In the corporate tax world, one dreaded phrase reappears when you talk about dividends: “Double Taxation”. All incorporated companies are taxed on the income they make. The shareholders are taxed again on any dividend distribution they receive from the company. So the same income is taxed twice. But, there is a way around it…

Master Limited Partnerships, or MLPs, are nearly identical to royalty income trusts. The only difference between them is double taxation.

Regular trusts must pay taxes on income before it is distributed to shareholders. Those shareholders also have to pay taxes on the already-taxed income when they receive it. MLPs, on the other hand, are limited partnerships. Therefore, they pay no taxes.

Only unitholders, as owners of MLPs are called, are responsible for paying taxes on the income they receive from the partnership.

MLPs are usually trusts comprised of natural resource, financial services, and real estate assets. Many own oil and gas wells, refineries, or pipelines. Others own hotels, restaurants and stores – much like REITs. Still others own certain assets like royalties in gold or copper mines. Some specialize in certain countries or regions, while others are more diversified.

One downside of MLPs is you shouldn’t invest in them through IRAs or other tax deferred accounts. Since they already receive a tax benefit, many IRAs won’t include them. Those that do, could complicate the tax scheme.

MLPs don’t send 1099 forms like most trusts and other investments. Instead, they send out Schedule K-1 Forms at the end of the year, which will describe the unitholder’s allocated income, gains/losses, deductions, and credits. You can use any losses in these as passive losses to offset other income during the year for taxes.

While this isn’t a complete tax shelter for your investment cash, it does one important thing. Since the partnership itself isn’t taxed, the yield is higher, you receive more of your share of the profits without the tax man touching it, and you are still able to use any losses to offset your other gains.

Most MLPs offer safe investments, such as the resource royalty ones. The partnerships themselves offer you cash flow straight from real operating assets without any of the overhead, since the royalty MLPs aren’t actually the ones operating.

Another advantage of MLPs are the many small-cap options you have. There are hundreds of MLPs with market caps below $1.5 billion. Below are our favorites…

Top 5 Small-Cap Master Limited Partnerships:

• Genesis Energy L.P. (GEL: AMEX) – general oil and gas conglomerate operating in supply and logistics, refinery, and pipeline sectors.
• Penn Virginia GP Holdings L.P. (PVG: NYSE) – manages coal and natural gas properties in Illinois, Kentucky, New Mexico, Virginia, and West Virginia.
• Pope Resources L.P. (POPE: NASDAQ) – owns and operates timberland and is involved in the property management.
• Magellan Midstream Partners L.P. (MMP: NASDAQ) – involved in the marketing, supply, and distribution of propane, natural gas, liquefied natural gas, and petroleum gas.
• Quicksilver Gas Services L.P. (KGS: NYSE) – engaged in gathering and processing of natural gas and liquefied natural gas.

All of these should provide investors with years of income, without the burden of “Double Taxation”.

Sincerely,
Jim Nelson

December 12, 2008

Jim Nelson

Jim Nelson began his investing career during the tech boom at age 14 – with purchases of Starbucks and AOL. Early inspiration came from an old Tweedy Brown whitepaper: “What Works in the Market.” He graduated with a degree in Political Science from Pittsburgh University, Nelson focuses on income investing, including dividends, covered calls, and fixed-income. Additionally, he covers MLPs, ADRs, utilities, consumer staples and tobacco. Nelson is the managing editor of Lifetime Income Report.

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