Will Energy Master Limited Partnerships (MLPs) Decimate Unsuspecting Investors?
Recent statistics indicate that there are over 110 MLPs trading on major exchanges, with oil & gas midstream activities – gathering, processing, natural gas compression, pipelines, storage, refining, distribution, and marketing – representing the dominant activity.
The latest U.S. Securities & Exchange Commission filings by a number of Energy Master Limited Partnerships (“MLPs”), however, provide yet another example of the treacherous income tax ramifications that could potentially whip saw investors if oil and natural gas prices continue to be depressed.
A case in point is clearly illustrated, for example, by the specific risk factor disclosures that were contained within the annual report (“Form 10-K”) that was filed by Energy Transfer Partners, L.P. (NYSE:ETP) on February 29, 2016 for its fiscal year that ended on December 31, 2015.
These risk factor disclosures included the following two (2) specific warnings:
Unitholders may be required to pay taxes on their share of our income even if they do not receive any cash distributions from us.
“Unit-holders will be required to pay any federal income taxes and, in some cases, state and local income taxes on their share of our taxable income even if they receive no cash distributions from us. Unit-holders may not receive cash distributions from us equal to their share of our taxable income or even equal to the actual tax liability that results from the taxation of their share of our taxable income.
In response to current market conditions, we may engage in transactions to delever the Partnership and manage our liquidity that may result in income and gain to our Unit-holders without a corresponding cash distribution. For example, if we sell assets and use the proceeds to repay existing debt or fund capital expenditures, you may be allocated taxable income and gain resulting from the sale without receiving a cash distribution. Further, taking advantage of opportunities to reduce our existing debt, such as debt exchanges, debt repurchases, or modifications of our existing debt could result “cancellation of indebtedness income” (also referred to as “COD income”) being allocated to our Unit-holders as taxable income. Unit-holders may be allocated COD income, and income tax liabilities arising therefrom may exceed cash distributions. The ultimate effect of any such allocations will depend on the Unit-holder’s individual tax position with respect to its units.”
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Tax gain or loss on disposition of our Common Units could be more or less than expected.
“If Unit-holders sell their Common Units, they will recognize a gain or loss equal to the difference between the amount realized and the tax basis in those Common Units. Because distributions in excess of the Unit-holder’s allocable share of our net taxable income result in a decrease in the Unit-holder’s tax basis in their Common Units, the amount, if any, of such prior excess distributions with respect to the units sold will, in effect, become taxable income to the Unit-holder if they sell such units at a price greater than their tax basis in those units, even if the price received is less than their original cost. In addition, because the amount realized includes a Unit-holder’s share of our nonrecourse liabilities, if a Unit-holder sells units, the Unit-holder may incur a tax liability in excess of the amount of cash received from the sale.
A substantial portion of the amount realized from the sale of your units, whether or not representing gain, may be taxed as ordinary income to you due to potential recapture items, including depreciation recapture. Thus, you may recognize both ordinary income and capital loss from the sale of your units if the amount realized on a sale of your units is less than your adjusted basis in the units. Net capital loss may only offset capital gains and, in the case of individuals, up to $3,000 of ordinary income per year. In the taxable period in which you sell your units, you may recognize ordinary income from our allocations of income and gain to you prior to the sale and from recapture items that generally cannot be offset by any capital loss recognized upon the sale of units.”
The common sense interpretation of this complicated legalese – investors in MLPs may owe taxes, in some instances substantial taxes, on income that they never received.
If you are an individual or institutional investor who has any concerns about your investment in any Master Limited Partnership investment, please contact us for a no-cost and no-obligation evaluation of your specific facts and circumstances. You may have a viable claim for recovery of your investment losses by filing an individual securities arbitration claim with the Financial Industry Regulatory Authority (FINRA).