By Martha Barnes

Oklahoma NARO Director

Do you know that you do not have to sign a Division Order in Oklahoma [or in most other states]? Do you know that you might accidentally give away some of your rights if you do? Do you know that you can demand interest if the payments are late? Do you know that you do not have to wait to get royalty checks until the amount is at least $100.00? Do you know that the operator still needs a copy of your W-9 with your correct name and address so that you get paid in a timely fashion and do not have Federal Income tax taken out? (You must pay it if you owe it. It is easier to pay what you owe than trying to get back what you might have overpaid.)

With the necessary disclaimer that this information should not be construed as legal or tax advice, here is a useful form letter that I use when communicating with an operator. I always send by certified mail return receipt and keep a copy of the letter, the original Division Order, and the returned green receipt in my file so I know the date and who signed for it. 

Download Your Free Division Order Form Letter Template

Taken from the August 2023 Royalty Owner Action Report (ROAR) Newsletter.

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Many oil and gas professionals often calculate valuations of minerals on a Net Royalty Acre basis. This is a mathematical concept to normalize variations in royalty rates. For example, if you and I each own the exact same net mineral acres in a parcel of land, but I have leased my minerals at a 1/8th royalty rate and you have leased yours at a 1/4th royalty rate, the revenues you will receive will be twice as much as I will receive. As such, your producing minerals are worth roughly twice as much as mine. The way these interests are normalized is as a ratio of the royalty rate relative to a “standard” 1/8th royalty rate. So, if we each own 40 net mineral acres at these royalty rates, I would own 40 net royalty acres and you would own 80 net royalty acres.

Generally speaking, the formula to calculate royalty acres is as follows: 

Net Royalty Acres (NRA) = Net Mineral Acres (NMA) x (Lease Royalty Rate / [1/8 Standard Royalty Rate])

To amend our example, let’s say I leased my interest at a 1/5th royalty rate. We would calculate my net royalty acres as follows:

NRA = 40.00 net mineral acres x ([1/5] Lease Royalty Rate / [1/8] Standard Royalty Rate) NRA = 40.00 x (0.20 / 0.125) NRA = 40.00 x 1.60 NRA = 64.00 Net Royalty Acres This mathematical concept can also be used inversely to calculate your net mineral acres in a parcel based on the Net Revenue Interest (NRI) you are receiving in a well or unit.

THIS MONTH'S PRO TIP

Landowner Problem: You inherited a large number of properties and don’t know where to begin figuring out what or how much you own.

Pro Tip Solution: Start by looking for any source documents you may already have. Specific examples would be the probate records of your predecessor or the deeds whereby they acquired the properties. If you don’t have those records, you can start by listing the properties you are being paid for. Review your checks and list the names of the wells and their respective counties/ states. Then you can search the respective state regulatory agency or a fee-based service provider to find where those properties are located geographically. Contact the operators to see if they can tell you what your ownership is (both net and gross acreage) as a successor owner. Similarly, every time you are contacted to sell or lease your minerals, have the offering party provide you with a copy of the source document (they often have some access to the records that indicate your ownership). Create a database list of some kind that helps you list these properties and wells. Don’t feel that you must make it overly complicated at first—just make it something that you can build, work with, and understand. In the end, know that there is a community here at NARO that can help you gain control and confidence in the management of your assets.

This is just a sample of the many helpful and informative articles that you will find in our monthly newsletter: the Royalty Owners Action Report (ROAR).

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Testimony For The Record Of The National Association of Royalty Owners, Inc. (NARO)

before the 
Senate Committee on Finance
Climate Challenges:
The Tax Code’s Role in Creating American Jobs, Achieving Energy Independence, and Providing
Consumers with Affordable, Clean Energy
April 27^th, 2021

Jack Fleet, Executive Director
National Association of Royalty Owners, Inc. (NARO)
7030 S. Yale Ave., Suite 404
Tulsa, OK 74136
jfleet@naro-us.org

My name is Jack Fleet, executive director of NARO.  I appreciate the opportunity to provide testimony to the committee on this important topic.

This testimony is being provided to present NARO’s concerns about legislation which has been proposed in Congress and would remove Percentage Depletion Allowance for oil and gas production. This action will be harmful to millions of middle-income American royalty owners and result in the loss of royalty payments, many of whom are retirees living on fixed incomes.

NARO shares concerns of the domestic energy community, in particular oil and natural gas, in the treatment of US government policy regarding stimulation of domestic energy production.  To that end, my testimony is focused on the significant negative impact to royalty owners through the modification of removing Percentage Depletion Allowance from our Federal Tax Code. Percentage Depletion Allowance is the only tax deduction that many royalty owner takes on their royalty income.

Who is NARO?

