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Energy Master Limited Partnerships – Investors May be the Ones Getting Drilled

As noted in an April 1, 2016 article in The Wall Street Journal (“MLP Investors’ Maze of Tax Trouble Keeps Getting Worse”), investors are learning the hard way that energy MLPs, set up to shield companies from Uncle Sam, could have unexpected tax consequences when times get tough.

It is yet another sign investors didn’t fully understand what they were getting into when they poured billions of dollars into master limited partnerships before the oil bust.

According to the article, “the implications are getting a test case in Linn Energy. When the Houston-based oil and gas producer announced plans to restructure its debt on March 22, it offered its 350,000 investors a deal many will likely jump to accept: swap their units in the MLP for an equal number of shares in LinnCo, the firm’s corporate parent. The swap will let those investors avoid a tax bill for their share of the forgiven debt, which counts as a gain. But there is a catch. Investors who exchange their Linn MLP units for shares could trigger another tax hit, because the swap counts as a sale.”

Investors in other energy-related MLPs could soon be facing similar choices.

“The energy partnerships are structured to avoid corporate income taxes by passing much of their tax burdens along with the bulk of their earnings through to investors. That arrangement worked well when oil and gas prices were rising. But with prices falling and some MLPs nearing a restructuring or bankruptcy, investors face the possibility of being left with units that have lost value and a tax bill as well, a double-hit that has surprised many investors.

The rub is the exchange of units for shares counts as a sale, and the sale of partnership units is far more complex than the sale of regular stock. For example, it can trigger a ‘recapture’ of benefits that investors have already received in their annual tax-deferred payouts for things like depletion and depreciation. Investors who exit a partnership also must take into account their units’ share of its liabilities.

At worst, an investor who opts for Linn’s offer could face both ordinary taxable income due to recapture and a capital loss, because of a steep decline in the value of the units, that can’t be used to offset it.

Investors holding Linn units in an IRA or Roth IRA could also face tax bills on the exchange of units for shares. To prevent abuses, the law imposes a special levy on certain partnership income if the total in all IRAs exceeds $1,000 a year. Even if investors holding MLPs in an IRA haven’t owed this levy on their annual payouts, a sale of units could come with a tax and capital losses within an IRA aren’t deductible.”

While the majority of IRA owners are unaware of these rules, IRA custodians are charged with enforcing them and some are reportedly watching more closely than they have in the past. Last year, Pershing reportedly filed tax forms for about 5,000 investors holding Kinder Morgan Energy Partners in IRAs after its 2014 restructuring and, most recently, Fidelity Investments has announced additional oversight of partnerships in IRAs for 2016.

If you are an individual or institutional investor who has any concerns about your investment in any energy related 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).

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