The New Marcellus Shale Gold Rush - Estate Planning?

Been attending a couple seminars and meetings lately aimed at estate planning and the effects of Royalty payments on the estate.  The implied consequences are staggering.  So are the proposed legal fees for setting up Family Limited Partnerships, LLC's, ect.  I am really wondering if a lot of what they are hyping is true. 

 

The real scare part is the impact of possible future royalty valuation in the estate. If, as explained, the next 20 years worth of royalties can be added to the value of the estate and taxed at the time of death it could concievably add 10-12 million to an estate of a 200 acre land owner.  The tax on this and other parts of the estate would then be due from the estate within 90 days.  At a possible 45% tax rate this could mean 3-5 million due then.  For most the only way to pay that would be to sell the land and royalty rights, most likely at less than favorable prices.

 

So my question is has anybody had any experience or gotten any good advice from a tax or estate professional they trust.  Some of the figures I have gotten for setting up a Family Limited Partnership top $15,000.  Including appraisials of royalties, 3-6K, Legal Fees 8-9K. 

 

All of this is so new to area that I worry some of these outfits may be riding on/manufacturring a wave of hysteria.  If all the hype is true I definatley see the need to set things up now, cost seems pretty steep though.

 

This is my first post since joining last month so if I didnt put in the proper forum I apologize

Thanks

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Permalink Reply by philip andrews on November 16, 2010 at 4:30pm
I WOULD NOT DO THE LLC. IT'S IS VERY COSTLY . JUST MAKE A WILL UP AT $60.00 EACH. YOU ARE TALKING OF MONEY IN THE FUTURE, AND YOU DON'T HAVE IN HAND. WITH THE LLC EVEN THE TAXES ARE MORE. THE PEOPLE SETTING UP THE LLC ARE ALL FOR IT.
Permalink Reply by David Stewart on November 17, 2010 at 6:10am
Yeah, Kinda the way I feel about it unless someone can show me more about it reducing the estate taxes the kids will be hit with. the major drive for me right now would be locking in appraisal figures for the potential royalties while things are still in a pre production phase. Just not sure how that gets figured in the estate years down the road.
Permalink Reply by Sondra Fisher on November 17, 2010 at 5:31am
The estate part of this drilling is a very confusing issue. I have several clients who had numerous questions, or had trouble finding a good attorney on this matter, which prompted me to set up an informative seminar to hit all aspects of the drilling. I selected a very good, ruputable land attorney to review leasing and an a CPA-Estate attorney to explain the law and some ideas on protecting your estate. The seminar is in Washington, PA tomorrow if you are interested
Permalink Reply by David Stewart on November 17, 2010 at 6:12am
Sondra,

Thanks would love to go but distance is to far and the time frame doesn't work for me right now.
Permalink Reply by Charlie on November 17, 2010 at 9:56am
Hello David-

As an estate planning attorney, I am afraid to say that setting up a FLP or FLLC is going to cost you. They are a fairly complex business structure which do really require meticulous planning. I understand your initial reticence to the fees, but in many ways you answered your own question.....an FLP, along with their potential valuation discounts can save your estate significant amounts of tax. The relatively inexpensive cost of setting it up today could save your heirs a lot of money. Further, isolating the natural gas and minerals in a business structure can provide you, individually, with liability protection in the event of an accident on the property.

I will try and break down simply how the FLP structure works,

In its simplest form, WHICH I DO NOT RECOMMEND, a husband and wife each contribute property to a limited partnership and each receives in exchange a 1% general partnership interest and a 49% limited partnership interest. Gifts of limited partnership interests are then made to family members.

The appeal of such a plan is obvious if (1) discounts of as high as 40% - 50% for lack of marketability and for a minority interest are available in valuing the gifts- i.e. you can gift more for less to your children (2) the gifts qualify for the $13,000 gift tax annual exclusion, (3) the gift property is not includible in the donor's gross estate- i.e. moving cash out of your estate now at a reduced price and thereby minimizing the potential impact of the estate tax, and (4) the FLP is recognized for income tax purposes.

The general partners' will remain in control over the partnership.

The advantages of an FLP include:

The timing of cash flow to limited partners can be controlled by the general partner;

The holding of multiple assets by a single entity may reduce management costs;

Making annual gifts is simplified when a gift of a limited partnership interest is compared with a gift of an undivided interest in a particular property or properties;

Creditors of a limited partner cannot reach partnership assets;

The possible "downsides" of FLPs are the start up costs and the valuation uncertainty of the limited partnership interest for gift tax purposes. In general, this uncertainty will not end - Please see my earlier post in July discussing FLPs.

I would urge you to consider other alternatives in estate planning if you are concerned about the cost of the FLP. A simple will is not enough. Please feel free to respond if you have anyother questions about the structure and again check out my earlier post, it has some things to be concerned about with the FLP.
Permalink Reply by Joshua Shedden on November 17, 2010 at 12:15pm
?
Permalink Reply by David Stewart on November 17, 2010 at 6:21pm
charlie,

thanks for you informative response. I am still talking with estate planning attnys. I previously set up basic trust arrangements to handle our wills, health care and property estate planning. The idea of them taxing the potential income of a well as part of an estate was a shocker. We have several hundred acres in a couple seperate locations and two seperate wells planned now on them already. It is looking like the the smart way to go is to plan now. Only problem is spending the money before we really see any.

