Master Limited Partnerships (MLP): Oil Companies which pay No Tax

Master Limited Partnerships are similar to REITs in that they do not pay income taxes, and their shares trade on the major stock exchanges just like regular stocks. However, REITs and MLPs are different in structure. Unlike REITs, which are a special type of corporation, MLPs are partnerships. An MLP’s general partner is responsible for running the partnership, and individual investors are limited partners.

MLPs get special tax treatment. An MLP does not incur income taxes. Its income is allocated among all partners in proportion to their ownership interest. To qualify for the tax benefit, 90 percent of an MLP’s income must come from activities in real estate, commodities, or natural resources such as mining, timber or energy production and related activities. However, MLPs may not be suitable for IRAs and other tax-sheltered accounts.

The special tax treatment afforded MLPs seems to have a special appeal to major oil and natural gas producers. Many of them have transferred their petroleum and natural gas pipeline assets to MLPs that the oil companies control as general partners.

In fact, almost all MLPs operate pipelines transporting crude oil, natural gas, and other petroleum products.

Over the long-term, at least in theory, the combination of share price appreciation plus dividends should result in 9 to 12 percent average annual returns, and possibly even higher. Consequently, pipeline operators, as a group, generally offer the best investment opportunities.

MLPs are tricky to analyze because most record large non-cash depreciation charges that reduce reported earnings but not cash flow which fuels dividends. You best bets are MLPs with a strong dividend growth history and plenty of pipeline construction projects underway.