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A MLP ETF With a Catch

The ALPS Alerian MLP ETF not only offers investors a chance to invest in a basket of master limited partnerships but it promises to minimize the hassles at tax time.
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NEW YORK (TheStreet) -- ALPS may have a hit on its hands with the launch of the ALPS Alerian MLP ETF (AMLP) - Get Alerian MLP ETF Report. This fund's introduction marks the first time investors can gain access to a basket of master limited partnerships in an ETF form.

ALPS' offering follows a growing trend within the exchange-traded product universe of firms that are launching products aimed at tracking companies responsible for transporting and storing natural gas and other fuels.

The energy sector has always a popular investing destination as players look for opportunities to bank on our insatiable appetite for power. Recently, master limited partnerships, which boast large distributions, have become particularly popular as sources of comfort during these turbulent times.

According to its factsheet, the dividend yield for the Alerian MLP Infrastructure Index which underlies AMLP was nearly 7% as of the end of June.

While attractive, the strong yields from MLPs come with a catch making them more complex than other asset classes when tax time comes around.

MLPs such as

Kinder Morgan Energy Partners



Magellan Midstream Partners

(MMP) - Get Magellan Midstream Partners, L.P. Report


Plains All American Pipeline

(PAA) - Get Plains All American Pipeline, L.P. Report

pass through their income to investors which results in a K-1.

Traditionally, exchange traded products designed to track MLPs have been structured as exchange traded notes in order to avoid having to issue K-1s. Rather than tracking an actual basket of MLPs,

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TheStreet Recommends

JPMorgan Alerian MLP ETN

(AMJ) - Get J.P. Morgan Alerian MLP Index ETN Report

and UBS

E-TRACS Alerian MLP Infrastructure ETN

(MLPI) - Get ETRACS Alerian MLP Infrastructure Index ETN Report

are set up as unsecured debt obligations.

Any income payments from these funds are reported on the standard 1099 form. Although they skirt some confusion around tax time, ETNs carry added credit risk which may dissuade cautious investors from jumping aboard.

AMLP, on the other hand, is structured as an ETF. Because it tracks an index, one would expect that investors holding AMLP would be presented with a K-1. Interestingly, however, the fund promises to mimic its ETN competitors and avoid issuing a K-1.

AMLP's prospectus attempts to explain how it manages to avoid hassles at tax time. According to the paperwork, AMLP is taxed as a regular corporation. This means the fund is required to pay federal, state, and foreign corporate taxes on its taxable income. Currently the federal income tax rate applicable for corporations is 35%.

This is unlike most other investment companies, which are treated as regulated investment companies, allowing them to avoid paying state and federal taxes on their taxable income.

The tax structure that comes with owning AMLP is the sacrifice that investors will have to make if they want to own an actual basket of MLPs rather than an unsecured debt note issued by


(JPM) - Get JPMorgan Chase & Co. Report

or any of the other firms offering MLP ETNs. For now, investors appear willing to accept this, as AMLP has already managed to amass an average volume of over 500,000.

The showdown in the MLP arena is getting heated and there is no doubt that more companies will soon be entering the fray with their own products designed to track this attractive asset class. Investors need to be cautious and do their homework, however, before diving in. Nobody wants to be caught by surprise when tax season rolls around.

-- Written by Don Dion in Williamstown, Mass.

At the time of publication, Dion Money Management did not own any equities mentioned.

Don Dion is president and founder of

Dion Money Management

, a fee-based investment advisory firm to affluent individuals, families and nonprofit organizations, where he is responsible for setting investment policy, creating custom portfolios and overseeing the performance of client accounts. Founded in 1996 and based in Williamstown, Mass., Dion Money Management manages assets for clients in 49 states and 11 countries. Dion is a licensed attorney in Massachusetts and Maine and has more than 25 years' experience working in the financial markets, having founded and run two publicly traded companies before establishing Dion Money Management.

Dion also is publisher of the Fidelity Independent Adviser family of newsletters, which provides to a broad range of investors his commentary on the financial markets, with a specific emphasis on mutual funds and exchange-traded funds. With more than 100,000 subscribers in the U.S. and 29 other countries, Fidelity Independent Adviser publishes six monthly newsletters and three weekly newsletters. Its flagship publication, Fidelity Independent Adviser, has been published monthly for 11 years and reaches 40,000 subscribers.