Home etftrends.com MLPs: Understanding the Tax Treatment of ETFs vs. Direct Investments

MLPs: Understanding the Tax Treatment of ETFs vs. Direct Investments

Direct investments in MLPs come with tax complications; however, investing through ETFs can simplify the experience.

While MLPs are a highly tax-efficient way to own midstream energy infrastructure assets, investors that hold individual MLPs have to deal with the hassle of a K-1 tax form, which typically arrives late in filing season (typically in February or March). In some cases, investors also have to worry about unrelated business taxable income (UBTI), as well as state level income taxes, according to Stacey Morris, head of energy research at VettaFi.

“The benefit of investing in an ETF that holds MLPs, like the Alerian MLP ETF (AMLP), is you don’t have to deal with a K-1 and only in very rare instances do you have UBTI… Importantly, you also don’t have state level income taxes,” Paul Baiocchi, chief ETF strategist at SS&C ALPS Advisors, said during MLPs 101: Dividends, Tax Efficiency, and More on April 11.

“You simplify the ownership or the access to an MLP by owning it through an ETF, and importantly, you diversify away some of the idiosyncratic risk of owning individual MLPs,” Baiocchi added. “If you’re just buying one or two MLPs or three or four MLPs you’re really tied to the performance and the management of those individual companies. If you have a basket of MLPs, you’ve diversified some of that idiosyncratic risk away.”

 AMLP and the Alerian Energy Infrastructure ETF (ENFR) offer an easy way for investors to gain diversified exposure to the industry.

AMLP and ENFR each issue a single 1099 form, eliminating the complexity of a K-1 form. K-1 forms are processed by the issuer of the ETF, and investors are then given a 1099 form. Both ETFs are IRA and 401k eligible and do not generate UBTI.

There are some differences in the tax treatment of AMLP and ENFR due to the different structures of the two funds. ENFR is RIC-compliant, meaning it caps MLP exposure at 25% and thus does not pay taxes at the fund level. The other 75% of the portfolio is U.S. and Canadian energy infrastructure corporations. Since AMLP comprises 100% MLPs, it is structured as a C-Corporation and therefore is taxed at the fund level.

AMLP may be best suited for investors that prefer higher income, tax-deferred distributions, and liquid access to MLPs.

On the other hand, ENFR is best suited for investors who prioritize total return over income or are investing in a tax-deferred account. As the lowest cost energy infrastructure ETF on the market per FactSet, ENFR is also best suited for cost-conscious investors.

For more news, information, and analysis, visit the Energy Infrastructure Channel.

vettafi.com is owned by VettaFi LLC (“VettaFi”). VettaFi is the index provider for AMLP and ENFR, for which it receives an index licensing fee. However, AMLP and ENFR are not issued, sponsored, endorsed, or sold by VettaFi, and VettaFi has no obligation or liability in connection with the issuance, administration, marketing, or trading of AMLP and ENFR.

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