ESSAY ON TAXATION OF PASSIVE INCOME

Partners in a trading partnership have substantial tax benefits due to

the treatment of the partnership as generating neither passive nor
portfolio items for income tax purposes.

Generally, a partner who does not materially participate in a

partnership's trade or business activity is considered to be passive with
respect to the activity, thereby potentially limiting his ability to deduct
losses from the activity. However, a partnership engaged in trading
securities is not a passive activity for its partners, according to Temp.
Regs. Sec. 1.469-1T(e)(6).

Further, the distributive share of income and deductions of a trading

partnership is not treated as portfolio income and deductions as it
would be for a partner in an investment partnership. Trader status is
determined at the partnership level with the benefits of the trading
activity passed out to the individual partners, even if they are limited
partners and without regard to their participation in the activity.

The tax benefits for an individual partner of a trading partnership (in

contrast to a partner in a passive or investment partnership) include:

* No passive loss limitations: Partners can fully deduct their share of

the partnership's operating expenses (such as rent, salaries, office
expenses and professional and management fees), without regard to
the passive loss limitations.

* Above-the-line deduction of operating expenses: The distributive

share of the partnership's operating deductions is deductible when
computing adjusted gross income (AGI), rather than as a miscellaneous
itemized deduction. Thus, partners in a trading partnership are not
subject to the following limitations on operating deductions:

1. Miscellaneous itemized deductions are deductible only to the extent

they exceed 2% of AGI; and

2. Certain itemized deductions are deductible only to the extent they

exceed 3% of the excess of AGI over a threshold amount.

The above-the-line deduction also causes a reduction in AGI, which

may permit a greater deduction for medical expenses, as well as
miscellaneous and overall itemized deductions.

* Elimination of AMT issues: A partner in an investment partnership

cannot deduct any of his share of the partnership's operating expenses
against the alternative minimum tax (AMT) because the deductions are
treated as miscellaneous itemized deductions, not deductible when
computing the AMT. Since a partner in a trading partnership deducts
these expenses as trade or business expenses when computing AGI,
they are allowed in full against the AMT.

Generally, losses from passive activities that exceed the income from
passive activities are disallowed for the current year. Unused passive
losses are carried forward to all future years. A similar rule applies to
credits from passive activities.

“Passive activities are trade or business activities in which you do not

materially participate. In general, all rental activities are passive
activities, even if you do materially participate. You materially
participate in an activity if you are involved in the operation of the
activity on a regular, continuous, and substantial basis. Rental real
estate activities are not passive activities if you are a real estate
professional and meet certain requirements. Guidelines for
determining material participation and the rules for a real estate
professional can be found in Publication 925, Passive Activity and At-
Risk Rules.

A special rule applies for rental real estate activities in which you
actively participate. The rules for active participation are different from
those for material participation and are also discussed in Publication
925.

Rules passed as part of the Tax Reform Act of 1986 that limit the
amount of income investors can shelter from current tax. Losses can
be deducted from passive activities only in the amount to which
income results from passive activities. Furthermore, losses from one
passive activity can be used only to offset the passive income earned
from a similar passive activity. For example, losses from publicly
traded partnerships can be applied only to offset passive income
earned from publicly traded partnerships.”

Basic Tax Principles for MLP Investors

Owning units (shares) in an MLP is different from owning corporate

stock in a number of
ways, most notably their taxation. That is because an MLP is a
partnership, and you, as
an investor, are a limited partner. To understand how an MLP investor
is taxed, it helps
to know the basic principles of partnership taxation.
Partnership Tax Basics: Income

• An MLP, like all partnerships, is a pass-though entity which pays no

tax itself. It is
treated by the tax code not as a separate entity but as a collection of
partners.
• The unitholder, as a limited partner, is treated for tax purposes as if
he is directly
earning the MLP’s income.
• Each unitholder is allocated on paper a proportionate share of the
MLP’s income,
gain, deductions, losses, and credits. This is reported annually on the
K-1 form.
• The unitholder calculates his share of taxable income and pays tax
on it at his own
tax rate. The tax is owed whether or not the unitholder receives a cash
distribution

