Millions of dollars are changing hands from oil and gas developers to landowners in Pennsylvania. Advance planning for succession can drastically reduce the taxation and costs of passing wealth to the next generation.
If a landowner has substantial acreage, the best time to plan for succession is before any oil and gas lease is signed. Once a lease is signed, the value of the land increases. After a successful gas well is drilled on or near the land, its value increases even more.
For example, a father owns 200 acres which he has farmed for a generation. It has a fair market value of $300,000 as a farm. Father has five children and intends the farm to pass to them when he dies. He is approached by a gas developer, and learns he can get $4,000 per acre in a leasing bonus, and will get as much as $200,000 per year in royalties if a successful well is drilled.
If father signs the lease, received the bonus and gets the royalties, he will have several millions of dollars in value. At his death, there will be approximately 15% lost to inheritance tax and probate fees. Additionally, under new income tax laws, father will fall into the highest income bracket and pay high taxes.
Instead, father should consider gifting portions of the farm to the children before signing the lease and before any well is drilled. Each child could receive actual acres of land by deed. Or father could set up a family limited partnership where a child becomes owner of a percentage interest, but father is able to keep control of decision making. The bonus and royalty payments would be divided into shares according to the ownership and would go directly to each child. There would be far lower costs at father’s death.
A different scenario confronts the landowners who have no children. In this case, charitable giving may be the answer. A couple in their 70’s may desire to benefit others, but also wants to be able to live comfortably for their remaining years. This couple could place the gas and mineral rights into a charitable remainder trust (CRT) where they will receive an income for their lives and the remainder will become owned by the charity. By donating the rights to the CRT, the revenue from the subsequent lease will be free of tax. The charity can pay a stream of income that is larger because capital gains taxes were avoided. The charity will also receive more overall than if the donors had received the revenue, paid tax, and willed the rest to the charity. This is a win for all concerned as the charity has more and can do more good work.
The time to act is before an oil and gas lease is signed. After a lease is signed, the values are much higher. However, even after the lease and/or well is in place, estate planning can be tailored to help reduce taxes and probate costs.