It doesn’t matter who wins the election… Taxes are going up soon.
I know, one candidate says taxes are only going up for those making $250,000 or more. The other claims taxes won’t go up for anyone…
But as the Vice President would say, “It’s all a bunch of malarkey.”
We have a $1-trillion-per-year deficit and no one wants to meaningfully cut spending.[ad#Google Adsense 336×280-IA]They all say they do… But try eliminating a government department or program that’s located in a Congressman or Senator’s home district, and you’ll hear howling so loud you’ll think there are wolverines in your backyard.
All of this political posturing about taxes reminds me of George Bush’s infamous line, “Read my lips, no new taxes.” Of course, two years later, he raised taxes.
And I’m not even talking about the fiscal cliff, which will allow the Bush (W’s) tax cuts to expire and will increase taxes on dividends to your ordinary income tax rate.
Regardless of the fiscal cliff or who’s in the White House next year, I expect to have to pay more in taxes by 2014…
Earning Income Through Partnerships
This is why I’m a big fan of master limited partnerships (MLPs). And once you understand them, you’ll become one, too.
MLPs are stocks that are somewhat similar to real estate investment trusts (REITs), which are more familiar to most investors.
Like REITs, MLPs must pay out 90% of their earnings to investors in order to avoid corporate income tax.
But unlike a REIT – where you’re a shareholder – in an MLP, you’re a partner in the business.
This has an important tax ramification.
As a partner in the business, when you receive a dividend payment (called a distribution) most of it is considered a return of capital.
And returns of capital aren’t taxed.
So any distribution you receive from the company isn’t taxed in the year you receive it.
Instead, it lowers your cost basis.
Pay Uncle Sam After You Retire
The IRS always gets its money. But in the case of MLPs, it’ll have to wait for it.
Here’s how it works…
Let’s say you buy 100 shares of an MLP for $20 per share and receive a $1-per-share distribution, where all of it is considered a return of capital.
(The company will send tax documents that let you know how much is a return of capital.)
In the year you receive the $100 ($1 per share), you won’t pay taxes on the distribution. Instead, it lowers your cost basis to $19. Moving forward, over the next three years, you receive $1 per share in cash each year. After four years, you’ve collected $400 in cash and haven’t paid a penny to Uncle Sam.
But now, your cost basis is $16 ($20 – $4).
Let’s say you then sell the stock for $22. You’ll pay capital gains on $6 instead of $4 per share.
That’s because you bought it for $20, sold it for $22, and had your cost basis reduced by the $4 you received in cash.
So you still have to pay taxes on the money you receive. But you pay it later.
Owning MLPs can be a terrific way of generating tax-deferred income while you’re working and presumably in a higher tax bracket. But the idea is to then take profits and pay taxes when you’re retired and in a lower tax bracket.
Of course, when you’re retired, you might want to hang on to the strong income streams that most MLPs produce.
Ending Up Overweight By Chasing Yields
Because MLPs must pay out 90% of their income, their yields are usually higher than most dividend-paying stocks.
For example, the JPMorgan Alerian MLP Index ETN (NYSE: AMJ) – which tracks an index of MLPs – yields 5.02%.
Though, specific MLPs – like Energy Transfer Partners (NYSE: ETP), which yields 8.4%, and Linn Energy (Nasdaq: LINE), which yields 7.2% – can offer a much more attractive yield.
You probably already notice that both of these are energy stocks.
Roughly 80% of MLPs are in the energy sector. And many of them are pipeline companies. So although you may find MLPs very attractive from a yield and tax perspective, you don’t want to put so many in your portfolio that you’re overweight in energy stocks.
MLPs also have tax consequences that you should talk to your tax professional about, including increasing the cost of tax preparation.
But in general, MLPs are a great way of generating a strong yield while telling Romney and Obama they’ll have to wait for your money until you decide you’re ready to pay them (by selling the stock).
Don’t be fooled into thinking your taxes won’t go up… No matter what a candidate promises. But regardless, MLPs can be a great way to hang on to the cash generated by your income-producing investments until you’re ready to sell.
— Marc Lichtenfeld[ad#wyatt-generic]
Source: Wealthy Retirement