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What if I don’t do any planning after I sign an oil and gas lease?

Posted: October 17, 2010

Landowners who lease their mineral rights have many decisions to make related to any potential income from a producing well. These decisions relate to managing that income, planning for taxes, and planning for future generations. This article describes potential consequences 'if I do nothing.' (This is part 1 of a 2-part series.)
photo by Craig McKibben

photo by Craig McKibben

John C. Becker
Penn State Professor of Agricultural Economics and Law

Landowners in the Marcellus Shale area face considerable pressure to plan for the wealth the Marcellus is expected to bring them if their lease is included in a pool of producing wells.  And this planning comes in the face of significant uncertainty --about how much income a landowner will receive and the potential effect of income and estate taxes at the federal level.  With all of this uncertainty in play, an obvious question to ask is, “What if I don’t do any planning now?’  What if I do nothing after I sign a gas lease? What happens when a well on my property is producing and I am paid bonus payments and possibly royalty income?

The following situation  is a  couple that has signed a lease and is sitting around the table after watching an ad or reading an article that discusses the need to plan now.

What happens to the interest I own as a result of leasing the gas interest to a drilling company if something happens to me? 

A royalty interest is considered to be the interest in underlying gas (or oil) reserve that is retained when the owner of land grants to someone else (i.e. the lessee) the right to determine whether a commercial quantity of gas exists, and if it does, to develop the property and produce the gas.  The lessee’s interest is considered to be a working interest in the gas reserves. There are different outcomes, depending on the situation:

  • If the royalty interest is held as tenants by the entireties (i.e. John and Mary, husband and wife), a surviving spouse becomes the owner when the other spouse dies.  At the surviving spouse’s death it becomes part of that spouse’s estate and subject to distribution through that person’s will, living trust or intestate succession.  During the surviving spouse’s lifetime the spouse could also chose to share that asset with someone else in a joint ownership arrangement or transfer it to some other entity that manages it during the surviving spouse’s lifetime. After the spouse’s death it can pass to whomever the spouse selects.  The surviving spouse may find the income insufficient to meet all needs and wind up using all of it to meet immediate needs.
  • If a gas lease is held as joint tenants with right of survivorship (a parent and children where the right of survivorship among all of them is specifically mentioned), a surviving owner(s) becomes the owner when one of the owners dies.  At the death of the last surviving joint owner, the interest becomes part of that person’s estate and is distributed according to that person’s directions.  As each joint owner passes away, the remaining joint owners will face inheritance taxes and may face estate tax on the fractional share that passes to them from the deceased owner.
  • If gas lease is held as tenant in common (two or more people who are not married to each other and who do not specify the right of survivorship relationship to apply to them), at death of a tenant in common the tenant’s share of the interest becomes part of the deceased tenant’s estate and passes to heirs designated in a will or trust or to intestate heirs if there is no will or trust to control the disposition of the owner’s property.

What rights do my creditors have in a royalty interest I have?

Income from a royalty interest is considered to be part of your property.  Your creditors can attach this interest if they have a judgment that allows them to seize your property in payment of debts of other obligations that are reduced to a judgment, such as an unpaid loan, mortgage of other debt.

I am concerned about financing the possibility that I may need long-term care in the future.  How will ownership of a royalty interest affect my eligibility for long term care options?

A royalty interest that pays you income and is under your control can provide you with income to pay the cost of long term care, or it can cover the cost of insurance that pays the same thing.  If you no longer have any resources to pay for this care, you can seek medical assistance (Medicaid) benefits.  To become eligible you must first devote some of your income and deplete most of your own personal assets paying for this care. Receipt of royalty income will be an asset you will be expected to use to pay for your care before you become eligible for Medicaid payments.  If the royalty income is paid to a trust that benefits you, the terms of the trust will determine if the trust fund is an asset that must be used for your care before you become eligible for Medicaid assistance. 

My spouse is considered to be the owner of a royalty interest after my death.  What happens if he remarries after my death?

As your spouse owns property after your death, your spouse can decide what happens to it after your death.  If your spouse remarries, the new spouse may be given a share of that royalty. A second spouse may become the owner of this interest after your spouse's death if the second spouse inherits all of your spouses property.  That will be a decision your spouse makes.

Part 2 will be issued Oct 24th.