 33% brackets should end up in the expanded 24% and 32% brackets, they point out.
Furthermore, the 20% rate for business income from pass-through entities will probably reduce individual income taxes, at least the taxable portion of MLP distributions, for those in the current upper tax brackets, the analysts state.
Since late 2014, uncertainty associated with large funding needs and, at times, debt market turbulence has contributed to MLP equity-price weakness, according to Brian Watson, senior portfolio manager and director of research with OppenheimerFunds’ SteelPath unit.
But several key shifts in the midstream sector — or pipeline MLPs — should alter this situation, Watson notes. (Midstream players represent the largest sector in the MLP industry.)