Don’t forget the Tax Implications of

Oil & Gas Leases


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


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.





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    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:






Year End Farm Tax Questions



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


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


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>





 This website or its affiliates are not authorized to give legal, real estate, or tax advice. We simply provide public information from trusted sources. However, this site is

 not responsible for information provided by third party sites. We suggest you contact a tax professional for personal advice. All information is provided for informational

purposes only.


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