Some Companies That Pay Dividends Without The Double Taxation

Having regular checks coming in buys a whole lot of patience when it comes to a bad market.

With too many folks trying to guess or hope that the market has bottomed, the real way to prepare yourself for if and when they’re wrong is to make sure that you own a big enough base of stocks that pay you to own them.

Dividends are one of the surest means to make this all happen. And it doesn’t matter what age you are or where you are in your investment career — as everybody, and I mean everybody needs a large base of cash paying stocks for their portfolios.

Two Oil Stocks That Pay You

One group of stocks that I have been recommending for many years continues to pay you handsomely to own them: publicly traded partnerships (PTPs).

And in particular — since I started Stocks That Pay You in February — I’ve been recommending two partnerships that are doing exactly what you and I need for our own portfolios.

They are Linn Energy (NASDAQ:LINE) and Enterprise Products Partners (NYSE:EPD).

These are on two sides of the energy market. Linn produces oil and gas from lower-cost fields while Enterprise Products processes and transports petrol and its derivative products.

Linn and Enterprise have outgunned the S&P so far this year. Linn has a return of over 29 percent, while Enterprise has delivered a return of over 18 percent. This compares quite well even to a bounce in the S&P by muliples.

And along the way, dividends are solid and haven’t budged for Linn — paying 63 cents quarter after quarter for the past year — and up from prior years, equating to a yield of over 12 percent.

Meanwhile, Enterprise — being the ideal middleman in the petrol market — keeps upping its payments: currently running at around 54 cents, giving you and me a yield of around 8 percent.

The key of course is that these partnerships have solid assets that keep generating cashflows. They have stress-tested balance sheets and forward looking plans for keeping credit when they need it. And all along the way — even when petrol isn’t that profitable for most — they keep chugging along.

These might be new to you, but they should be high on your list of dividend paying stocks to buy next. For some of you that haven’t yet bought into a partnership, I’ll go through the basics.

The ABCs of Investing in Partnerships

Partnerships — also known as PTPs (Publicly Traded Partnerships) and MLPs (Master Limited Partnerships) — are stock shares that trade on the major exchanges, including the New York Stock Exchange (NYSE) like Enterprise or Nasdaq for Linn.

Unlike regular corporations with publicly traded stock, partnerships don’t pay any corporate-level tax — rather, they effectively pass through the majority of their profits to investors in the form of dividends.

Partnerships raise capital by issuing shares that are also called units. To qualify for partnership status in the US market, a partnership must receive at least 90 percent of its income from qualifying sources that can include a wide variety of businesses ranging from energy and other resources to real estate, infrastructure and a host of other heavy capital intensive industries and businesses.

Partnerships mostly are made up of two basic entities: limited partners (LPs) and a general partner (GP). When you buy a share in a partnership you become an LP owner — entitling you to the cash distributions that come from the basic operation of the partnership business. And of course - just like with ownership of shares in a regular corporation — LP owners do not actively manage or control the assets of the partnership.

The management of a partnership is done by the GP, just like management done by the guys in the executive suites and boardrooms of regular traditional public corporations.

For partnerships, GPs are paid for running the operations for LP owners in two ways:

First, most GPs also own LP units and receive cash flows just like any investor. And second, GPs earn what’s known as an incentive distribution or dividend for their management duties.

The effect of the incentive distribution deal is that the higher the dividends paid to LP shareholders, the higher the management fee paid to the general partner. The idea behind this is to give the GP an incentive to try and boost distributions.

The bottom line is that partnerships are simply another form of incorporating that enables companies with steady cash generating businesses to efficiently raise capital and distribute profits to us regular shareholders.

Not Your Father’s Partnerships

Now, some of you might have bought into a partnership or two way back in the ’70s and ’80s and have a bad memory of the experience.

As you know, the US tax code isn’t always well put together and is fluid over time, resulting in opportunities and pitfalls for those caught on the wrong side of Congress’ fiscal whims.

Back a quarter century ago, the US tax law set up a great ride for the charlatans of the brokerage industry. Under the old IRS tax code, partnerships were able to pass through lots of depreciation and passive losses — which not only could count against partnership revenues for tax liabilities — but also against other passive (and in some cases active) incomes for shareholders of partnerships.

This led to some wild times and way too many abuses. The result was that Congress finally stepped in and ended the fiasco and changed the laws, disallowing the use of phantom tax losses against other non-partnership tax liabilities.

This meant that scam partnerships that were sold to shelter other income became worthless, or worse, for investors. And with all of the bad ones overshadowing the quality ones, the market went through the wringer. Scams were outed, lawsuits filed and settled. But the genuine, quality partnerships that weren’t just tax avoidance schemes went on and continue to provide solid performance for investors.

Partnership Taxation Basics

Moving forward, we now have a long history of tax law that has enabled quality partnerships to thrive, with investors profiting and Uncle Sam getting his cut as well.

Partnerships do not pay corporate taxes like regular common stock companies. The profits are passed directly to shareholders, who then have to pay tax on the dividends. This avoids the double taxation of profits that has continued to be part and parcel of regular common stock corporations.

In addition to not being subject to double taxation — depreciation also works to reduce the partnership shareholder’s taxes.

The annual tax statement from the partnership’s GP, reported by your broker, bank or trust company, will show the gross amount of the dividends that were paid to you as well as how much of the payment is made up of a depreciation allowance — which can amount to as much as the majority of the dividends.

This is considered a return of capital by Uncle Sam and thus reduces the amount of income that is taxable. The catch is that the amount of the return of capital reduces the cost basis of your shares, which then comes into play on any capital gains that you might (and hopefully will) have when you sell your shares in a partnership.

The statements of the dividend income and the depreciation comes not in the form of your regular 1099s, but rather in another very similar form called a K1. But just like with your 1099s, these should just go on to your accountant/taxman with usually no more fuss than with any other investment income tax reporting.

The key of course to all of this is that good partnerships are structured to cut you in on the profits to a greater extent than a regular common stock corporation. That’s why they’re perfect for investors who, like you and me, want to own stocks that pay you to own them month after month and year after year.

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