Jan 26, 2015 4 min read

For the past few years, Colleen Toe and some of her neighbors who receive royalties for natural gas produced from their properties deducted the cost of production from their payments and paid taxes on the net amount of their income.

But Toe said she and at least one other landowner were informed this month by the state Department of Revenue they may have to pay back those deductions.

A certified public accountant familiar with natural gas royalties said those who received the letters shouldn’t be hasty in writing checks to the tax-collection agency.

For Toe and her husband, William, the back payments would total $15,701 for the years 2011, 2012 and 2013, plus penalties and interest.

Toe said she and her husband have 96 acres that are part of a contiguous 640-acre parcel shared with 20 other landowners in Chartiers Township where the royalties are paid by Range Resources.

According to Toe, she and other landowners have their taxes done by a variety of accountants.

Toe said she and her husband receive a royalty of 14 percent for natural gas production from the parcel, but said it is difficult to determine the actual production costs, other than the monthly non-itemized figure provided by Range in its royalty payment statement.

In Pennsylvania, drillers are permitted to share production costs with their leaseholders.

While the costs aren’t itemized, Toe said to reach the net amount of income, she subtracts the gross amount, which she said includes the production cost.

However, in its letter, the Revenue Department notified the landowners of a “limited scope audit” she said is focused on the deductions they took on the production costs.

“I think the law is ambiguous,” Toe said last week.

Tim Gooch, a CPA with the Wellsboro, Tioga County, office of Baker Tilly Virchow Kruse LLP who also chairs the Pennsylvania Institute of Certified Public Accountants’ Marcellus Shale Committee, said it’s not unprecedented in Pennsylvania “that a taxpayer would receive a letter” from the Revenue Department questioning a deduction.

“But I wouldn’t roll over and write a check and assume that the taxing entity is correct,” said Gooch, who also sits on PICPA’s Marcellus Shale Communication and Marcellus Shale Conference Planning subcommittees.

He recommended those who received the letters contact the Revenue Department to determine if it needs additional information.

According to the letter the Toes received, if they agree to the department’s proposed changes, they would pay the additional tax due plus appropriate penalties and interest.

They have until Feb. 9 to submit an amended return. If they remit an amended return by the deadline, they can also enclose a penalty abatement petition form. They also are permitted to be represented by an accountant. Toe said last week their accountant was forwarding additional information to the department.

“Many taxpayers claim percentage depletion for federal purposes, but PA does not allow percentage depletion in excess of the cost basis of the (oil, gas or mineral)] rights,” Gooch wrote in a follow-up email. “Expenses deducted from the royalties are deductible, but not real estate taxes, interest or intangible drilling costs.

“Without direct knowledge of the situation, we cannot determine what the department has identified, but it also does not necessarily mean that they are correct,” Gooch concluded.

Toe said last week a representative from state Rep. Brandon Neuman’s office also met with them to discuss their situation.

Some legislation related to treatment of landowners’ production costs already is in the works.

On Wednesday, the Senate Environmental Resources and Energy Committee unanimously approved two pieces of legislation – SB 147 and SB 148 – intended to provide more protections for people receiving royalties from oil and gas drilling.

SB 147 asks that drillers disclose more information on royalty check stubs, while SB 148 would bar oil and gas companies from retaliating against landowners who raise questions about their royalty payments.

“Our goal is to ensure that leaseholders across Pennsylvania are treated fairly,” said state Sen. Gene Yaw, R-Bradford, the prime sponsor of both bills. “Most notably in Bradford County, but across my district, leaseholders have contacted me with concern over inadequate payments and questionable deductions from their royalty checks. This legislation will undoubtedly work to level the playing field.”

According to StateImpact.npr.org, which covered the introduction of the bills in a story on its website, the Marcellus Shale Coalition took no position on the bills.

“However, the coalition supports reasonable disclosure to leaseholders and will continue to work with the General Assembly to address any real or perceived issues,” said MSC spokesman Patrick Creighton.