Where to Find Yield -- Investing for a Good Return -- Part 4

No discussion of high yield investments would be complete without addressing MLP's. Normally, these are companies that engage in businesses like natural gas pipelines, oil field trusts, and the like. Although these companies are traded on the stock exchange, what is bought and sold are not shares of stock, but rather units of ownership in the limited partnership. Because of this, the tax treatment of ownership is different from normal stock investments. Master Limited Partnerships do not pay tax at the corporate level. Instead, at the end of the year, the MLP sends out a form K-1 to each partner which tells that person what his or her share of the taxable income and loss for the year has been. The level of distributions from the company does not determine the tax; it is the actual profit and loss of the company. As a result, ownership of units in an MLP means that completing ones taxes become more complicated when April rolls around. Often, the MLP is delayed in sending out the K-1s, so the unit holders have to file for extensions until the form comes in. The common response to this problem is to put the MLP units into an IRA or other non-taxable account. That is not an entirely satisfactory solution, however, as there are taxes which can be levied upon the IRA dependent on the amount of distributions from the aggreagate of the MLPs. I will not explain those rules here; just realize that they may come into play and make tax filings more difficult.

My favorite among the MLPs has, for a long time, been Plains All American Pipeline, L.P. (symbol PAA). Plains, as the name suggests, is a large energy pipeline company. As of now, it is paying just under 5% in distributions. It has consistently raised the distributions for many years now. It has also been a steady performer when it comes to the stock price itself. In addition to the distribution, the price of the stock is more than five times what it was when the company first went public during the 1990s.

There is also a way to invest in MLPs without having to deal with all of the tax complications. There are corporations that do nothing but invest in MLPs. These entities pay tax at the corporate level, so dividend that get paid to shareholders are treated like any other corporate dividend for tax purposes. A good example is Tortoise Energy Capital Corp. (symbol TYY) and its sister entity Tortoise North American Energy Corporation (symbol TYN). Both pay about 6% in dividends (TYY just below and TYN just above.) Further, since these companies holdings are MLPs, and since the MLPs frequently operate at a paper loss (due to heavy depreciation or depletion), the distributions frequently come as tax free return of capital. Such a distribution reduces ones tax basis in the stock, so there ultimately will be a capital gain when the stock is sold.

This area is one that is complicated because of the tax issues that these investments raise. I would avoid the problem by investing in companies like TYY and TYN. Putting a part of an income portfolio into this type of investment is a good way to diversify and reduce risk.

DISCLOSURE: My accounts are long TYY and TYN but I have no holdings in PAA.