Partnership Tax Basics: Distributions

• The quarterly cash distributions are not the same as your share of
the MLP’s
income.
• Under the tax code, the distributions are a return of capital and are
not taxed when
received.
• Your basis in your partnership units (the amount you paid, increased
or decreased
by various adjustments) is lowered by the amount of the distribution.
• Thus, when you sell your units, your taxable gain (sales price minus
adjusted basis)
is increased by the amount of the distributions.
• Often you will hear someone say that “80% (or a similar number) of
the MLP’s
distribution is tax-deferred.” As long as your distribution is less than
your basis, it is
100% tax-deferred. What they mean is that your share of the MLP’s net
taxable
income equals about 20% of the tax-deferred distribution.

Basis Adjustments
• Basis is used to determine your gain or loss when you sell your units.
• Your initial basis is the price you paid for your units.
• Your cash distributions adjust your basis downwards.
• Your share of taxable partnership income each year adjusts the basis
upwards.
• Your share of deductions like depreciation adjusts it downwards.

• As long as your adjusted basis is above zero, tax on your

distributions is deferred
until you sell your units. If it reaches zero, future cash distributions will
be taxed as
capital gain in the year received.

• If a unitholder dies and the units pass to his heirs, the basis is reset
to the fair
market value of the units on the date of death, and the prior
distributions are not
taxed.

Gain and Recapture

When you sell our MLP units, your taxable gain is the difference
between the sales
price and your adjusted basis.
• Not all of the gain when units are sold is taxed at capital gains rates.
• The gain resulting from basis reductions due to depreciation is
taxed at
ordinary income rates—this is called “recapture.”
• Gain attributable to your share of some types of assets held by
the MLP—
substantially appreciated inventory and unrealized receivables—
is also taxed
as ordinary income.
• These items will be reported on the K-1 for the year in which you sell
your units
Basis Adjustments

I. Partnership Investment Information for Buckeye Partners,

L.P

Buckeye Partners is a publicly traded master limited partnership.

Buckeye partnership units are traded on the New York Stock Exchange
under the ticker symbol BPL. Investors may buy and sell BPL units
through any registered securities broker or through a direct purchase
plan which offers a distribution investment option. They are inviting
new investments and the plan brochure available in their website;

Partnership Characteristics
As a publicly traded partnership, Buckeye Partners, L.P. differs in
several ways from stock corporations:

• A partner in a publicly traded partnership owns units of the

partnership rather than shares of stock and receives cash
distributions rather than dividends. The cash distributions are not
taxable as long as the partner's tax basis in the partnership
exceeds zero.
• Generally, a corporation is subject to federal and state income
taxes but a partnership is not. All of the income, gains, losses
and deductions of a partnership are passed through to its
partners who are required to show their allocated share of these
amounts on their personal income tax returns.
• While a holder of corporate stock receives a Form 1099 each
year detailing required tax data, a unit holder of a partnership
receives a tax reporting package including substitute Schedule K-
1 and other forms to file with their income tax return. This tax
reporting package shows a partner's allocable share of the
partnership's income, gains, losses and deductions.
• Compared to a corporate form of organization, the partnership
form enables Buckeye to distribute to investors a greater
percentage of cash generated by the business.

According to that the Computershare Investment Plan,

the purpose of the Plan is to provide interested investors with a simple,

convenient, and affordable way to invest funds and reinvest
distributions in unit of Buckeye Partners, L.P. at prevailing market
prices with relatively low transactional costs , the key features of the
plan are

• Low Processing Fees and Service Fees.

• Book-Entry Unit Ownership-Safekeeping.
• Build Your Ownership Over Time
• Acquire Fractional Units
• Easy Withdrawal, Sale or Transfer
• Automatic Investments.
• Online Investing.

Coming to its tax part offer the investor will receive, if applicable, a
K-1 tax form to assist them in preparing your income tax return.
Automatic reinvestment of distributions does not relieve the investor of
any income tax that may be payable on his partnership earnings

Any account with an uncertified social security number or taxpayer

identification number will be subject to backup withholding tax at the
current applicable rates. Any account that is Form W-8BEN certified for
foreign status will be subject to Non-Resident Alien (NRA) withholding
tax at the current applicable rates.

