MLP investing is known for offering attractive income via distributions and dividends. Notably, the segment is currently providing more generous yields than other income-oriented investments.
Several midstream companies increased their payouts for 4Q23, building on a track record of growth in recent years. It’s worth noting there has not been a dividend cut in the broad Alerian Midstream Energy Index (AMNA) or the MLP-focused Alerian MLP Infrastructure Index (AMZI) since July 2021.
The AMZI and AMNA indexes are yielding 7.2% and 6.1%, respectively, as of February 26. The Alerian MLP ETF (AMLP) provides exposure to AMZI, while the ETRACS Alerian Midstream Energy Index ETN (AMNA) tracks the AMNA index.
See more: “4Q23 Midstream/MLP Dividend Recap: The Growth Continues”
Investors have had a healthy appetite for income-generating investments in recent years, as investment income can help offset market volatility. Income can come in the form of dividends and distributions, terms that are used interchangeably but have different tax implications.
Corporate Dividends
C-corporations most commonly distribute cash payouts in the form of dividends. Qualified dividends are taxed at the lower long-term capital gains tax rate. This is as opposed to an individual’s regular income tax rate, which is higher. Qualified dividends typically include those paid by U.S. companies, or international companies trading on a major U.S. exchange.
Conversely, nonqualified dividends, such as those paid by REITs, are taxed at the regular income rate, according to the IRS.
MLPs Distributions
Income provided by MLPs are called distributions because of the partnership structure. MLPs are pass-through entities. That means they do not pay taxes at the company level if 90% or more of their income is from qualifying sources. This has historically allowed MLPs to pay out more of their cash flows to investors as distributions.
Importantly, MLPs not only provide generous income, they provide tax-advantaged income. MLPs do not have the double taxation associated with corporate dividends, and have historically provided attractive income that is largely a tax-deferred return of capital, meaning taxes are not paid on that portion of the distribution until the investor sells their position. Typically, 70%-100% of MLP distributions are considered a tax-deferred return of capital, according to VettaFi.
MLP unit holders are responsible for paying state income taxes on the portion of income allocated to the unit holder for each individual state in which the MLP operates. However, unless the unit holder owns a large position, the share of allocated income is small, and the unit holder may not have to file in some states due to minimum income thresholds.
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