Master Limited Partnership Tax Rules
Posted on May 16, 2013 | AAII Journal
The unique structure of MLPs gives them tax advantages, but also makes them more complex. Find out how distributions and gains are taxed.
For those who are new to them, the first thing to understand is that an MLP is simply a publicly traded partnership (PTP). (Not all PTPs are MLPs, however; a number of PTPs are simply commodity pools.) By buying shares, technically referred to as “units,” in an MLP, you become a partner (or a “unitholder”) in this very large partnership. As a partner rather than a corporate shareholder, you enter a whole new world of taxation. Partnership taxation is what makes MLPs a tax-advantaged investment, but it also makes them more complex than many other investments.
As a partnership, an MLP is not considered to be a separate entity for tax purposes the way a corporation is, but rather is a pass-through entity—sort of an agglomeration of all its partners. An MLP does not pay corporate tax; instead, all the things that go into calculating tax—income, deductions, gain, losses and credits—are divided up among the unitholders as if they had earned the income themselves. Part III of the K-1 tells you your total share of each of these items.
You pay tax on your share of the partnership’s taxable income, as determined by all the items on the K-1. It is important to remember that you will owe tax on this income whether or not you receive a cash distribution.
What about the distributions? Do you pay tax on them as well? You might think so, since the quarterly cash distributions look a lot like dividends; however, MLP distributions are not dividends, but quite a different creature. When you fill out your tax return, the only thing you have to worry about paying tax on is your share of net partnership income. The portion of the distribution that is equal to net income is covered by that tax payment.
An Income-Generating Options Strategy
Posted on May 10, 2013 | AAII Journal
Writing covered calls can add extra income to a buy-and-hold strategy, but it limits profits on the underlying stock.
Poor Advice About Social Security
Posted on January 8, 2013 | AAII Journal
A new working paper finds that individuals who turn to financial advisers for help on when to start taking Social Security benefits are often misguided.
Managing the Mental Aspect of Investing
Posted on December 10, 2012 | AAII Journal
Investors should consider whether they are being influenced by a good or bad herd behavior and who is on the other side of a trade.
How Investors Miss Big Profits
Posted on November 26, 2012 | AAII Journal
Back in 1993, a curious thought crossed my mind while analyzing the federal regulations that were new at the time.
Mutual funds were permitted to report investment returns for one, three, five and 10 years (“alpha”), but how many investors actually kept their investments unchanged for those specific periods? If all investors did not hold on to their investments for those precise periods, then they had to be doing better or worse than was being reported.
Alpha is a measure of performance on a risk-adjusted basis. Alpha takes the volatility (price risk) of a mutual fund and compares its risk-adjusted performance to a benchmark index. The excess return of the fund relative to the return of the benchmark index is a fund’s alpha. Simply stated, alpha represents the value that a portfolio manager adds to or subtracts from a fund’s return. Investors’ alpha is the value a retail investor adds to or subtracts from the alpha delivered by the portfolio manager. The return of the respective index is considered to be zero alpha, so any excess over the index is considered positive investor alpha.
I developed a calculation that would measure whether mutual fund investors were actually earning more or less than the reported alpha. In 1994, DALBAR issued the first Quantitative Analysis of Investor Behavior (QAIB), showing that investors had severely underperformed the average mutual fund alpha! This underperformance continues to this day.
Investors were actually missing much of the alpha that mutual funds had earned. Using the S&P 500 index to approximate the returns that equity mutual funds produced, investors were leaving between 10.97% and 4.32% on the table, as Table 1 shows.
This shocking finding of underperformance led to research to understand how and why millions of investors were missing so much of the alpha and, ultimately, what they could do to capture more of the profits that funds were earning.
Adherence to Rules Helps Model Shadow Stock Portfolio’s Performance
Posted on November 22, 2012 | AAII Journal
Following a consistent, well-defined approach has helped the portfolio achieve an average return of 16.1% over the past 20 years. Plus, see the latest buys and sells.
Earnings Estimates and Stock Prices
Posted on November 20, 2012 | AAII Journal
Expectations play a key role in determining if a stock’s price “gains” or “loses” when actual earnings are reported.
The Top Financial Apps
Posted on November 19, 2012 | AAII Journal
These are some of the best financial apps for iOS and Android devices currently.
New Edge Stocks
Posted on November 13, 2012 | AAII Journal
Christina Wise of Investor’s Business Daily reveals which company traits make a story stock an attractive investment in her September 2012 AAII Journal article “The ‘New’ Edge: Characteristics of Winning Stocks.” These are the fundamental traits that past winning stocks possessed in bull market after bull market, decade after decade. This issue’s First Cut applies the key fundamentals highlighted in the article using AAII’s stock screening and fundamental database, Stock Investor Pro.
The starting universe of 5,564 stocks for this issue’s First Cut consisted of exchange-listed companies. The First Cut first looked for companies with positive current earnings per share that have been able to increase annual earnings at a 25% or higher rate for each of the last three years. Only 168 stocks met that stringent test. The First Cut then required that earnings per share for the most recent quarter be at least 25% higher than same quarter last year. We also looked for companies that have had an accelerating rate of quarter-over-quarter earnings growth. As a confirmation of the strength of earnings per share growth, the First Cut looked for quarter-over-quarter sales growth of at least 25%. Only 12 stocks possessed both strong historical year-over-year annual earnings growth and recent strong and accelerating quarterly growth.
To seek out companies with sustainable and improving profitability, the First Cut followed Wise’s fundamental test that firms have a return on equity of at least 17% and a net profit margin is better than the company’s average margin over the last three years. Since profit margins vary by industry, the First Cut also required that the company’s profit margin be higher than the industry norm. This type of filter helps to highlight companies that have a competitive advantage over their peers.
Only 10 stocks passed all of the fundamental factors exhibited by typical market winners and they made the First Cut. The table ranks these stocks by the price change over the last 52 weeks to highlight recent stock market success.
The Top ETFs Over Three Years: Real Estate Dominates
Posted on November 5, 2012 | AAII Journal
Five real estate funds led all ETFs in terms of three-year returns. Dividend-focused ETFs led many equity fund categories.