Master limited partnerships have garnered a strong following among income investors. However, when investing in a MLP-related exchange traded product, investors should understand the difference between an exchange traded fund and an exchange traded note as the two investment vehicles are not the same.
Both MLP-related ETFs and ETNs track an underlying benchmark index comprised of MLPs. However, the ETFs are structured as C corporations, whereas ETNs are organized as an unsecured debt issued by an underwriting bank.
Unlike other energy sector stocks, MLPs primarily deal with the distribution and storage of energy products, so their business model is less reliant on the commodities market since MLPs profit off the quantity of oil and natural gas they are able to move around. To qualify as an MLP, the companies pass through at least 90% of their income to investors, making the assets an attractive yield-generating investment.
However, since MLP ETFs are structured as a C corp., these corporations are also required to pay corporate income tax on distributions before the distributions are passed through to investors – MLP ETFs are required to pay corporate taxes or a 35% federal rate on returns. Additionally, fund investors are also taxed on the fund dividends and capital-gains distributions.