Bonuses are generally calculated on a per-acre basis, so your property size may be a factor. Other factors may include availability, accessibility and cost of surface drillsites, offset production and competition, anticipated oil or natural gas production in your area, access to seismic testing, proximity of pipelines and production results in your area. The number of factors that are considered when determining royalty and bonus amount offers can differ from one individual to another within a given area.
A royalty is a percentage of production based on the proceeds of the sale of the oil or natural gas. Royalty payments start after oil or natural gas is produced and these payments continue for the life of the well.
Royalty payments begin only if your property is placed in a producing unit — meaning when and if oil or natural gas is actually produced and sold. The time from the lease signing to mineral production can range from months to years and is determined by a variety of factors. While the bonus money is attractive because it is immediate and tangible, the royalty income can be much more substantial as it can last for decades.
Chesapeake properly reports lease bonus payments as Rents in Box 1 of IRS Form 1099–MISC. Lease bonuses are a form of rental payments, paid in advance of drilling, that give operators the right to explore for minerals and are received upon the execution of a oil or natural gas lease.
Payments to landowners are considered royalties only after the well begins producing. A lease bonus is not considered a royalty because the payment is made before oil or natural gas production commences and is determined without regard to any possible production. A royalty represents the cash value paid based on a percentage of oil or natural gas production from the property. Royalty payments are reported in Box 2 of Form 1099–MISC.
Most land owners are concerned with the classification of lease bonus payments as royalties because of the ability to deduct depletion expense on royalty payments. According to the Internal Revenue Code §613A(d)(5), percentage depletion is not allowed on lease bonuses, and the term “gross income from the property,” for the purposes of the depletion calculation, shall not include any lease bonus, advance royalty or other amount payable without regard to production from the property. Since lease bonus payments are not subject to depletion, it is inappropriate to classify this income as Royalty Income in Box 2 of Form 1099–MISC.
For more information about reporting bonus and royalty payments, click here.