Before You Buy Energy Transfer or Enterprise Products for the Yield, Here's the Complication Nobody Mentions.

Energy Transfer (NYSE: ET) and Enterprise Products Partners (NYSE: EPD) are both popular stocks among income investors. They're both midstream pipeline companies that are well-insulated from volatile commodity prices because they simply charge downstream and upstream "tolls" to use their infrastructure. As long as those resources keep flowing through their pipelines, they can generate plenty of cash to fund their big distributions.

Energy Transfer, which operates more than 140,000 miles of pipeline across 44 states, pays a forward yield of 6.3%. Enterprise, which operates over 50,000 miles of pipeline across 27 states, pays a forward yield of 5.6%. Both companies have historically spent only about half of their distributable cash flow (DCF) on distributions, so they can easily cover those yields.

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But before you buy Energy Transfer and Enterprise as high-yield plays, you should be aware of an issue which investors often overlook. Both companies are master limited partnerships ( MLPs ) instead of traditional corporations, so they treat their investors as partners rather than shareholders. Let's see how that key difference makes them more complicated investments.

The key differences between MLPs and corporations

MLPs are pass-through entities that allow their income to directly flow to their partners. By comparison, traditional corporations are separate, taxable entities that hold their own income.

MLPs blend their own income with a return of capital (your own invested cash) in their distributions. When they do that, only the portion that came from the MLP's income is taxed as a capital gain. Those distributions are more tax-efficient than dividends from corporations, which are fully taxed as capital gains unless they're locked up in a tax-deferred account.

With each distribution, the MLP's trading price will decline by the amount paid out. However, it will recover as long as its underlying business continues to expand. With Energy Transfer and Enterprise, their businesses will keep growing -- and boosting the value of each MLP unit -- as long as they keep using their excess DCF to build more pipelines.

However, the distributions from MLPs must be reported separately, on a K-1 form, to the IRS when you file your taxes every year. That extra step can be cumbersome for investors who are accustomed to reporting their regular dividends on the simpler 1099-DIV form.