Don’t forget the Tax Implications of Oil & Gas Leases WRITTEN BY THE OHIO STATE EXTENSION STAFF The interest of leasing land for oil and gas exploration throughout northeastern Ohio has the potential to provide landowners with substantial revenue. An important consideration for landowners who receive bonus payments or royalty income is how to manage the tax implications. Oil and gas revenue are subject to federal and Ohio income tax and must be reported appropriately. Lease payments received for the right to drill are subject to ordinary income taxes. A reminder the higher the lease payment, the higher the tax bracket a landowner will be subject. As a general rule, you will need to set aside 35-40% of the payment for federal and state taxes. When the well is drilled, the owner will begin receiving royalty payments which will once again be subject to ordinary income taxes. Lease payments are reported to landowners on IRS form 1099 MISC, Box 1, Rents. Lease payments must also be reported on page 1 of Schedule E, Supplemental Income and Loss. This then flows to line 17 of IRS Form 1040 and is not subject to any self-employment tax. Royalty payments are reported to landowners on IRS form 1099 MISC, Box 2, Royalties. Many farmers are confused thinking they can offset any oil & gas tax obligation by purchasing equipment, buildings, or land. Since the bonus lease and royalty payments are listed on Schedule E and not Schedule F, it cannot be offset by farm expenses. However, minimizing the profit on Schedule F can help reduce the amount of overall taxable income on the Form 1040. Many have also asked about using bonus money to pay off debt. Unfortunately, payments of principal on a loan are NOT deductible. Only the interest portion of a loan payment is tax deductible. For landowners who are able and willing to negotiate a lease of their oil and gas mineral rights there is the potential for significant income. It is suggested that landowners seek the assistance of a qualified attorney and accountant during the negotiations.
SPECIAL THANKS TO THE OHIO STATE EXTENSION WHO CONTINUALLY PROVIDES THE PUBLIC WITH INFORMATION THAT HELPS IMPROVE OUR COMMUNITIES. THESE ARTICLES ARE THANKS TO THE OHIO STATE EXTENSION. TO LEARN MORE ABOUT OUR STATE, CLICK HERE TO VISIT THE OHIO STATE EXTENSION WEBSITE FOR TRUMBULL COUNTY.
Farmer’s Tax Guides Available Do you need a resource to answer those tough farm tax questions? Do you need a resource to answer those tough farm tax questions? If so,farmers can receive a free copy of IRS Publication 225, the 2011 Farmers Tax Guide, at their local OSU County Extension offices. The 2011 Farmer’s Tax Guide is an 89 page publication which can be used as a guide for farmers to figure taxes and complete their farm tax return. Farmers will want to take notice the Schedule F has been revised this year. The major change to the form is the line numbers for reporting farm income are not the same as in prior years. The income payments reported on lines 1a and 2a will now be for specified sales of resale or raised products which are received through a merchant card or a third-party network. These generally will be reported to the farmer on Form 1099-K, Merchant Card and Third Party Network Payments. Merchant cards include, but are not limited to, Visa® and Master-Card®. Third-party networks include, but are not limited to, Paypal® and Google Check-out®. The IRS instructions for Schedule F (Form 1040) state that merchant card and thirdparty network transactions are to be reported on line 1a or 2a even if a Form 1099-K is not received. Other sales of commodities which were reported in past years on lines 1a and 2a are now reported on 1b and 2b. Some of the new topics for the 2011 tax year which are included in this publication are: standard mileage rate, start-up costs back to $5,000 in 2011, increased section 179 expense deduction dollar limits, special depreciation allowance, selfemployed health insurance deduction, lower selfemployment tax rates, maximum self-employment net earnings, and new medicare tax rates. The Farmers Tax guide can also be found on-line at http://www.irs.gov/pub/irs-pdf/p225.pdf The Rural Tax Education Site has an example Schedule F on their web site to help producers as they complete their Schedule F. The sample return can be found on web site at:
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Year End Farm Tax Questions WRITTEN BY THE OHIO STATE EXTENSION STAFF
As winter approaches, it is a good time for farmers to grab a cup of coffee and start to gather their income and expenses records to determine their cost of production and profitability for 2011. It is also the time to take a peek at potential income tax liability for the year. Here is a look at some of the questions which have been asked recently to OSU Extension about farm taxes. With potential for strong incomes from crop production this year, what are some strategies farmers can use to reduce their potential tax burden? Now is time for farmers to take a look at their records to examine potential income tax liability. Remember, that paying taxes is not a bad thing! By paying self-employment tax, the farmer is paying into social security which is the primary source of retirement income for many farmers. That said, farmers can use a variety of methods to reduce their liability. This may include using I.R.C. § 179 expensing and/or bonus depreciation, purchasing 2012 inputs in advance, or utilizing Farm Income Averaging to borrow unused tax brackets from the 3 prior years. Farmers can also postpone sales of raised commodities or use deferred-payment contracts to delay receipts into 2012. Farm input costs are projected to be higher next year, should farmers consider purchasing some of those inputs this year to save money and offset tax levels? Every farm’s tax obligations are unique; however the pre-purchasing of inputs is one way to reduce your tax liability for the current year. Remember that your deduction may be limited to 50% of your other deductible farm expenses for the year. Any prepayment of livestock feed must also meet specific business purpose criteria and must not cause a material distortion of income. What is bonus depreciation, how can farmers use it for tax purposes, and how is it scheduled to change next year? Over the past decade, Congress has repeatedly allowed faster depreciation of capital assets to stimulate business investment by providing a “bonus” depreciation allowance in the year the asset is purchased. The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 extended the depreciation bonus for 2011 and 2012 to encourage new equipment purchasing. The additional first-year depreciation rules allow farmers to deduct on their 2011 income tax returns 100% of the cost of qualifying assets purchased in 2011 and 50% of the cost of qualifying assets in 2012. How can farmers use Section 179 deductions and how is that tax strategy scheduled to change in 2012? I.R.C. § 179 expensing allows farmers to elect to deduct part or all of the cost of qualifying farm assets in the year they are placed in service. The deduction is limited to the taxpayer’s income from all businesses and is also limited to a set dollar amount that varies by tax year. Under current law, the dollar limit is $500,000 for 2011, $125,000 in 2012, and $25,000 in 2013 and beyond. New and used equipment is eligible for this deduction. What other changes are known or projected for next year, and how might farmers prepare for or react to those? Farmers purchasing depreciable items should take notice now of the reductions which may occur in 2012. The reduction of the I.R.C. § 179 expensing will drop from $500,000 in 2011 to $125,000 in 2012 and then $25,000 per year thereafter. In addition, the bonus depreciation is scheduled to drop to 50% of the purchase price of eligible assets in 2012. So if the purchase of capital assets is in your farm’s business plan, now is the time to consider such a purchase. A word of caution, don’t buy “new paint” or “new steel” without first doing a comprehensive cost analysis. I am a new farmer, are there any special tax deductions that I can take? For 2011, you can deduct up to $5,000 of your business start up costs paid or incurred after October 22, 2004. The increased limit of $10,000 for start-up costs was only allowed in 2010. READ MORE>
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