Issue 1: Marcellus Shale Gas Exploration – much to consider before a well is drilled
By Taunya Knolles Rosenbloom, Esq. & Scott P. Borsack, Esq.
June 9, 2010
Geologists have known for decades that buried deep below the hills of northern Pennsylvania and southern New York lied methane rich layers of shale. Until just recently scientists were unable to economically extract the trapped natural gas in commercial quantities at a cost that made economic sense. With the development of new extraction techniques and more accurate geological surveying methods, much of the trapped gas can now be removed from the ground, generating significant income for landowners and exploration companies alike. For many families, income from the so-called Marcellus Shale “gas rush” is as unexpected as striking oil was for families in Texas and Oklahoma many decades ago. Exploration companies promising riches have negotiated with families to secure exploration rights across the affected region. With so much excitement and so much money at stake, landowners may not have considered the tax impact of their new found wealth in time to minimize the tax burdens. There is much with which to be concerned.
There are several tax regimes with which a landowner needs to be concerned. First and foremost are income taxes – both state and federal – levied upon signing bonuses and royalty income. These amounts are paid upon items of income when received. There is little if any planning that can be undertaken to deal with income taxes on royalties and bonuses once a lease is signed. Some landowners look to transfer real estate or rights to oil and gas royalties to family members, whether by lease or deed. Done wrong, these transfers can result in realty transfer taxes due to the Commonwealth. These same transfers could also yield gift taxes to the federal government. Should the landowner die during the production phase of an oil or gas lease, taxing authorities will likely argue that the royalty rights have significant value yielding significant estate and inheritance taxes due the state and federal governments. Each of these particular tax issues should be carefully considered. These tax concerns will be addressed in future articles in this space.
There are many decisions to be made as one begins the journey into oil and gas exploration. A landowner first has to decide whether to transfer rights to oil and gas to an entity, or continue to retain the rights individually. The best course here is to transfer these rights to an entity, either a limited partnership, limited liability company or corporation.
There are many reasons to consider entity ownership of oil and gas exploration rights. Oil and gas exploration and extraction is a risky business. Natural gas is explosive, and a leak at a well head, or transfer facility could cause significant damage to property, to say nothing of the harm to people. Real estate and oil and gas royalties rights held individually and not in an entity could expose the landowner to personal liability resulting from accidents related to the extraction and transportation process. While it is true that the exploration company is likely the real party responsible for any harm, it could take several years of hotly contested court action to arrive at that place, if such a determination is ever made at all. Many leases have the landowner protect the exploration company from these harms. Imagine the potential harm to a landowner’s family from an unforeseen circumstance.
Ownership of oil and gas exploration rights in an entity isolates the risk from the exploration, extraction and transportation process from the other assets of the landowner. Chief among those “other assets” is the cash accumulated from entering into royalty. With the oil and gas rights owned by a separate legal entity, most of the risk inherent in these activities is captured by the entity, like a mason jar locks in its contents. It makes good business sense to move these rights into the “mason jar” as soon as possible.
In our next article, we shall focus on some of the estate and gift tax issues which Marcellus Shale landowners face. Planning to deal with these issues can create opportunities for those who act in a timely manner.
June 9, 2010
Geologists have known for decades that buried deep below the hills of northern Pennsylvania and southern New York lied methane rich layers of shale. Until just recently scientists were unable to economically extract the trapped natural gas in commercial quantities at a cost that made economic sense. With the development of new extraction techniques and more accurate geological surveying methods, much of the trapped gas can now be removed from the ground, generating significant income for landowners and exploration companies alike. For many families, income from the so-called Marcellus Shale “gas rush” is as unexpected as striking oil was for families in Texas and Oklahoma many decades ago. Exploration companies promising riches have negotiated with families to secure exploration rights across the affected region. With so much excitement and so much money at stake, landowners may not have considered the tax impact of their new found wealth in time to minimize the tax burdens. There is much with which to be concerned.
There are several tax regimes with which a landowner needs to be concerned. First and foremost are income taxes – both state and federal – levied upon signing bonuses and royalty income. These amounts are paid upon items of income when received. There is little if any planning that can be undertaken to deal with income taxes on royalties and bonuses once a lease is signed. Some landowners look to transfer real estate or rights to oil and gas royalties to family members, whether by lease or deed. Done wrong, these transfers can result in realty transfer taxes due to the Commonwealth. These same transfers could also yield gift taxes to the federal government. Should the landowner die during the production phase of an oil or gas lease, taxing authorities will likely argue that the royalty rights have significant value yielding significant estate and inheritance taxes due the state and federal governments. Each of these particular tax issues should be carefully considered. These tax concerns will be addressed in future articles in this space.
There are many decisions to be made as one begins the journey into oil and gas exploration. A landowner first has to decide whether to transfer rights to oil and gas to an entity, or continue to retain the rights individually. The best course here is to transfer these rights to an entity, either a limited partnership, limited liability company or corporation.
There are many reasons to consider entity ownership of oil and gas exploration rights. Oil and gas exploration and extraction is a risky business. Natural gas is explosive, and a leak at a well head, or transfer facility could cause significant damage to property, to say nothing of the harm to people. Real estate and oil and gas royalties rights held individually and not in an entity could expose the landowner to personal liability resulting from accidents related to the extraction and transportation process. While it is true that the exploration company is likely the real party responsible for any harm, it could take several years of hotly contested court action to arrive at that place, if such a determination is ever made at all. Many leases have the landowner protect the exploration company from these harms. Imagine the potential harm to a landowner’s family from an unforeseen circumstance.
Ownership of oil and gas exploration rights in an entity isolates the risk from the exploration, extraction and transportation process from the other assets of the landowner. Chief among those “other assets” is the cash accumulated from entering into royalty. With the oil and gas rights owned by a separate legal entity, most of the risk inherent in these activities is captured by the entity, like a mason jar locks in its contents. It makes good business sense to move these rights into the “mason jar” as soon as possible.
In our next article, we shall focus on some of the estate and gift tax issues which Marcellus Shale landowners face. Planning to deal with these issues can create opportunities for those who act in a timely manner.