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Potential MLP Tax Rule Changes Aren't That Taxing

Absent a complete corporate tax overhaul, master limited partnerships' tax status looks safe.

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The Alerian MLP Index sold off nearly 7% in mid-November after the presidential election, as concerns about the fiscal cliff, budget deficit, and changes to favorable tax regulations took hold. Beyond marketwide concerns about pending dividend and capital gains tax increases, master limited partnership investors seemed concerned that MLPs may be subject to corporate taxes and new carried interest rules. These threats--which have existed for years--have been amplified lately by fears regarding the drastic measures needed to resolve the federal government's budgetary woes. MLPs, which do not pay taxes at the entity level, look to be an easy revenue target, but we believe it is highly improbable that they will see any major changes to their tax-favored status. In the unlikely event that MLPs became subject to corporate taxation, however, we'd expect only a modest impact on valuations.

Removal of Congressional Support Unlikely
Master limited partnerships have enjoyed pass-through tax status since the Tax Reform Act of 1986, which was designed to encourage private investment through a lower cost of capital. MLPs pass through their income to unitholders, who then pay taxes on that income at their own marginal tax rates often only when the units are sold. MLP income is therefore taxed only once, in contrast to the double taxation that happens when corporations pay entity-level taxes on income and shareholders pay a second layer of taxes on dividends received.

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Connie Hsu does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.