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Linn Energy Vs LinnCo: Cramer Sorts Out the Confusion

Tuesday, 16 Oct 2012 | 6:14 PM ET

What on earth is the difference between Linn Energy (LINE) and LinnCo (LNCO)? Cramer explains."At first glance, you might wonder why the heck LinnCo even exists, " said Cramer. "This company's sole purpose is to own units inLinn Energy , an independent oil and gas producer.

Although the Mad Money host calls Linn Energy 'a tremendous company with an excellent business model, ' he also says Linn Energy stock has a tragic flaw.

"Linn Energy is a master limited partnership, and the rules about how MLPs are taxed, and more important, how their distributions are taxed, are very different from the rules regarding the taxation of ordinary dividends from regular companies, " said Cramer.

Those rules make MLPs very unappealing to certain types of investors. "For example, if you own an MLP like Linn Energy in a tax-favored vehicle like an Individual Retirement Account or IRA, then you might end up paying taxes on Linn's distributions because of something called unrelated business taxable income or UBTI, " Cramer explained.

The other problem with owning an MLP like Linn Energy is that it's complicated.

"Regular companies pay dividends, but MLPs pay distributions, and those distributions are taxed as a return of capital. Generally, that means you don't end up paying any taxes on the distributions until you sell the stock, but the calculations involved are complicated, so it also means that you should really talk to a tax professional if you're going to invest in MLPs. And at the very least you'll have to do a lot of additional paperwork come tax season, " Cramer added.

Cramer: Buy LinnCo for Your IRA
LinnCo went public last week, and Mad Money host Jim Cramer, explains the company's relationship to Linn Energy, and why he thinks investors should buy some LinnCo for their IRA.

That's where LinnCo comes in. Remember, all LinnCo does is own units of Linn Energy, but here's the crucial point, it's a regular corporation. That means you can own LinnCo in your IRA and not get hit with the unrelated business tax.

Digging down into the numbers, "Linn Energy currently pays out $2.90 in annual cash distributions. Every quarter Linn Energy will pay its distributions to LinnCo, which, remember, exists solely to own units in its parent company."

"Then LinnCo has to pay taxes on that money, but the rate will be very low—probably between 2 and 5 percent. And whatever's left after taxes, LinnCo will pay to its shareholders in the form of a regular dividend."

"So if Linn Energy's distribution remains at $2.90, then LinnCo's annual dividend payments will probably come to around $2.74. Which means at these levels, LinnCo would yield 7.2%, actually slightly higher than Linn Energy's 7.1% yield, " Cramer said.

So here's the big question: which one is right for you?

"Personally, I think you should buy some LinnCo for your IRA, because with that 7.2% yield, it's practically the perfect retirement stock, especially if those dividends can compound tax free for the rest of your working life, " Cramer concluded.

Call Cramer: 1-800-743-CNBC

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