“I recently heard about 10-86 Plans. Do they have something to do with the oil and gas industry? Would this be a good investment?” – Judy L., Volusia

 

With interest rates at historical lows, a variety of alternative investments have been marketed to “yield-starved” investors. Frankly, I hadn’t heard the term, “10-86” Plan, until I received your question. I did some research and found information referencing Master Limited Partnerships (MLPs). From what I can gather, the term “10-86” is associated with the promotion and marketing of MLPs.

 

In short, an MLP is a special type of limited partnership. Limited partnerships, themselves, are not that unusual; they are a basic form of business ownership with at least one “general” partner (typically an active manager of the business) and one or more “limited” partners (typically passive investors in the business). What makes MLPs different is that they are traded on the major U.S. stock exchanges and that they are required to generate 90% of their revenues from natural resource activities. MLP’s play a significant role in America’s energy infrastructure, including transportation, processing, refining, storage and delivery of the nation’s natural gas, crude oil and refined fuels.

Since MLPs are taxed as partnerships, their investors avoid the double taxation experienced by shareholders of regular corporations (taxation of the company’s net income and then taxation of dividends received by the owners). Unlike a publicly-traded stock, an MLP is subject to the tax treatment of a partnership, which generally means that all tax items pass through to owners of the MLP (the owners receive an annual Schedule K-1). These tax calculations and the reporting can become complex and tedious. For example, MLP owners may have to file taxes in multiple states where the income was earned.

MLPs are marketed with a variety of benefits that could include tax-favored cash flow, stable and predictable distributions, competitive returns and low correlation with other investment types. The latter could make them an effective vehicle to improve a portfolio’s diversification.

MLPs also have a variety of risks to consider that include: volatility in commodity prices, changes in regulatory oversight, tax law changes, higher potential financing costs when interest rates rise, and potential business interruptions due to natural disasters, accidents and terrorism. Another significant and important factor to consider is liquidity: while the liquidity of MLPs has improved with the increasing popularity of exchange-traded funds (which hold a basket of MLPs), the ability to buy and sell could still not be as easy as traditional investments such as equities and bonds.

While I would caution against “loading up” on MLPs, these alternative investments can be a suitable addition to a portfolio. For instant diversification across many MLPs, I would favor buying an exchange-traded fund (ETF), like Alerian MLP ETF (ticker AMLP) or J.P. Morgan Alerian MLP ETN (ticker AMJ), as opposed to an individual MLP.

“David, maybe you could clear something up for me? I just moved from New York to Florida. I was wondering if I have to change my New York will to a Florida one? If I go to a lawyer, I am sure he will tell me I have to change [it].” – Al L., Volusia

 

Meet with a local attorney. Consider it part of your “moving costs” to Florida. A competent, experienced attorney can assess your situation and your documents, and then guide you on whether any changes need to be made. If you are concerned about costs, ask the attorney if the initial meeting is complimentary. If you simply need your will reviewed and don’t have any other issues, ask the attorney if you can pay a flat rate for the review. If there are deficiencies, you can then get a quote for the attorney to prepare the needed documents (if the cost seems high, you can then shop around).

 

“Regarding your recent column about Estate and Gift Taxes, the exemption amount has switched from a million to five million [dollars], and values in between, in the past years. I assume that our government can legislate changes in that number in the future as they have in the past. The question is . . . what happens if the exemption is lowered in the future, and the sum of the previously reported gifts exceed the exemption amount?” – Bill H., Volusia

 

You are exactly right, Bill. Congress and the President can make all sorts of changes to the tax laws, including lowering the Estate and Gift Tax Exemption from its current $5,250,000 per person amount. The higher the exemption amount, the lower the tax revenues collected . . . and most everyone knows that our government currently spends more than it collects in taxes. I would not be surprised to see the exemption amount drop to between $2,000,000 and $3,000,000 as part of some “grand compromise” by our elected officials to address the federal budget deficits. With all that said, tax laws are usually applied on a “going forward basis,” not retroactively. For example, let’s say you used all of your $5,250,000 lifetime exemption amount to make current gifts in 2013. Later, the “grand compromise” occurs and the exemption amount is lowered to $2,250,000. The lower amount would very likely take effect in a subsequent calendar year. To the heart of your question, the $3,000,000 you gave in 2013 in this example would be grandfathered in. It is unlikely that the IRS would go back and hit you with taxes on those prior gifts. For exactly the concerns you expressed, Bill, I have recommended families use all or part of the current $5,250,000 exemption to make gifts to their children and grandchildren, either outright or through the use of special trusts. It is usually prudent take “the bird in hand” when it comes to tax laws.

 

David D. Holland, a CERTIFIED FINANCIAL PLANNER™ practitioner, hosts a weekday radio show. He has also authored two books in his Confessions of a Financial Planner series. Holland offers investment advice through Holland Advisory Services, Inc., a registered investment adviser in Ormond Beach. He can be contacted at (386) 671-7526. Email your financial questions to info@DavidHolland.com.