Linn Energy (NASDAQ: LINE) is America's largest oil and gas master LLC -- which means that its treated as an MLP for tax reasons -- and a favorite among high-yield income investors. The appeal isn't hard to see. A generous 10.7% yield, paid monthly, makes this one of the best ways for long-term investors to profit from the eventual recovery in oil prices. However, there are three reasons I think investors should consider LinnCo (NASDAQ: LNCO), Linn Energy's C-Corp holding company, as an alternative that might make it a better buy for you today: retirement account-friendly nature, simpler paperwork at tax time, and a higher yield.
What's the difference between Linn Energy and LinnCo?
LinnCo represents a holding company whose only asset is units of Linn Energy, from which it receives distributions that it uses to pay out its dividends.
Why would Linn Energy bother creating this C-Corp alternative to its already popular LLC? Two main reasons: First, LinnCo allows Linn Energy to periodically raise additional equity capital to fund its growth. This is a strategy that Linn Energy recently pursued by filing paperwork with the SEC that would allow it to sell $500 million in additional equity capital for both Linn Energy and LinnCo.
Second, by spreading the offerings over two tickers, and using an "at the market" strategy, where shares or units are offered gradually rather than all at once, the dilutionary negative price effects -- secondary offerings frequently cause share prices to crash -- are kept to a minimum. Linn Energy is planning to leverage this $1 billion in new capital to form a joint venture with private-equity group Quantum Energy Partners called AcqCo, which will be able to potentially hunt for $2.5 billion in high-quality oil and gas assets, which are now trading at rock bottom prices thanks to the oil crash.
The new joint venture offers investors in both Linn Energy and LinnCo numerous benefits that should help it grow its payout when oil prices recover.
Simpler tax rules make LinnCo appealing for retirement accounts
The main difference between Linn Energy and LinnCo comes at tax time. LinnCo is a C-Corp, which means it sends investors a 1099 form each year, versus the K-1 investors get from Linn Energy. K-1 forms make tax preparation more complicated, and many financial advisors recommend that MLPs or LLCs like Linn Energy not be owned in tax-advantaged retirement accounts such as IRAs.
This reason is something called UBTI, or unrelated business taxable income. If your retirement account produces more than $1,000 of UBTI in a year, you'll owe Uncle Sam money, even though your account is otherwise sheltered from taxes. It also removes some of the beneficial tax treatments that are one of the key reasons to invest in MLPs in the first place.
LinnCo, on the other hand, is treated as a regular corporation and thus is ideal to own in tax-advantaged retirement accounts, as 100% of its payouts are considered qualified dividends and it generates no UBTI.
Why own LinnCo over Linn Energy?
So simpler tax rules and appropriateness for retirement accounts are two reasons to own LinnCo over Linn Energy, but there's another major reason investors should consider LinnCo over its LLC counterpart -- a higher yield.
As this chart shows, LinnCo's yield is currently 0.7% higher than Linn Energy's, but at times the yield difference between the two has been much greater -- recently as much as about 4%. Now a small yield differential of less than 1% -- the yield differential for most of LinnCo's existence -- is justified by the fact that LinnCo shares usually trade at lower prices because they don't receive some of the tax benefits that Linn Energy units do.
For example, LinnCo estimates that its C-Corp status results in a 2% to 5% tax liability each year for it, while individual investors will be subject to a 3.8% surcharge on net investment income created by the Health Care and Education Reconciliation Act of 2010.
However, the fact that the yield differential does fluctuate also creates periodic opportunities for both higher yield and additional capital gains. By this I mean that when the yield differential grows to greater than 1%, long-term investors might consider LinnCo shares "extra undervalued" relative to units of Linn Energy and choose to invest new cash there, knowing that when the differential returns to normal they will potentially experience additional long-term capital gains in addition to locking in a higher yield.
Note that this strategy applies only in the long term, since in the short term both Linn Energy and LinnCo prices are pretty much at the mercy of oil prices, which are extremely volatile, and whose short-term crashes can easily wipe out any small profits generating by this yield differential.
Bottom line: A higher yield and retirement account-friendly tax nature make LinnCo worth considering over Linn Energy
Don't get me wrong. I'm not saying the short term may not prove painful for investors in either Linn Energy or LinnCo, as oil prices are unpredictable and might drop even further. However, for investors with long-term time horizons of five or more years, the higher yield and retirement account-friendly nature of LinnCo mean that investors should have it at the top of their watchlists as a great way to generate substantial income while potentially profiting from crude's eventual recovery. In addition, LinnCo's periodic yield divergence from Linn Energy's offers substantially higher yield opportunities for the same high-quality oil and gas assets. Thus I'd recommend that long-term high-yield investors keep both on their radar.