Monday Mailbag: Renovations and Reform

Do you think the beneficial tax status of MLPs will be eliminated?

My sister is the queen of home renovation projects. She can paint a room, reupholster a chair, and evenly hang three frames side-by-side before breakfast. Her most recent project was revamping and repurposing a 30-year-old chest of drawers.

2015.07.20 Renovations and Reform - Picture

Speaking of things that are 30 years old and need a facelift, the tax code could benefit from a little revamping too. The last time we saw an overhaul was in 1986, and many speculate that it’s about time for the Senate Finance Committee to take on an improvement project.

Lawmakers might not be quite as gung-ho as my paint-slinging sister, however. I remember being at an MLP conference in mid-2014 and the topic of tax reform came up. The speaker said with great confidence that tax reform had almost no chance of happening anytime soon due to midterm elections. He was right. A couple of weeks ago, when I was on a call with an MLP tax attorney, the question of tax reform inevitably reared its head. His opinion was that it’d be unlikely for anything to occur this close to the upcoming election. So, if within a year and a half of elections is a no-go and in the year of midterm elections is also blocked out, that leads me to conclude that 2017 is the only possible year for tax reform in the next half decade.

Not only is there a narrow window for tax reform, MLP status will most likely hang around because it is already limited. Much of what drives this fear for investors comes from speculation that the US could see its own version of the “Halloween Massacre” which occurred in Canada in October 2006. In short, Canada announced that it would eliminate its version of the MLP structure, and investors suffered double-digit losses that day. The reason these two shouldn’t be painted with the same brush is that in the US, the scope of MLPs was already pared down in 1987, when Congress created Section 7704 of the tax code, which strictly limited the types of income-generating activities that would qualify for MLP tax treatment. Canada’s situation was a bit different in that they eliminated the entire structure and everyone was caught off guard.

The recent re-introduction of the MLP Parity Act may point to another reason why MLPs are here to stay. The MLP Parity Act seeks to expand the definition of qualifying income beyond depleting sources like oil and gas to include renewable energy. In the same way that you’d likely not buy new furniture for a house you were planning on burning down, it wouldn’t really make sense for legislators to consider adding to a structure they were planning on eliminating.

Finally, the tax advantages available for MLPs help channel investor capital toward energy—and infrastructure in particular—which is needed to meet national goals of energy security. Last year, the Interstate Natural Gas Association of America (INGAA) estimated that $641 billion will need to be invested in North American midstream infrastructure over the next 20 years. With this in mind and given the enormous amount of new jobs that come with the investment, it seems highly unlikely that the government would cut off the oxygen to a thriving asset class.

While sealing certain tax loopholes could affect some E&P companies, MLPs will likely remain largely unscathed. And although it is not our intention to paint over investor worries, given all the available facts, knocking down the framework of the MLP structure seems to be a reasonless renovation.

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