I’ve read numerous posts in this group about S-Corp vs LLC and it’s clear to me S-Corp is not the way to go. In my situation, both my son and I own mineral rights in Oklahoma but live in Texas. We are each paying extra on our tax prep for the mineral rights. We are considering consolidating both of our mineral rights in order to achieve the following goals:
Minimize the cost for all expenses including tax prep.
Set up a new entity which would hold the ownership of both of our current mineral rights in order to not have to go through the extremely time-consuming task of transferring ownership each time a generation passes ownership (we just did this a couple of years ago and it took almost 6 months).
Provide a process whereby the mineral rights pass to each future descendant(s) without having to deal with them in wills.
Distribute net cash of new entity minus the cost of maintaining a checking account without incurring monthly fees.
Based on these objectives, it is not clear to me whether an LLC or LP would be the best choice for our situation. I would appreciate any thoughts/feedback or links to information related.
If you use an LP, then you will need to specify a GP (General Partner) which will be responsible for management, leasing and other decisions. Most use an entity GP, rather than an individual. GP can be owned by all or some limited partners, and in the same percentage or not. Both entities will need to file tax returns, as will the LLC. This requires that you maintain a balance sheet for each entity, including mineral basis and reduction for depletion. Partners or members will receive K-1 with tax information for their individual returns, including pass-through of OK income taxes withheld. Your CPA will make sure you specify that the LLC is treated as a partnership for tax purposes on the first return (i.e., not as a corporation). Tax preparation may not be less expensive. Owners will still need to specify heirs if shares or partnership interests are transferred on death. Regardless, someone will have to do the work of managing the minerals, from leasing to D.O. to bookkeeping, etc. It can be a family member or hired outsider. Consider whether to pay a family member who will otherwise be working for free for everyone else. You will not be able to distribute 100% of the income as you need to retain funds for accounting and tax return preparation, legal fees, postage, etc. The bank account needs to be in the entity’s name.
Wow… so glad I asked… if we create an LLC to hold the mineral rights and tax file as S-Corp, will the LLC pay the taxes or the individuals who own the LLC?
LLCs, LPs and S-Corps can complicate ownership. The Corporate Transparency Act with its reporting requirements is working its way through the courts. Many opt for a trust as a means to avoid probate. At some point most LLCs, partnerships, etc., fail or become impractical in successive generations. They often end up with one descendant running the business. This can lead to misunderstandings or worse.
This post is not legal, tax or investment advice. Reading or responding to this post does not create an attorney/client relationship.
An S-corp must keep the same records as a partnership and file a tax return. The shareholders receive K-1s and pay the income taxes. If you each set up single-member LLCs, then the taxes are reported on your individual federal and state tax returns as you do now. Once there are multiple members, then entity returns (federal and state) are required. You also have to determine what state the entity is registered in as you must file an annual report at the state level for each partnership or LLC. You really need to consult your CPA to understand the tax requirements and returns of all these entities, and your lawyer to understand the annual paperwork and management requirements.
If you create an entity combining both of your assets, the new entity will then have to pay each of you, so now you’re adding a third party into the mix for your accountants, aka more work. You could create a life estate with your son as the remainderman or a trust for the future, but at the end of the day, if you and your son want to continue to get paid on the monthly royalties, there’s no way of getting around an accountant running numbers for both of you.
Great thought @Richard_Winblad. We have chosen a living trust for our estate management. A separate EIN may be a consideration dependent on the grantors. Part of our goal was to simplify tax preparation in addition to a simpler succession.
To be fair, I also included trust! This whole post is very confusing as it seems to center around paying an accountant. I can’t tell if a mom and son are sharing the same account but one side seems to be using an accountant but the other side says they are taking care of the bookkeeping. At the end of the day, it’s always best to hire an accountant that’s very experienced in oil and gas if you’re making more than say 15K a year from production. Heck, I’d even have my accountant look at it if it was much less; they will save you money and headaches down the line if you’re doing it on your own.
Even if you set up an entity, the ownership interest in the entity must pass to the intended inheritors via some legal mechanism such as a Will, Trust, or in some states by beneficiary designation.