The National Association of Royalty Owners is a volunteer led, member based, 501(c)6 and represents the concerns of an estimated 12.6 million royalty owners. Our mission is to support, advocate and educate for the empowerment of mineral and royalty owners.  We were founded by Jim Stafford in 1980 to address the concern of Windfall Profit Tax on royalty owners. We have members in all 50 states.

The average NARO member is over 60 years old, widowed and receives less than $500 a month in royalties, which supplements their social security income. 

Owners of producing mineral interest (royalty owners) are entitled to their proportionate share of production paid by royalty revenue. NARO holds to the claim the royalty owner’s right of equity and fair play in accordance with lease contracts and law. To that end, royalty owners have the right to be heard in matters regarding oil and gas energy policy, proposed legislation or regulatory issues that would positively or adversely affect their interest. 

NARO represents many royalty owners who do not have the wealth, time or resources of larger oil and gas or mineral companies and as a result, have a limited ability to make an impact and inform legislators of their concerns.

How many royalty owners are there?

Royalty owners come from all walks of life: ranchers, farmers, barbers, teachers, pharmacist, homemakers, factory workers, carpenters, retirees, widowers and just about every trade or profession in the United States.  Our members are your constituents, they are diversified politically and belong to all political parties. Many of them, no doubt, voted for members of this committee and depend on you to represent them.

In 2013, NARO gave testimony to the United States House of Representatives Committee on Ways and Means and estimated nationally there were 8,440,755 royalty owners. Today, that number has grown to an estimated 12,600,000.  The number of royalty owners is increasing due to fractionalization of mineral estates from generation to generation.  Additionally, there is an increase in citizens buy minerals and royalties for the first time. 

Today, we estimate the number of royalty owners in each state to be:

AK	20,400	AL	49,725	AR	382,500	AZ	216,750	CA	765,000
CO	981,750	CT	25,500	DC	25,500	DE	3,825	FL	242,250
GA	127,500	HI	12,495	IA	49,725	ID	53,550	IL	114,750
IN	40,800	KS	221,850	KY	16,575	LA	188,700	MA	45,900
MD	53,500	ME	8,288	MI	66,300	MN	71,400	MO	165,750
MS	58,650	MT	71,400	NC	100,725	ND	36,975	NE	29,325
NH	20,400	NJ	71,400	NM	242,250	NV	66,300	NY	191,250
OH	45,900	OK	2,537,250	OR	76,500	PA	18,500	RI	8,288
SC	33,150	SD	8,288	TN	89,250	TX	4,462,500	UT	58,650
WY	45,900

These estimates are only those that are currently receiving royalties on producing mineral estates. However, there are many more mineral owners in all states that are not receiving royalties.

Percentage Depletion Allowance:

This tax allowance is not specific to the oil and natural gas Industry. In fact, many natural resource industries are allowed to take depletion allowance, such as Sulphur, Uranium, other rare earth minerals, ores, industrial grade crystals, gold, silver, copper, timber and coal to name a few.  It should also be noted that small oil and gas operations that take advantage of percentage depletion allowance are capped at 15 barrels of oil per day per well. Many of these small operators produce 1-5 barrels of oil a day and have 11 employees on average.

Percentage Depletion is Not Cost Depletion:

Depletion represents the decreasing values of a limited reservoir of a non-renewable resource.  Just as an assets value depreciates over time and thus the tax liability on that value changes accordingly. The non-renewable resource is diminished over time and the value of that resource depreciates.

Most large companies use cost depletion to calculate the cost/expense involved in extracting or mining of the natural resource and the reserve that remains after the extraction. The alternative to this complicated method is Percentage Depletion Allowance, which is much simpler to apply, especially for the average royalty owner.

The Percentage Depletion Allowance for oil and natural gas is 15%. The flat percentage makes calculating this allowance easy and has limits to benefit the middle-income American royalty owner and has nothing to do with large companies.  While Cost Depletion is very costly, complicated and, in most cases, impossible for the small royalty owner to determine.  Contracts between the mineral or royalty owner and the operator do not provide for the details necessary for Cost Depletion to be determined.  

The proposal to eliminate Percentage Depletion Allowance would not eliminate a “subsidy” to “Big Oil” but would hurt the small royalty owner, most assuredly constituents of the members of this committee.  Subsidy is defined as a direct cash payment by the government to a person or business. While leaving Cost Depletion which the large oil and natural gas companies use untouched.  Further, people that buy minerals, such as one family member who buys out another family member’s interest, likely relied on the continued existence of percentage depletion in agreeing on the price.

Removing Percentage Depletion Allowance would also result in a tax increase for many royalty owners who make less than $400,000 per year.  As mentioned earlier, the average NARO member’s royalty income is $500 per month and supplements their social security and retirement income. Removing their Percentage Depletion Allowance would raise their annual taxable income and increase their tax burden., counter to President Biden’s commitment to protect incomes of those below $400,000 a year. 

