Royalty income, taxes and your 1099

What Box 2 counts

A payor that paid you at least $10 in royalties during the year files a Form 1099-MISC for you and must send you a copy by January 31 IRS, 1099-MISC instructions. Box 2 is the royalties box. It holds the gross royalty payments, and for oil and gas the instructions are specific: report royalties from oil, gas or other mineral properties before reduction for severance and other taxes that were withheld and paid.

Two limits on the box. Surface royalties do not go in Box 2; they belong in Box 1. And oil or gas payments for a working interest do not go in Box 2 either; they are reported on Form 1099-NEC IRS, 1099-MISC instructions. If you own a royalty, Box 2 is your box.

Why the 1099 is larger than your checks

Your stub takes the state’s tax out of the gross before it pays you: the gross value on the line, less severance tax, is the net that the check carries. The 1099 reports the gross. For an oil line the tax is 4.6 percent of the value, for gas 7.5 percent Tax Code §202.052 Tax Code §201.001, so the 1099 will run higher than the checks by about that much before any other deductions.

The 1099 counts what the payor paid during the calendar year IRS, 1099-MISC instructions. Stubs are labeled by sale month, and payment is due 60 days after the end of the month for oil and 90 for gas §91.402(a), so the 1099 for a year mixes sale months from two years. Match the checks by date paid, not by sale month.

Box 2 is gross. Your checks are net. The tax is the gap.

Where it goes on your return

Royalties from oil, gas and mineral properties, other than operating interests, go on Schedule E (Form 1040), Part I, line 4. Enter the gross amount even if state or local taxes were withheld, and include the taxes withheld by the producer on line 16 IRS, Schedule E instructions. For a royalty property you enter code 6 on line 1b. A depletion deduction, if you claim one, goes on line 18.

If you are in business as a self-employed writer, inventor or artist, the instructions send royalty income to Schedule C instead.

Depletion: the deduction for using up the mineral

A mineral in the ground is used up as it is produced, and depletion lets an owner deduct for that. You can claim it if you have an economic interest in the mineral property, and in a lease the deduction is divided between the owner who leased it and the lessee IRS Pub. 535 (2022). There are two ways to figure it, cost depletion and percentage depletion, and generally you use the one that gives the larger deduction.

For oil and gas, percentage depletion is limited to independent producers and royalty owners. You figure it at 15 percent of the gross income from the property, which for an oil or gas well is the amount you receive from the sale in the immediate vicinity of the well. It does not include lease bonuses or advance royalties. It applies to average daily production up to a depletable quantity, generally 1,000 barrels of oil a day, and the deduction is capped at the smaller of 100 percent of taxable income from the property or 65 percent of your taxable income for the year. Any amount over the 65 percent cap carries to the next year IRS Pub. 535 (2022).

Depletion also reduces your basis in the property, by the amount allowed or allowable, whichever is greater IRS Pub. 535 (2022).

If you inherited the minerals

The basis of inherited property is generally its fair market value at the date of the person’s death, or its value on the alternate valuation date if the estate chose that. If the estate had to file a federal estate tax return, you generally receive a Schedule A (Form 8971) from the executor with the estate tax value. If you did not, the appraised value at the date of death for state inheritance or transmission tax purposes can set your basis IRS Pub. 551.

That is the starting point for cost depletion, and it is worth having before the first 1099 arrives in your name. The steps for getting the payors to pay you are in inherited mineral rights in Texas, and the papers a payor asks for are in Texas division orders, where each heir’s taxpayer ID goes.

Reconcile your 1099 in ten minutes

1. Add up your checks by payor. Use the date paid in the calendar year, not the sale month.
2. Add back the taxes. Each stub shows the severance and other production taxes paid §91.502(5). The total of checks plus taxes should be close to Box 2.
3. Look at what is left. Deductions on gas lines, payments that fell in a different year, and adjustments can each move the total. A gap you cannot explain is a question for the payor.

The 1099 royalty reconciler does the sums for each payor. To see the tax on each line against the state’s rate, use the severance tax check. For a payor you think reported the wrong amount, or the wrong taxpayer, ask it to correct the form.