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Kinder Morgan Energy Partners, L.P. Message Board

  • DONEDEALER DONEDEALER Oct 23, 2011 4:56 PM Flag

    Loss of pass through taxation?

    This is a question for Abter 1 or anyone who has opinions on this. This threat continues to arise in the media and from government sources. Analogies are frequently made to the Canadian royalties loss of pass through. Let's ignore the probabilities of such an action and consider the impact on pipeline MLP's were it to happen.

    It appears that most Pipeline MLP's, unlike Canadian royalty trusts, have very little taxable income. Many have only 10% to 20% of their distrbutions being taxable to the limited partners. It is my understanding that this because of depreciation on the pipelines for tax purposes subtantially reducing taxable income. Asuuming this is correct then it appears that were they to become C corporations they would have very little income tax and their dividend distributions would be very similar to the those previously distributed to the limited partners and would be largely non taxable returns of capital.

    Comment invited.

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    • It is true that many MLPs generate little current year taxable income, especially for new investors. The income is tax postponed however, not tax avoided; when you sell you "recapture" that income and pay income tax. The tax postponement feature does indeed involve depreciation as measured by a conventional C corp.

      The value proposition of an energy MLP is highly dependent on the tax code structure. They offer a real value-added service to the economy (transportation and storage of energy related materials, with related services). The real value of many pipelines are not merely the hardware itself. A major part of the value is based on the land and legal right of way for the pipes & storage facilities, and the partnerships management ability to run the operations to provide the services. This part of the value does not depreciate; IMHO is actually increases in value as a scarce & hard to replace resource. Trying to build an entirely new pipeline or storage facility, especially into or near metropolitan areas, is close to impossible due to NIMBY and liability issues. This creates a very wide moat creating increasing value. The pipes and other hardware of course do deteriorate and depreciate (although perhaps not as fast as accounting rules acknowledge). After full daily/weekly/monthly/yearly/long-term maintenance capital expenditures (CapEX) are used effectively, which will replace all the hardware over time to keep it going, the pipeline enterprise becomes nearly internal. This is quite different for E&P pipes, and some G&Ps as well; if the oil or gas field gets played out the value of a perfectly maintained pipeline system to the now dry wells is worthless, and the land and right of ways are also.

      Back to your more germane question: An MLP converting to a C-corp, either through their own reorganization or as an acquisition that does not keep the MLP structure going, would be a VERY painful tax experience for one and all. The one time tax shock would be high (I believe the tax implications could be similar to sudden and unexpected sale of all your MLP investments, with a loss of all accumulated carry-forward credits), but going forward the operation of the business (as a C-corp) would be in an entirely new universe. There are of course pipeline service companies organized as a C-corp(including subsidiary as units of C-corps), but many such businesses have found it more profitable (often highly profitable) to sell and/or spin off the pipeline assets into an MLP. Going the other way would reverse that, and would likely be very unprofitable.

      The world of MLPs is pretty big, but I can't recall off the top of my head a situation where an MLP became a C-corp (and stopped operating as an MLP). The GP being bought by a C-corp? YES, that happens, but that keeps the MLP operating. The GP was not necessarily an MLP to begin with (some GPs are, most are not). I simply think it would be a tax disaster to go from being an MLP to being a C-corp.

      • 2 Replies to abter1
      • Your information sounds pretty scarry to me. I don't think I would want to invest in an MLP myself.

        THE GOOD CHICKEN

      • Abter,

        Thank you for your prompt response. First, I am retired and have no intention of ever selling MLP's and incurring the tax recapture. I plan to have these investments pass through my estate.

        I realize that a conversion to a C corporation would be the same as selling and a tax disaster. If there were a change in the law on MLP taxation would it permit the MLP to continue as a tax paying partnership or require the equivalent of a conversion to a C corporation? Could the assets be transferred to a corporation in a tax free transaction?

        My hope is that the discussion is academic and there will be no change in the law. But who knows?

 
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