I received a 1099-MISC for income from wells in which I am an unleased mineral owner. The operator listed the income in Box 7 as Nonemployee Compensation. The tax program I'm using is treating it as business income and therefore I'm having to pay self-employment tax on it. Is this correct? I don't feel this is earned income that I should have to pay Social Security on; I work for a school district and pay into the teacher's retirement fund, not Social Security. Any thoughts would be appreciated.
I am not an accountant but as far as I know most accountants familiar with royalty income treat it as "rents" for income tax purposes.
This is how the IRS classifies royalties: https://taxmap.irs.gov/taxmap/pub17/p17-069.htm#TXMP30377c2c
Kathy Stephens, tru dat you are not an accountant, and your accountant is apparently not much of one.
Google "irs agent manual oil gas" and you will get all kinds of stuff to reach your own conclusion.
casingpoint is correct that regardless of what form the income is reported on, it is taxed as ordinary income.
Ordinary income refers to income that is taxed according to the regular U.S. tax brackets and includes many types of income. Ordinary income refers to any type of income taxed at the U.S. marginal tax rates.
I have been using TurboTax for several years and they claim my royalty payments as "RENT". This has been accepted by the Feds and Louisiana.
MORE IN DETAILl:
Landowner and Fee Royalty Owner
A landowner generally owns what is known as a "fee interest," which consists of the ownership of both surface and mineral rights. The landowner can sell or lease all or any part of the land or minerals. A lease agreement usually provides for a cash consideration, or bonus, and a royalty to be paid to the landowner. The lease usually contains a provision for the lessee to pay a delay rental for each year development is not started or forfeit the lease.
Cash bonuses received upon the execution of an oil and gas lease are regarded, for income tax purposes, as advance royalties. The Supreme Court in Anderson v. Helvering, 310 US 404, 409 (1940); 24 AFTR 967; 40-1 USTC 553 stated "cash bonus payments, when included in a royalty lease, are regarded as advance royalties, and are given the same tax consequences." Bonus payments are not subject to percentage depletion after August 16, 1986 because of the enactment of IRC 613A(d)(5).
In any subsequent year during the term of the lease, the receipt of the delay rental will be ordinary income to the landowner on which no depletion is allowable. The delay rental is not an advance payment for oil but is in the nature of rent paid for the privilege of deferring development. See Treas. Reg. 1.612–3(c)(2) IRM 18.104.22.168.2.2 Delay Rentals, discusses how the lessee should treat its payment to the landowner.
If drilling results in a producing well, the landowner will receive periodic payments for its share of the production in accordance with the terms of the lease. These payments, called royalties, are ordinary income to the landowner. This income is subject to percentage depletion to the extent provided in IRC 613A and the regulations provided thereunder, provided that percentage depletion is greater than cost depletion. This will usually be the case when the fee interest in the entire property is acquired for the purpose of using the surface rights and, as a result, the landowner will have no basis in the mineral rights.
As an Unleased Mineral Interest (UMI) in Louisiana you would received production payments instead of royalty once a well has recovered 100% of the cost to drill and complete. Your monthly payments would still be subject to certain Lease Operating Expenses (LOE) deductions but would be reported and taxed as ordinary income regardless of which form you or your accountant should choose for reporting purposes.
You're welcome, Pam. Anything beyond my previous replies would be above my paygrade. Please consult a qualified CPA with experience with production payment income.