IRS Rocks the Boat

Last month, I discussed the perennial worries of MLP investors that some day Congress could revoke the preferential tax treatment MLPs enjoy (see As MLPs Test Limits, Trust Inertia.) Quite the opposite has happened in fact, as in recent years case-by-case Internal Revenue Service (IRS) rulings have expanded the range of activities qualifying for the MLP treatment.

But as the number of entities seeking partnership status continued to grow, so did the potential for a government clampdown. In fact, President Obama’s 2016 budget proposal proposes to treat publicly traded partnerships for fossil fuels as C corporations starting in 2021, which the U.S. Treasury claims would save taxpayers $1.7 billion over the next 10 years.

While this proposal is seen as a long shot, last week the Treasury and IRS did propose new rules that rattled some investors in the nontraditional MLPs. (See: Qualifying Income From Activities of Publicly Traded Partnerships With Respect to Minerals or Natural Resources.)

Some paper and packaging companies, including International Paper (NYSE: IP) and Rock-Tenn (NYSE: RKT), had requested an IRS ruling on spinning off their containerboard operations as MLPs. The new IRS rules appear to preclude that, and sent the shares of many containerboard makers lower. The IRS ruled that once chemicals or foreign substances are added to lumber, sawdust, and woodchips to convert them into paper, pulp and plywood, MLP status is no longer an option.

I had discussed the potential for a future unfavorable ruling in recent columns on the IPO for Enviva Partners (NYSE: EVA), which processes wood chips into wood pellets for export. Enviva doesn’t appear to have been affected by the ruling, and its units continue to trade above the IPO price.

Westlake Chemical Partners (NYSE: WLKP), on the other hand, did not fare so well. Westlake manufactures petrochemicals, vinyls, polymers and building products. The partnership went public last summer after requesting and receiving a favorable private-letter ruling from the IRS to the effect that its business constitutes “qualifying income” for MLP status.

But the new IRS rules say that some activities that qualified under previous private letter rulings will no longer do so. The proposal includes a 10-year grace period for partnerships currently reporting qualifying income from activities that would no longer qualify.

In a press release following the release of the proposed new rules, Westlake acknowledged that “such final regulations would make it difficult or impossible for the Partnership’s production, transportation, storage and marketing of ethylene and its co-products to continue to qualify as ‘qualifying income’ after the proposed ten-year transition period.”

Despite the proposed 10-year transition period, WLKP units lost as much as 30% of their value over the next three days:

Last week’s performance of WLKP vs. the S&P 500

This ruling was also unwelcome news for other chemical companies, such as Methanex (NASDAQ: MEOH), that had hoped to spin off certain assets as MLPs.

The IRS did indicate that this rule wouldn’t affect the vast majority of MLPs. So for most MLP investors, it’s business as usual for now. We’ll have more analysis of the new proposal in the May issue of MLP Profits.  

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