An Advisor’s Guide to Understanding Taxes in Intermediate Investing
Mid-size companies have engaged in heavy buyouts and have increased distributions this year due to increased free cash flow. For advisors and investors looking to take advantage of the industry’s continued growth, it’s important to understand the tax implications when it comes to MLP.
By investing in MLPs, a client opens up to unrelated business taxable income (UBTI), a mechanism that has been put in place to ensure that tax-exempt entities do not engage in activities outside of their own. primary source of income, or severely limited if they do.
UBTI is taxable income from a tax exempt entity and is particularly important in relation to retirement accounts and employee benefit plans; The UBTI triggers the Unaffiliated Business Income Tax (UBIT) for all kinds of IRAs and employee benefit plans.
The IRS defines UBITs as follows: “For most organizations, unrelated business income is income from a trade or business, carried on regularly, that is not substantially related to charitable purposes. , educational or other which are the basis of the exemption of the organization. “UBITs come into play after $ 1,000 or more of gross income from a business that is unrelated to the tax-exempt business.
Due to the structure of MLPs as flow-through entities, from a tax perspective, an owner of an MLP is treated as if they were directly earning the income created by the MLP. MLPs are publicly traded partnerships, and because they are not directly tied to the primary means of business of a retirement account, they incur UBTI.
While nothing prevents an investor from holding MLP securities in his tax-exempt accounts – in this case, his retirement accounts – he would be responsible for the UBIT on those securities. If not understood, it could be a tax blow for a client in tax season; advisers should also note that distributions and net income are different from taxable income.
ETFs offer investors and advisers a way to access MLPs, and intermediary investments in this case, without incurring tax obligations for their retirement accounts. An ETF is structured like a C-Corp and therefore is not considered a partnership when investing.
Image source: Alérian
Stacey Morris, CFA for Alerian, recently wrote an article explaining the interplay of UBTIs, MLPs and ETFs. In it, Morris explains that ETFs in a retirement account can be a bit redundant, and when calculating annual contribution limits in tax-exempt accounts, this may not be the best approach; instead, she recommends using an MLP exchange-traded note for retirement accounts.
Alerian offers a variety of ETFs and ETNs that can capture the continued growth of the middle industry while still retaining the tax benefits that MLPs can offer.
See also: Increase in buyouts for energy infrastructure companies
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