How Is Gas Lease Income Treated for Income Taxes?

by Diane Bacher

Natural gas leases generate taxable income. The payments fall into your ordinary income category, but certain nuances influence applicable deductions. Additional nuances affect inheritance and estate taxes, while land damage payments are not taxable income and royalty payments receive different tax benefits. The most significant information is related to allowable depreciation deductions that offset increased income during high-production years.

Marginal Tax Rate

Lease payments are entered into your tax form as ordinary income but will increase your adjusted gross income and, in turn, your marginal tax rate. The marginal tax rate is the percentage of your earnings that you can keep, but higher income means a higher marginal tax rate at which point tax breaks are reduced or eliminated. For example, gross incomes of $110,000 or more will phase out child tax credits. For lease payments, the marginal tax rate applies only to 35 percent of money earned from the natural gas lease.

Deductions

Natural gas lease income qualifies for special depreciation deductions that can offset increases in the marginal tax rate. The Internal Revenue Service Section 179 deduction applies to tangible property integrally used for gas production. The cost of certain types of associated property can be deducted but is subject to the income limits pertinent to the taxpayer as well as types of property.

Damage Payments

Land damage payments made to the lessor are not taxable. If the lessor also owns the surface rights, land damage payments may be made as a result of surface disturbances that occurred via the lessee's production processes. For example, a payment may be made to compensate for disturbances associated with well pad construction. Land disturbance responsibilities are negotiated and detailed in the mineral lease agreement, but there are instances when unforeseen disturbances result in payments. In any case, the land damage payments are tax-free but must be recorded on your income tax forms.

Other Considerations

Mineral lease income affects state taxes, Social Security benefits, property tax rebates and inheritance and estate taxes. Most productive mineral leases increase taxpayer income. Without applicable deductions, you may be required to pay more taxes. Individual retirement account contributions and health savings accounts can be useful tools to offset increased income. Consultation with a qualified certified public accountant can provide more detailed advice.

About the Author

Diane Bacher is a certified business energy professional with more than 16 years of experience in the environmental and energy sector. She has written numerous data and regulatory compliance reports for industrial, financial, educational and information-technology clients. Bacher's publications include the New Jersey Technology Council's "Tech News."

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