Dave
Permalink Reply by Charlie on November 18, 2010 at 6:07am
Dave-

If you are going to set up a family partnership, I would use the lease bonus money to set up the structure and wait until you are relatively certain that they are going to drill on the property.

For optimal value shifting of your estates assets to the next generation and reduction of overall estate taxes, the partnership should be in place before the wells are operational because of the lower valuation that will be placed on the land before production.

A couple of other items to note:

1. The valuation of oil and gas rights is a very new field. As such, not too many "experts" have experience in valuing such rights. If you are going to do the partnership and have it pass IRS muster, make sure you get an appraiser who knows what they are doing. This is essential.

2. If you are in PA., the partnership as opposed to the LLC is the optimal structure due to the capital stock tax, a tax is imposed on LLCs and not partnerships.

3. You mention that you have some "basic" trust agreements to handle your wills. Does this mean, a "revocable trust" with a pour over-will? These type of arrangements are intended to avoid probate and are helpful in many states. However, if you are in Pa., which I am, they are really not that useful. Pa.'s probate process is relatively easy and plus all assets that you do not name the revocable as owner will have to be probated anyway.

Hope this helps. Charlie
Permalink Reply by stormangasman on November 18, 2010 at 3:55pm
Sondra,thanks for your input,since I tuned in late,will there be a later seminar in the williamsport area ( lycoming co) ? This topic is very important to many shalers.

CHARLIE your info is very helpful and understanding ,But,are you saying if I try to pass property, on to my children with a "estate planned will" in effect ,with gas royalty checks coming in, that the property will be taxed for all furture income? thanks stormangasman
Permalink Reply by Charlie on November 19, 2010 at 10:35am
Storman-

I hope I did not confuse you too much (I tend to go overboard when talking about this stuff) and I am not sure what you are getting at with your question.

I will try and respond to what I think you are asking...

As you might know, there is no estate tax in 2010. However, in 2011 the estate tax comes roaring back. All estates valued over $1 million are subject to the tax (the $1 million threshold is being debated by governmental officials right now and is expected to bump up to $3.5 million if Congress decides to do something). This means upon your death, amounts in your estate in excess of $1million are taxable at a rate about 45%. In exchange for the tax, the IRS allows your heirs to bump up the basis of your property to its fair market value at the time of your death. For instance, say your house was worth $100,000 at your death and you bought it at $10,000 many years ago. The value of the house in your heir’s hands will be $100,000 for tax purposes. This rule is helpful when the estate has highly appreciated property, like stocks and bonds or real estate, that will be sold shortly after death.

For natural gas property, the basis step up rule may not be as beneficial. Your heirs will continue to have to pay income tax on any royalties from your property they receive after death. The property value itself, which should be pretty high if it is natural gas producing would be moved up to fair market value, but if your children do not want to sell the property and just want to retain the royalty stream of payments, they will be taxed on the income just like everybody else. An “estate planned will” can not help this. A good Will should have provisions in it to maximize your estate tax credit (the $1 million amount describe above), particularly if you are married. But, it can not get your heirs out of income tax.

The estate planning technique like the partnership structure described above and others (GRATS, IDGTs)are methods to reduce the value of your overall estate and transfer wealth during your lifetime in order to avoid the estate tax upon death. They are intended to get your estate as close to the $1,000,000 credit amount, so less estate taxes at death are due.

If you have further questions or I was totally off point (which tend to do alot) feel free to contact me.
Permalink Reply by stormangasman on November 23, 2010 at 4:33pm
Charlie.thanks for your reply,i think you hit my question on the head,I believe we need to set up a pardnership.we have a few hundred acres where the acrage is divided among 4 members.should we set up one parnership with all 4 in it or set up separate parnerships in order to pass things on to the next generation? Or is there something better?
Permalink Reply by Charlie on November 24, 2010 at 4:42am
As far as the number of partnerships, it depends. Who comprises the 4 members? Are they all in the same family? Are they spouses? If it is 2 couples that own the land, I would set up an FLP for each couple and then transfer the interests to the children.

In terms of best alternatives for you, the partnership (LP) is an excellent structure to pass wealth on to the next generation while you are living and reduce your estate value, utilizing discounts. However, there are risks involved in regards to IRS audit if it is not set up very carefully.

Another popular technique to consider may be the sale of the asset via an installment note to an intentionally defective grantor trust, which is a trust vechicle used to freeze the value of the assets put into the trust and shift future income and growth to the next generation. This technique works if the income and assets of the trust grow faster than the required interest and principal payment on the note. After the note is paid, all of the assets go to the next generation. With today's low rates and a highly appreciating asset with a consistent revenue stream it might be worth looking into.

Finally, if you really dont want to get too fancy.....why not tax free gifts each year to your children, utilizing your individual $13,000 gift tax exemption. It is simple and easy and you and your spouse can transfer a combined $26,000 to your kids every year. This is often overlooked and may not get the most tax bang for your buck, but it is at least a good start.

In any event, all of this stuff is pretty complicated. Find an estate planner who knows his stuff when implementing any of these structures.

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