With the Marcellus Shale leasing arrangements and royalties in Western Pennsylvania some lucky area land owners are now faced with important decisions involving large sums of money in a scale they have never encountered before. As exciting as this is, as with all sudden accumulations of wealth there are important accounting challenges that must be met, especially if one wants to minimize taxes.
Lump Sum or Annuity?
When the energy companies’ representatives working in Pittsburgh and Western Pennsylvania first contact landowners with potential drilling sites, they tend to entice them with up-front payments. From a tax standpoint, that represents an accounting challenges because many of the new Lessees have no experience with the limited ways in which lump sums of cash can be sheltered from onerous taxes.
That may be why so may savvy landowners, their attorneys, and their accountants prefer longer term royalties offering the largest share of the earnings they will realize over the life-time of the wells.
In some ways, this is similar to the decisions facing Pennsylvania lottery winners who are presented with a choice between a lump sum or an annuity. As attractive as the lump sum is on first look, its exposure to immutable tax issues in the year of issue begin to pale compared to the more elastic choices that come with measured, long-term royalties.
The landowner should be realizing a signing bonus and royalties in any agreement. We are, of course, looking at the entirety of the enterprise. And in that long-term comes a myriad of tax and accounting issues that Lessees need to address. In many ways these issues are identical to individuals and enterprises that have guaranteed income sources that are immutable.
More than just the needs of quality accounting that are brought to bear on regular enterprises, these consistent source of funds can and are viewed by tax code writers with special interest. For CPA’s working with Marcellus Shale lessee clients knowing inside and out the individual tax issues in Allegheny, Washington, Fayette and Indiana counties, along with the tax code of the Commonwealth of Pennsylvania, and of course, Federal Tax Law is vital.
Landowners need to order their financial affairs with some basic, common sense accounting guidelines:
- Is the purpose of the royalties to be used as the income for their lifestyles on a yearly basis? Or do they intend to use part or all of it for future based purposes, including leaving large estates to heirs and favorite charities and causes?
- As the royalty funds are distributed, does the Lessee plan to, at least initially, deposit the sum into nearby banks or qualified financial institutions, or will they set up separate private functions that will process the royalty payments? Sometimes the issue here is to introduce the Lessee to accounting and financial functions that they may not be familiar with for not having access to this kind of wealth before.
- Finally, what are the long-term financial plans that the royalties will facilitate? In other words, where does the Lessee see themselves and their families, five, ten, fifteen and even twenty years ahead? What investment strategies, tax strategies, and wealth preservation and management accounting strategies best help them to obtain those goals?
The wise landowner should seek the help of proven professionals who have the accounting and financial planning expertise to help guide those facing the happy challenges of Marcellus Shale drilling royalties.