Loss Limitations

The deduction by a unit holder of that unit holder’s allocable share of

partnership losses will be limited to the amount of that unit holder’s
tax basis in his or her LP units and, in the case of an individual unit
holder or a corporate unit holder who is subject to the “at risk” rules
(generally, certain closely-held corporations), to the amount for which
the unit holder considered to be “at risk” with respect to their
activities, if that is less than the unit holder’s tax basis. A unit holder
must recapture losses deducted in previous years to the extent that
distributions cause the unit holder’s at risk amount to be less than zero
at the end of any taxable year.

Losses disallowed to a unit holder or recaptured as a result of these

limitations will carry forward and will be allowable as a deduction to
the extent that his at-risk amount is subsequently increased, provided
such losses do not exceed such Unit holder’s tax basis in his LP units.

Upon the taxable disposition of an LP unit, any gain recognized by a u

nit holder can be offset by losses that were previously suspended by
the at risk limitation but may not be offset by losses suspended by the
basis limitation.

In general, a unit holder will be at risk to the extent of the unit holder’s
tax basis in the unit holder’s partnership units, excluding any portion of
that basis attributable to the unit holder’s share of partnerships non
recourse liabilities, reduced by (i) any portion of that basis
representing amounts otherwise protected against loss because of a
guarantee, stop loss agreement or other similar arrangement and (ii)
any amount of money the unit holder borrows to acquire or hold the
unit holder’s partnership units if the lender of such borrowed funds
owns an interest in us, is related to such a person or can look only to
LP Units for repayment. A unit holder’s at risk amount will increase or
decrease as the tax basis of the Unit holder’s LP Units increases or
decreases, other than tax basis increases or decreases attributable to
increases or decreases in the unit holder’s share of partnership no
recourse liabilities.

The passive loss limitations generally provide that individuals, estates,

trusts, certain closely-held corporations and personal service
corporations can deduct losses from passive activities, which include
any trade or business activity in which the taxpayer does not
materially participate, only to the extent of the taxpayer’s income from
those passive activities.
Moreover, the passive loss limitations are applied separately with
respect to each publicly traded partnership. Consequently, any passive
losses that the partnership generate will only be available to unit
holders who are subject to the passive loss rules to offset future
passive income that the partnership generate and, in particular, will
not be available to offset income from other passive activities,
investments or salary.

Passive losses that is not deductible because they exceed a unit

holder’s share of income may be deducted in full when the unit holder
disposes of the unit holder’s entire investment in the partnership in a
fully taxable transaction to an unrelated party. The passive activity loss
rules are applied after other applicable limitations on deductions such
as the at-risk rules and the basis limitation.

II. QR ENERGY, LP

The following details they provided for the investment prospects for
their IPO

Company Description

QR Energy is a Delaware limited partnership formed by affiliates of the

Fund to own and acquire producing oil and natural gas properties in
North America. Their properties consist of mature, legacy onshore oil
and natural gas reservoirs with long-lived, predictable production
profiles. As of June 30, 2010, their total estimated proved reserves
were approximately 30.0 MMBoe, of which approximately 69% were oil
and NGLs and 69% were classified as proved developed reserves. As of
June 30, 2010, we operated 83% of their assets, as measured by value,
based on the estimated future net revenues discounted at 10% of their
estimated proved reserves, or standardized measure. Their estimated
proved reserves had standardized measure of $474.2 million as of June
30, 2010. Based on their pro forma average net production for the six
months ended June 30, 2010 of 5,127 Boe/d, their total estimated
proved reserves had a reserve-to-production ratio of 16.0 years.

