MLPs And Other Tax Preference Investments On The Chopping Block

Includes: AMJ, EPD, GLD, MUB, SDY, VNQ
by: Richard Shaw

Energy master limited partnerships are in the cross-hairs of tax increase intentions of the current U.S. administration (a.k.a. "the Buffett tax"), as are several other tax preference investment categories. Those others include, dividend stocks, municipal bonds and probably equity REITs.

As a result, we expect extra levels of volatility in those groups as the tax and spending debate continues through the remainder of this year.

Even though not all investors may be personally taxed at higher rates, if larger investors who may account for a significant share of total investment in those groups are taxed at higher rates, the impact on prices would logically be negative.

Capital gains on all assets are also in the cross-hairs.

Anytime the potential return of an investment goes down, whether arising from the investment itself or externally due to taxes, investors will bid the price down.

Because the spectrum of assets under the tax change focus is so broad, we would expect a further backing away from stocks until the matter becomes more clear.

AMJ is an ETN tracking the 50 largest MLPs (mostly energy pipelines), and Enterprise Products Partners (NYSE:EPD) is the largest MLP. Their charts follow.

We have previously published a series of articles detailing attributes of MLPs.

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Even though AMJ is a bond, and not an MLP, it tracks MLPs, and would therefore be impacted in the same way as the MLPs themselves.

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SDY (the S&P 500 Dividend Aristocrats ETF) is a representative of dividend stocks, which would probably suffer if a minimum tax rate is imposed on upper income tax rates. Even if the lower capital gains tax rate is maintained, but there were an overriding minimum tax on all income, dividend stocks would suffer.

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Municipal bonds are at risk, and were separately named in a different release about the president's jobs plan (see our article about that).

MUB is a representative fund for muni-bonds, which we would expect would suffer if a minimum overriding "Buffett tax" were imposed.

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Equity REITs are probably also at risk under the Buffett Tax as well. If the character of income coming out of REITs is not maintained for all investors (if an overriding Buffett Tax trumps depreciation), then equity REITs would logically suffer as well.

VNQ is a representative equity REITs.

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Thinking the Unthinkable Side-Bar
These days thinking outside of the box is more important than usual.

One possibility - we are not saying a probability - is a punitive tax on gold investments.

Gold ownership was punished in the 1930s and it could happen again.

Since gold ownership today includes certificated ownership as well as physical ownership, a more sophisticated approach than the physical confiscation of the 1930s would be likely.

We would not put a zero probability on gold ownership being termed as "anti-social" or betting against America, and somehow taxed on gains at an even higher rate than now, and higher than even the Buffett Tax.

We don't believe gold is anti-social. It is based on a lack of faith and trust in paper money. However, since paper money is the child of government, we can see how some might view avoiding currency and debt of the government and corporations, and ownership of companies, as anti-social in some way that deserves anti-gold-owner tax policy.

It is not possible, in our view, to raise investment taxes on the wealthy, however they are defined, without negatively impacting returns for the market overall. Therefore the cost of the rich paying what is being termed their "fair share" would not be borne by them alone.

The same is true for corporate taxes. Higher corporate taxes get translated as higher product and service prices, which is a cost borne by all.

On top of that, higher product and service prices, reduce export competitiveness, which is a negative for jobs, which in turn has a negative impact on stock prices - a cost borne by all.

We do not believe it is possible to isolate a tax cost within one group from collateral impact on the total system.

Overall, under the Buffett tax, or any other tax effectively targeting investments, many risk assets would be seen as worthless.

Ordinary interest income would see no change in tax rates under the Buffett Tax. As a result, a partial shift from stocks to bonds would be likely. That would only amplify a current tendency toward that shift as the baby boomers move into a more risk averse period of their lives.

QVM has long positions in GLD in some accounts and does not have positions in any other mentioned security as of the creation date of this article (September 19, 2011).

This article provides opinions and information, but does not contain recommendations or personal investment advice to any specific person for any particular purpose. Do your own research or obtain suitable personal advice. You are responsible for your own investment decisions. This article is presented subject to our full disclaimer found on the QVM site available here