Department Issues Timely Guidance On Oil And Natural Gas Interests

by McNees Wallace & Nurick LLC
Contact

[author: Randy L. Varner]

On October 10, 2012, the Department of Revenue issued Informational Notice 2012-04, dealing with the Realty Transfer and Personal Income Tax treatment associated with the division and transfer of interests in oil and natural gas. While the Department does not break any new ground in the notice, the notice does provide a nice summary of the tax consequences surrounding these “Marcellus Shale” transactions.

Realty Transfer Tax
Initially, the notice tackles the Realty Transfer Tax (“RTT”) issues. The notice provides that the assignment of a lease for the production or extraction of coal, oil or gas is not subject to RTT. If the assignment covers the reserved real estate under the royalty clause of an oil or gas lease, then that assignment is subject to RTT. An assignment of royalty income is a personal property interest and therefore is not subject to RTT.

Personal Income Tax
The real meat of the notice addresses the Personal Income Tax (“PIT”) issues. The notice clarifies that if a mineral rights estate owner sells the mineral rights, the consideration less basis is taxable for PIT purposes and should be reported on Schedule D of the PA-40.

If both the surface rights and mineral rights are sold, the seller must allocate a portion of basis to the mineral rights estate. If this was not done when the seller originally acquired the property, an allocation must be made by taking the basis and multiplying by a fraction, the numerator of which is the FMV of the mineral rights estate and the denominator of which is the FMV of the entire real estate. The FMVs shall be determined as of the date the seller originally acquired the property. If an allocation cannot be made, a zero basis must be used.

A mineral rights owner who is the lessor under an oil or gas production lease may sell and assign his rights to income from future production payments under the lease. For PIT purposes, the sale and assignment are treated as anticipatory assignments of income. With respect to the assignor, he will be deemed to have received royalty income to the extent of the sales price. This income would be reported on Schedule E of the Pa-40 in the year in which the sale proceeds are received (no subsequent deduction will be permitted when the actual production payments are made to assignee).

With respect to the assignee, the tax treatment depends on whether the transaction is open (future production payments not readily ascertainable) or closed (amount readily ascertainable). The notice makes clear that open transactions will be very rare and will be handled on a case by case basis. There is a rebuttable presumption that all transactions are closed. For a closed transaction, each future payment is considered a partial non-taxable return of the assignee’s basis and the remainder is taxable royalty income to be reported on Schedule E of PA-40. The taxable and non-taxable amounts are prorated based upon the amount of anticipated future payments and the assignee’s basis.

Example: A lessor under a gas lease sells and assigns his right to future production payments for 10 years. The assignee agrees to pay $10,000 for the future payments. Therefore, the assignee will have a basis of $10,000 in the future payments. It is anticipated that that total amount of production payments over the 10 years will be 50,000 (1 yearly payment of $5,000 for 10 years). Therefore, by the time all future payments are made, the assignee will have recovered his basis plus an additional $40,000 of royalty income. The assignee’s basis accounts for 20% of the future production payments and the taxable royalty income accounts for the remaining 80%. Therefore, the assignee must account for 20% of each production payment as a return of basis ($1,000) and the remaining 80% as taxable royalty income ($4,000).

If there is an open transaction, the assignee is permitted to use the cost recovery method and apply the production payments to recover the entire basis first, then anything beyond basis is taxable royalty income reportable on Schedule E of PA-40.

Finally, donative transfers of production payments are treated as an anticipatory assignment of future income to the assignor. When a production payment is made, the assignor is deemed to have received the payment and in turn, transferred the payment to assignee. Therefore, the assignor has royalty income in the year the production payment is made, and the subsequent transfer is a gift and not subject to tax.

As noted above, there is no new treatment contained in the notice; however, it is a helpful resource for those involved in these transactions. Please feel free to contact any member of the McNees SALT team should you have questions relating to the points raised in this article. In addition, McNees has a Oil and Gas Group that can assist should you or your company require assistance with respect to Marcellus Shale issues.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© McNees Wallace & Nurick LLC | Attorney Advertising

Written by:

McNees Wallace & Nurick LLC
Contact
more
less

McNees Wallace & Nurick LLC on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Privacy Policy (Updated: October 8, 2015):
hide

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.

Security

JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at info@jdsupra.com. In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at: info@jdsupra.com.

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.
Feedback? Tell us what you think of the new jdsupra.com!