When working with income from an oil and gas lease, the process can get tedious. It is essential to understand the process when dealing with income from an oil and gas lease, as the IRS expects to be informed about various types of income. Luckily, experts from Ferrari Energy have provided a few tips to help better understand and work through the process below.
There are a handful of different types of income produced by oil and gas leases. Income types include royalty payments, received lease payments, bonuses received as a part of the agreement, and delay rental payments. Oil and gas income has to be adequately reported and is subject to both federal and state tax income. Check with your state to see if oil and gas income is subject to your state’s taxes.
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Reporting Royalty Payments
A landowner will get a periodic royalty payment as stated in the lease terms if a producing well is the result of drilling. As long as the drilling unit is in production, royalties will be paid. To report a royalty payment, fill out Form 1099 MISC, Box 2. An individual taxpayer must report royalty payments, known as ordinary income, through Schedule E or Form 1040. Self-employment taxes do not apply to royalty payments.
Reporting Oil and Gas Lease Bonus and Delay Rental Payments
Oil and gas lease payments are often known as lease bonus payments. This type of income is cash payments received by a landowner before drilling. Lease bonus payments are deemed ordinary income for tax reporting intent. Payments are usually paid based on per acre. Such payments are typically due once a year at the lease’s primary term or one single payment referred to as a lump-sum payment or paid-up lease that combines all annual payments into a single payment. To report an oil and gas lease bonus payment to landowners, fill out an IRS Form 1099 MISC, Box 1, Rents. On page 1 of Schedule E, Supplemental Income and Loss is where lease payments must be reported. Self-employment tax does not apply to this amount, and the amount is also recorded on Line 17 of IRS Form 1040.
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A delay rental payment is mentioned in some oil and gas lease agreements. The developer can pay this payment to elongate the primary term and get more time added to start activities revolving around drilling. Delay rental payments are considered ordinary income. When reporting a delay rental payment, you report it the same way you would a lease bonus payment.
About Ferrari Energy
Ferrari Energy is a mineral and leasehold acquisitions company founded by chemical engineer Adam Ferrari. The company focuses on empowering and partnering with landowners to ensure they understand the profits and benefits they can get from their land. Ferrari Energy provides numerous services, including engineering valuation and acquisition of mineral and leasehold rights, mineral title analysis, oil and gas lease review, and paystub analysis to confirm accurate well interests and payment amounts.