A Donald Trump administration may well mean lower taxes on all types of investment income, including dividends, interest and capital gains. This is good news for investors of all stripes, who may be able to save big on their stock sales next year. And those who hold units of master limited partnerships (MLPs) or exchange-traded funds (ETFs) that invest in them may especially benefit from the new tax regime. Trump’s new tax plan could spell big savings for investors when it comes time to sell these investments.
How They Work
Master limited partnerships have some characteristics of a partnership and also some traits of a publicly-traded security. Like partnerships, these investments pass through all income that is generated by the partnership directly to the partners. The general partner operates the partnership, and its investors are limited partners who are entitled to their respective share of the partnership’s profits, losses and expenses. Partners will receive a K-1 form every year that breaks down the numbers that they need to report on their tax returns. (For more, see: MLPs: A Boon to Your Portfolio?)
MLPs are sold in units rather than shares and they trade on the exchanges like stocks do and have their own ticker symbols. Most MLPs are now created in the energy sector and are capital-intensive businesses. With Trump's support for opening up U.S. fossil fuel production, energy MLPs that own infrastructure, such as pipelines, storage, terminals and processing plants, could see a boost.
MLPs are attractive investments for many wealthy investors because the dividends that they pay are usually tax-free. They also usually pay out considerably more than traditional fixed-income securities such as bonds or CDs. According to Morningstar, "Most MLPs offer very attractive yields, generally falling in the 5% to 7% range for limited partnerships and 3% to 4% for general partnerships," CNBC reports. This is a fantastic yield, considering that the 10-year Treasury is currently yielding about 2.5%.
However, the dividends that are paid by the partnership also reduce the investor’s cost basis in it, so when it comes time to sell the units of the MLP a large tax bill may be due. But Trump’s tax plan is to consolidate and reduce the tax brackets to 12%, 25% and 33% and tax capital gains at half of those levels for investors in their respective brackets. He also wants to cut the tax rate for all types of pass-through entities to 15%. These changes could drastically reduce the tax bill on the sale of these investments for many investors. (For more, see: How Does an MLP Differ from Other Business Structures?)
It could also push up the value of these vehicles because they may become more attractive to investors who previously eschewed them because of their tax treatment. Investors who don’t wish to invest directly in them may want to consider purchasing shares of an ETF that does, such as the Alerian MLP ETF (AMLP) and the First Trust North American Energy Infrastructure Fund (EMLP). These funds will provide them with diversification and liquidity, and they can still receive the competitive dividend yields that MLPs provide.
The Bottom Line
It remains to be seen whether Trump will be able to implement his tax plan. He will almost certainly need to get a few Democrats in his corner in order to pass it through Congress. He may be forced to make major concessions in order to do this, and many experts are predicting that this will happen. Critics contend that Trump’s tax plan could elevate our national debt to a dangerous level and roil the international markets. But if Trump is able to get his plan passed in its current form, it could create a real heyday for all types of investors who will be able to receive interest and dividends and sell highly appreciated holdings and get a lower tax bill. (For more, see: The 5 Largest MLP ETFs and ETNs.)