Canadian trust investors got more tax news to ponder this week. Rep. Richard E. Neal (D-Mass) has filed a bill, which has been referred to the House of Representatives’ Ways and Means Committee, that would codify taxation of trust distributions as “ordinary income” in the US.

The threat that such a bill might pass appears to be having at least some affect on prices of certain trusts today. However, this development is hardly the catastrophe some are painting it.

For starters, trusts held in IRA accounts are wholly unaffected. In fact, the Canadian government is apparently in the process of repealing the 15 percent withholding tax, which would make it much more attractive to hold Canadian equities, including trusts, in IRAs.

In addition, many US investors have already been paying full rate on their trust distributions. That’s because brokers continue to send out erroneous Form 1099s. Also, the marginal tax rates of most US trust investors are well below top rate. In fact, they’re far below it for many of the Canadian Edge readers I’ve talked to.

Ironically, the immediate effect of this is a major positive. Investors now have the ultimate ammunition for declaring their trust distributions as qualified dividends for 2006, as well as for all previous years. That includes the mutual funds and pure royalty trusts as well. After all, if these trust dividends weren’t qualified, why would it be necessary to pass a bill to change their status?

There’s a risk here: The threat of a bill may trigger further selling from despondent US investors. Handicapping any bill’s chance of passage is highly speculative, and until this one either fails or sails, it presents more uncertainty on that basis.

In my view, however, it would be a serious mistake to react precipitously to this. It all really boils down to one question: Is the only appeal of the trusts you own their tax status, or is it that they have strong businesses that are becoming more valuable?

If it’s all about the business, then you have no business selling. Strong trusts continue to trade at hefty discounts to equivalent corporations on both sides of the border.

Even if the “Tax Fairness Act” survives in its current form, no trust will pay additional taxes until after 2011. And with the average Canadian corporation paying an effective tax rate of just 6.6 percent, there will be plenty of loopholes for most to minimize taxes thereafter.

Moreover, as I’ve pointed out, a growing number of trusts have declared their intention to continue paying big dividends well after 2011. Some like Yellow Pages Income Fund (YLO.UN, YLWPF) have gone so far as to say they won’t be cutting dividends at all when the Tax Fairness Act kicks in and requires them to be taxed as corporations. And many are showing their ability to make good on those pledges as their businesses expand and their cash flows rise.

Furthermore, the rules on real estate investment trusts (REITs) were clarified this week to the effect that virtually all will retain their exemption after 2011 And oil and gas is all about energy prices and what the trusts have in the ground. There will be ups and downs. But as long as energy is in a bull market, good oil and gas producer trusts are going a lot higher in coming years, no matter how they’re taxed.

It’s certainly possible we’ll see more selling in the days ahead as some throw up their hands and walk away. But increasingly in the past few months, every time the weaker hands panic, private capital has come in behind the selling to grab shares of good trusts at discounts. These are the guys who really crunch the numbers, and they’re obviously seeing a whole lot of emerging value.

If you’re really worried about the potential impact of the tax bill, the best way to avoid sleepless nights is to move your trusts into an IRA account. That way, they’ll be tax-free no matter what Washington does or doesn’t do. But I would use any weakness in coming days to add to positions in our favorites—not reduce them—just as private capital no doubt will.

I also have one other suggestion. Drop your representative a line expressing your opposition to this bill. Our campaign against the 15 percent Canadian withholding last year didn’t wholly succeed, but it certainly got the attention of the members.

I suspect many members are wholly unaware of this bill, and all it will take is a little prodding to stir up opposition. In the meantime, hang in there with high-quality trusts.

Below is a possible sample letter. Remember to be courteous.

Dear Rep. XXX:

I’m a [retiree, pensioner, individual investor, working person saving for the education of my children]. I write to express my concerned opposition to a bill introduced by Massachusetts Rep. Richard Neal that would revoke Canadian income trusts’ qualified dividend status.

Like many who depend on their savings, I rely heavily on dividends from my investments. The tax-advantaged status of dividend income has been a major benefit to me in the past few years. In fact, as yields on traditional instruments such as money market funds and bonds have fallen, it’s become ever more important.

I don’t invest exclusively in one particular sector. But Canadian income trusts are an ideal savings vehicle because they represent strong businesses that pay high dividends. The discipline of paying above-average distributions forces a certain degree of transparency on them that, quite frankly, I wish more US corporations would adopt.

I read that Rep. Neal is pitching his bill as righting some kind of unfair advantage conferred on these investments versus ordinary US stocks. Leaving aside the question of why US stocks don’t pay higher dividends, this is based on a flatly erroneous assumption.

It’s true the trusts themselves don’t pay Canadian income taxes. As a US investor, however, I’m taxed in Canada at a withholding rate of 15 percent for all distributions received. I’m then taxed again in the US, currently at the 15 percent qualified dividend rate.

The Neal tax does nothing to change the taxation of the trusts in Canada. Instead, it hits hard at investors like me, who are trying to live off our savings.

I urge you to do what you can to defeat this severely misguided bill.

Very truly yours,

(Signature)