Conclusion:

NARO stands strongly behind keeping Percentage Depletion Allowance and opposes efforts to eliminate it. Removing this allowance will put an added financial burden on the citizens that own these natural resources and hurt those that use their royalty income to supplement their social security and retirement.  All of this, just as the economy and our citizens are starting to recover from the COVID pandemic. 

I would like to conclude with an example of the impact royalty income means to a NARO member, Ms. Mosley of North Carolina with mineral and royalty interest in West Virginia.

“The royalty money supplements my small social security allowing me freedom from fear of poverty. And it allows me to donate to charities, including in the county where my minerals are (different from my residence). My cataract surgery with special replacement lenses was possible with the royalty money. President Biden has said that he will not raise taxes on incomes under $400,000. Well, mine is quite a lot less than that, and removal of the depletion deduction would certainly raise my taxes!”

_____________________________________

i “The Need for Percentage Depletion Allowance for Mineral/Royalty Owners: How Tax Policy Can Simultaneously Affect the Equitable Treatment of Royalty Owner, and National Security” by NARO 2013 

Before I dive into the specifics of a quick and easy check that all royalty owners should do before filing your state & federal income tax return, let’s talk about what we mean when we say “royalty audit”.  A royalty audit is simply the process of double checking your royalty statements against production data reported to the state oil and gas commission and posted oil & gas prices.  In other words, it is the process of auditing the royalty payments from the operator to make sure they are correct (or that they at least seem correct given available data).

While most operators report royalties correctly, the fact of the matter is people can make mistakes and you need to stay on top of your royalties in order to proactively catch these  mistakes.

In order to perform a quick year-end royalty audit, you only need your check stubs (also called royalty statements) for the year in question and any 1099-MISC forms received from the oil & gas company (or companies if you get paid by more than one) for that year.  
In order to perform a full-blown royalty audit, need your check stubs (also called royalty statements) for the year in question, any 1099-MISC forms received from the oil & gas company (or companies if you get paid by more than one) for that year.  It is also helpful to have a copy of your oil & gas lease, any Divsion Orders you may have signed, and a computer or other device to look up the production data that was reported to your state oil & gas commission and to look up historical oil & gas prices to compare for the months in question.

For what we are going to focus on today, you only need two things:

1. Your Form 1099-MISC or equivalent document showing the royalties you were paid for the previous year (for each operator you receive royalties form).
2. The check stubs from the operator(s).

If you didn’t receive a 1099, work with your accountant to determine what you should report to the IRS.  Even small royalty interests usually receive a 1099 so you can also contact the company’s owner relations department to find out the status as it may have not been issued yet.

If your operator provides a running total of the cumulative royalties paid in each royalty statement, you first need to find your last check stub from that operator (from December or the last month you were paid).

Then, simply compare what is showing up in Box 2 of your 1099-MISC or the box titled “Royalties” with the total gross payment amount for the year shown on that last check stub (before any production/severance tax or state taxes are deducted from the check amount).  The amount shown in Box 2 “Royalties” amount on your 1099 should match the gross payment amount that is reflected on your last check stub from that year.

Again, this assumes the operator provides this running total of the gross and net royalty amounts on your check stubs.  If they don’t, you simply have to add up the Owner Gross amounts from each check stub to determine the total you were paid for the year.

You may notice that the amount shown under “Royalties” and the Gross payment amounts don’t match what was actually deposited into your account.  That is ok because you are paid on the net payment amount which is the amount that is left after any taxes or other deductions are subtracted.

If the amount on your 1099 doesn’t match the total gross amount for that calendar year, then you need to dig deeper.  Double check that you’ve included the amounts from all the check stubs for that year if the operator does not provide the totals for the year.  Check your math.  Tip: Use Google Sheets or Microsoft Excel to create a table with the dates of each check and gross and net amounts you can enter into separate columns.  Then you can add up the amounts in each column to calculate the total gross amount and total net amount that you were paid.  This allows you to double check each value you entered to make sure it is correct as sometimes you can mistype something into a calculator and not realize it.
If after double checking your math you still have a discrepancy, contact the operator’s owner relations department, and explain your issue or ask to speak with someone in their accounting department.  Again, sometimes operators make mistakes and the 1099 that you receive can be incorrect.  I’ve received a corrected 1099 from operators on more than one occasion.

This time of year presents the opportunity to perform a quick and easy royalty audit to at least make sure that what is being reported to the IRS matches what you were paid.  Of course, this assumes that the operator paid you correctly and that is why it is helpful to perform a more in-depth royalty audit to compare the volumes and prices from your royalty statement to the volumes reported to your state oil & gas commission and the average prices reported by the EIA.  That will have to be the subject of a future article or in the meantime, be sure to check out the member section of the NARO website to watch on-demand replays of past NARO Webinars on this topic.

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