Description of Business

They are a Delaware limited partnership formed by affiliates of the

Fund to own and acquire producing oil and natural gas properties in
North America. Their properties consist of mature, legacy onshore oil
and natural gas reservoirs with long-lived, predictable production
profiles. As of June 30, 2010, their total estimated proved reserves
were approximately 30.0 MMBoe, of which approximately 69% were oil
and NGLs and 69% were classified as proved developed reserves. As of
June 30, 2010, they operated 83% of their assets, as measured by
value, based on the estimated future net revenues discounted at 10%
of their estimated proved reserves, or standardized measure. Their
estimated proved reserves had standardized measure of $474.2 million
as of June 30,

2010. Based on their pro forma average net production for the six
months ended
June 30, 2010 of 5,127 Boe/d, their total estimated proved reserves
had a reserve-to-production ratio of 16.0 years.

We believe their business relationship with the Fund enhances their

ability to grow their estimated proved reserves over time. The Fund is
a collection of limited partnerships formed by the founders of Quantum
Energy Partners and Don Wolf, the Chairman of the Board of their
general partner, for the purpose of acquiring mature, legacy producing
oil and natural gas properties with similar characteristics to the
Partnership Properties. After giving effect to its contribution of the
Partnership Properties to us, the Fund had total estimated proved
reserves of 53.5 MMBoe, of which approximately 79% were classified
as proved developed reserves, with standardized measure of $560.7
million as of June 30, 2010, and interests in over 1,000 gross (630 net)
oil and natural gas wells, with pro forma average net production of
approximately 12,518 Boe/d for the six months ended June 30, 2010.
They believe that the majority of the Fund’s retained assets are
currently suitable for acquisition by us, based on their criteria that
properties consist of mature, legacy onshore oil and natural gas
reservoirs with long-lived, predictable production profiles. The Fund
has informed us that it intends to offer us the opportunity to purchase
these mature onshore producing oil and natural gas assets, from time
to time, in future periods. The Fund has no obligation to sell properties
to us following the consummation of this offering, and except as
provided in the omnibus agreement, the Fund has no obligation to
offer additional properties to us following the consummation of this
offering.

Properties

Their properties are located across four diverse producing regions and
consist of mature, legacy onshore oil and natural gas reservoirs with
long-lived, predictable production profiles. Approximately 72% of their
estimated reserves as measured by value, based on standardized
measure, have had associated production since 1970. As of June 30,
2010, they produced from 2,099 gross (534 net) wells across their
properties, with an average working interest of 25%, and a 66% value-
weighted average working interest, which is calculated by dividing (a)
the aggregate sum of the products of each property’s working interest
and standardized measure as of June 30, 2010 by (b) the aggregate
standardized measure for all properties, as of June 30, 2010. Based on
their June 30, 2010 reserve report, the average estimated decline rate
for their existing proved developed producing reserves is
approximately 9% for 2011, approximately 9% compounded average
decline for the subsequent five years and approximately 8% thereafter.
As of June 30, 2010, approximately 9.4 MMBoe, or 31%, of their
estimated proved reserves were classified as proved undeveloped.
Such proved undeveloped reserves were approximately 82% oil and
included 325 identified low-risk infill drilling, recompletion and
development opportunities in known productive areas. Based on the
production estimates from their reserve report dated June 30, 2010,
They believe that through 2015, their low-risk development inventory
will provide us with the opportunity to grow their average net
production to approximately 5,600 Boe/d,
without acquiring incremental reserves.

(1) The degree of depletion of proved reserves with respect to each

region was calculated by dividing the proved reserves for such region
as of June 30, 2010 by the sum of proved reserves for such region as of
June 30, 2010and the cumulative production from that region.

(2) Standardized measure is calculated in accordance with SFAS No.

69, Disclosures about Oil and Gas Producing Activities, as codified in
ASC Topic 932, Extractive Activities Oil and Gas.

“Because we are a limited partnership, are generally not

subject to federal or state income taxes and thus make no
provision for federal or state income taxes in the calculation of
our standardized measure. “
(3) Includes estimated oil reserves attributable to an 8.05% overriding
royalty interest on oil production from the Fund’s 92% working interest
in the Jay Field, which represents approximately 4% of our pro forma
average net daily production for the six months ended June 30, 2010.

Source: Market screen, Yahoobuz.com , IRSfilings, SEC filings,

natpt.com, SEC fileing, computer share