I'll try to give you some basics about the taxation of distributions that I remember from my corp tax class (many years ago). The first thing to know is that there is a difference between the GAAP earnings that are reported in SEC filings and earnings releases, and taxable income the way it is determined for a company's tax filings. Second, the general tax rule is that for a distribution to be taxable to the party receiving it, the entity that pays it must have earnings and profits (called "e&p" for short). If the company paying the distribution has not earned a profit, then its distribution is a nontaxable return of capital. Such a return of capital reduces the security holder's cost basis in the stock.
The calulation of "earnings and profits" is determined according to the tax rules, not the GAAP rules, so it's quite possible for a company to report a profit for GAAP and SEC reporting purposes, but still have a loss for tax purposes. Some of the differences in GAAP and tax relate to the treatment of hedges and depreciation. For example, some hedges, like those used by oil and gas producers to lock in prices on their production, are marked-to-market each quarter in the Company's GAAP financial statements as the price of the underlying commodity fluctuates. The marking to market of these hedges can produce a non-cash gain or loss for GAAP purposes, but a different result (or no effect) for tax purposes. With depreciation, what is allowed for GAAP purposes may be different for what is allowed for tax purposes.
Don't worry too much about an MLP's reported GAAP earnings as the mark-to-market of the hedges obscures the key metric which is Distributable Cash Flow or DCF. Most MLPs report their DCF (which is a non-GAAP statistic which the SEC requires all sorts of disclaimers and explanations by the company).
Distributions from a partnership are not taxable when received as long as your basis is greater than zero; they do however reduce your basis and are taxable upon sale of your interest. Recapture of depreciation upon sale effectively makes the majority of distribution taxable at ordinary income rates, though that can vary widely between the different MLPs.
For god's sake, please! None of the above is on target, bits and pieces are correct. There's no reason to write a book on this stuff, just use google, this is the modern age after all, it's not necessary to ask taxation 101 questions in chat boards. But, once again . . .
- MLP's are federal income tax partnerships, the taxable income (loss) of which flows through to the unit holders on Schedule K-1.
- Losses are considered "passive" and as the MLP is a "publicly traded partnership" under tax law, losses may only offset business income from this MLP, or at the complete disposition of the units. Interest, dividend and capital gain income (if any) are picked up regardless of there being a loss from business activities. One must keep track of accumulated passive losses, as they carry over and are treated as if they arose in the following year.
- One establishes an income tax "basis" in the units upon purchase, which is increased by income, and reduced by distributions and losses, whether claimed under the passive rules or not. Distributions are not taxable per se, unless they exceed basis, not something that's likely unless you hold the units for many years.
- Upon the sale of units, a gain or loss is reported equal to the net proceeds less your tax basis. In a partnership with depletion and intangible drilling cost deductions, some portion of the gain may be ordinary, even if the units are held for a period qualifying for long-term capital gains treatment. Depreciation typically does not cause recapture because depreciable assets used in the oil and gas business do not appreciate, and there is unlikely to be "Section 1245" recapture potential from this source. In any case, the MLP keeps track of such matters.
- If a sufficient amount of units are held in a nontaxable entity, such as a retirement account, a tax on "unrelated business taxable income" may be levied, at corporate rates. One should therefore be aware of the approximate amount of such income and try not to exceed it if possible. The rules for UBTI and all of these basics are easily accessible on the web, a click or three away.
- In modern times, with all MLP's I am aware of, it is not necessary to keep track of your basis or ordinary income recapture potential, as the MLP will do this for you and summarize the reporting in the year of sale. You do however have to track passive losses, not only for "regular" income tax purposes, but also for the alternative minimum tax. Doing so should not challenge anyone with a high school education, thus apparently disqualifying this entire thread, but for professional tax preparers these matters are routine.
I hope like hell I never have to type all this crap again. It's called a search engine, people. You know, google? Bing? Okay, not many know about the latter, I grant you.
I know this is off topic, but the PSE board is pretty dead. PSE is about to offer shares. Might be a good time to pick some up as we hopefully experience the momentary share price decline associated with these offerings. I know the price is pretty dear, but the safety of the company and it's distribution is solid and even more so with this offering. Current debt is 135 million. This offering could net 55-60 million. If this is used to pay down debt, then their debt/equity becomes very low which has been a part of the safety prospect with this company. Oil-based. Pretty good parent. Low debt. Solid operators. I don't mind a lesser yield with a company like this.