While the Marcellus and Utica shales present a boon to the Pennsylvania economy, the negotiation of a lease should not be the only legal consideration for a landowner. There are a multitude of estate and income-tax issues to consider both before and after signing a lease and before drilling commences.
Landowners should consult with an attorney knowledgeable in the shale gas area before signing a lease. After signing a lease, a title search is conducted and, upon completion, landowners may receive a cash bonus or advance rental, which is treated as ordinary income for income-tax purposes. Records filed by the gas company with the county will determine the landowner's decimal interest and percentage of royalties. Once the landowner knows the nature and extent of his or her royalties, planning can be personalized. Landowners should consider which type of entity is best suited to receive bonus payments and royalty interest.
There are non-tax-related reasons to plan for bonus and royalty payments. If a landowner decides to retain the land, then estate plan documents such as wills or revocable trusts should be reviewed to ensure that the land, money already received and/or future bonus or royalty payments pass to the intended heirs in a sensible manner. For example, if landowners simply want to ensure that the land or royalty payments or family assets stay within the family unit and are not subject to the claims of creditors or the divorce of a child or grandchild, then a trust of some sort might be incorporated into the estate plan.
Some landowners have expressed a desire to share some or all of the bonus and/or royalty payments with their heirs while they are alive. Some of the more popular strategies include separating the ownership of the surface and subsurface rights and the utilization of family limited partnerships and dynasty trusts.
The first thing to consider is whether the landowner wants to separate the ownership of the surface (the land itself) and subsurface rights (oil, gas and other mineral rights). This could aid in gifting interests in property or in preparing for a sale of the land.
If the landowner wants to sell the land, subsurface rights can be sold along with the land or be retained by the seller. If the landowner wants to share the potential income stream that can be derived from the subsurface rights, those oil and gas rights can be gifted separate and apart from the land, which in turn can be gifted in whole or in part.
Let's now explore the benefits of separating the surface and subsurface rights and the planning vehicles that can be utilized. As stated previously, if the subsurface rights are separated from the land and then gifted to a trust, partnership, etc., the cash flow generated from the natural gas exploration can be shielded from inheritance taxes, divorce and other creditors. In addition, if done in a timely manner, the income can be removed from being an "available resource" for Medicaid qualification purposes and the use of a partnership or similar vehicle can allow landowners to treat their children differently (whether they want them to share equally or in different shares, in trust or outright distributions, etc.).
Severing the surface rights from the subsurface rights, however, can have a negative impact on the overall value of the property. It can also affect the rights of ingress and egress and may limit the use and enjoyment of the property.
Should a landowner choose to separate the surface and subsurface rights, a number of options are available to pass subsurface rights on to the next generation, including: a will or revocable trust, an LLC (limited liability company), LP or FLP (limited partnership or family limited partnership), trust or life estate deed. Landowners should always consult with their estate attorneys to determine the best option for their situation.
Inheritance Tax Issues
The American Taxpayer Relief Act of 2012 (ATRA) was recently signed into law and contains a host of tax law changes. One of the taxes that was addressed was the federal estate and gift tax. Prior to the enactment of the ATRA, the federal estate and gift tax was a conglomeration of piecemeal extensions to existing laws with expiration dates that had the effect of reverting the tax rates and credits back to 2001 levels. More specifically, had the ATRA not been signed into law, the top marginal tax rate for federal estate tax purposes would have increased to 55 percent (and in some instances 60 percent). In addition, the amount that a taxpayer can transfer free from the federal estate and gift tax (the credit equivalent amount) would have fallen to $1 million (indexed to inflation) from the 2012 level of $5.12 million.