How to Earn 25% a Year from an Obscure Tax Loophole
By Tom Dyson
January 22, 2008
In 1986, Tom Boyd and his wife moved to Oxnard, California, to be closer to the ocean.
Tom was 50 years old. He'd just quit his job at Chrysler in Indiana, where he'd spent 17 years working as a tooling engineer. His kids had moved away from home. Tom was ready for a new life.
That's when the million-dollar business idea struck him...
A friend had mentioned that Texas would soon be celebrating the 150-year anniversary of the Battle of the Alamo. Boyd's idea was a candy tin in the shape of Texas, decorated with a map of the state and its major landmarks.
Boyd built a prototype, found a sales representative, and started selling loads of his candy boxes in airport gift stores.
Of course, 49 other states have their own airport gift shops. But
Boyd needed financial help to make more prototypes. The banks wouldn't lend him money... He had no track record. Then one day, Boyd met a welder at the local community college. Boyd's business idea impressed the welder, who invested $13,000 in Boyd's California-shaped box in exchange for 45% of the net earnings.
Lawyers call this arrangement a "partnership." There's no corporation, no stock, no dividends, and no taxes. It's just two men in business together. The profits from the business flowed straight into their bank accounts. Then they paid tax on their annual incomes, like everyone else.
Tom's California candy tin turned out to be a hit. He started producing the boxes in his garage, then moved to occupy 1,200 square feet in the corner of a factory. Eventually, Boyd got his own 20,000-square-foot factory and a huge contract with Disney to produce boxes with Disney characters on the lids...
I found Tom Boyd's story in a 1989 issue of Inc. magazine. The column is about the benefits and drawbacks of limited partnerships. The biggest benefit is not having to pay taxes…
One of the secrets of income investing is avoiding tax. When you avoid tax, you generate higher returns without taking on more risk. Consider what an efficient income investment Tom's candy tin was for the welder. The profits from this business flowed straight through to his bank account as if he were working right alongside Tom Boyd in his factory. He paid no tax along the way.
If he'd made the same investment in a successful candy-tin corporation, he wouldn't have received a penny until after the government had taken a 35% corporation tax from the company's profits. Then the government would tax his dividends again (at the 15% dividend rate) when he filed his income taxes.
What you might not know is that you can invest in partnerships just like Tom Boyd's candy-box business through the stock market. The yields from these "master limited partnerships" (MLPs) are much higher than yields on investments of similar risk...
Today, 88 businesses qualify for partnership status under the government's rules. And as you can see from the table, they generate high returns for their owners.
Returns from 1998 to 2008 |
|
Total |
Annualized |
Alerian MLP Index |
253% |
13.5% |
S&P 500 |
76% |
6% |
Russell 2000 |
96% |
7% |
S&P REIT Index |
118% |
8% |
S&P Utility Index |
130% |
8.5% |
According to Merrill Lynch's research, REIT dividends have averaged 6.6% over the last 10 years, utility dividends have averaged 4%, but MLP dividends have averaged 7.9%.
You likely know several MLPs already. Kinder Morgan used to be part of Enron. Carl Icahn's company – Icahn Enterprises (formerly American Real Estate Partners) – is a partnership. And though you've probably heard of Blackstone Group and its private-equity operations, you may not know Blackstone is also structured as an MLP.
Most partnerships are energy businesses. In fact, most of them operate pipelines. The rest are in real estate. The government wanted to give these businesses a big incentive to expand the national infrastructure. In essence, it gave them an incredible advantage: They don't have to pay tax.
These partnerships simply have to return all their earnings back to the partners every year, just like Boyd's candy-box business.
If you're serious about beating the market... and generating high dividend yields... I suggest you look at the MLP sector of the stock market.
Check out the National Association for Publicly Traded Partnerships for a full list of the partnerships and other information.
Good investing,
Tom
Editor's note: Tom Dyson is a regular contributor to DailyWealth, a free investment newsletter focused on the world's best contrarian opportunities. We write with a simple belief in mind: You don't have to take big risks to make big money with your investments.
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