Most tax efficient way to pass on money to kids?

[skyvue]

I am trying to help my grandmother, father, uncles and aunts figure out the most efficient way to quickly pass along some money from my grandmother to her kids.

Background: My grandmother is 85 years old (grandfather died 10 years ago). She has steady income from pensions and social security to more than meet her monthly expenses. She is actually saving money on a monthly basis currently and has a decent amount of assets in the bank (I don't know the exact number). She still lives on the family farm of 200 acres that one of her kids (my uncle) is now actively farming. This uncle lives next door and and 3 of her other children also live nearby and help care for her when she needs help, though she is actually doing very well for her age.

The farm is located in southeastern Ohio where there is a boom from the natural gas industry. Land is much more valuable today than it has been historically. She has the opportunity to lease the mineral rights for her farm (140 of the 200 acres) so they can drill for natural gas. She really doesn't need the money, but the proceeds from leasing the ground would be $700K upfront with more money to come when and if the well actually produces gas and/or oil (she would get a percentage of the proceeds). The well most likely will not even be on her land but rather they would drill under her property horizontally from adjacent farms.

My grandmother has 7 kids, all who are all still living. Once she gets the initial money from leasing the mineral rights, she said she doesn't want or need the money and thus wants to pass along to her children. The math is obviously pretty simple ($700,000 / 7 kids = $100,000 each).

What would be the most tax efficient method for her to pass along this $100K to each of her kids if she were to try to do it within a single tax year? I say single tax year rather than passing along a little each year because she indicates thats is her preference.

Thanks

[prudent]

I would think she can simply gift it immediately. It would count towards the lifetime gift exemption (currently a little over $5 million but due to revert to $1 million on Jan 1) but there would be no tax. However, I wonder if it might be a good idea to explore options that help protect not just the immediate payment, but also the potential royalties and the farm itself. Perhaps a trust for the land and mineral rights.

[reggiesimpson]

I would consult an estate tax attorney.

[skyvue]

I would think she can simply gift it immediately. It would count towards the lifetime gift exemption (currently a little over $5 million but due to revert to $1 million on Jan 1) but there would be no tax. However, I wonder if it might be a good idea to explore options that help protect not just the immediate payment, but also the potential royalties and the farm itself. Perhaps a trust for the land and mineral rights.

Are there any specific forms or documents required to "gift" amounts this large?

The farm and land itself will pass onto my one uncle who is currently farming it. He will get this land at a pre-determined (discounted) price. He will then pass along that money in equal amounts to the other 6 kids. However, this really has nothing to do with the mineral rights. The land itself and the mineral rights ownership are 2 different things. I am not sure my grandmother has thought about how she plans on passing along the mineral rights themselves. Setting up a trust for the mineral rights sounds like a good idea. It would allow each of her kids to continue to profit from the royalites. I am pretty sure her current will does not address that particular issue.

[sscritic]

Farmers usually have children.

7 children
7 farmers x 4 kids = 28 grandchildren
10 great grandchildren (most of the grandchildren haven't had children yet, but there might be more in some farm families).

That's 45 descendants. Include 6 spouses in the children's generation and 24 in the grandchildren's and you have 75 people you can give gifts to.

75 x $14,000 annual exclusion is $1,050,000 of tax free gifts in 2013.

Back when the annual exclusion was $3,000, my one year old daughter got her $3,000 from her great grandfather who was following this plan. He wasn't a farmer, so he didn't have 75 people to give the money to, but he gave away as much as he could.

P.S. and no forms are required with this method.

[skyvue]

Farmers usually have children.

7 children
7 farmers x 4 kids = 28 grandchildren
10 great grandchildren (most of the grandchildren haven't had children yet, but there might be more in some farm families).

That's 45 descendants. Include 6 spouses in the children's generation and 24 in the grandchildren's and you have 75 people you can give gifts to.

75 x $14,000 annual exclusion is $1,050,000 of tax free gifts in 2013.

Back when the annual exclusion was $3,000, my one year old daughter got her $3,000 from her great grandfather who was following this plan. He wasn't a farmer, so he didn't have 75 people to give the money to, but he gave away as much as he could.

P.S. and no forms are required with this method.

So anything above $14K is considered taxable income to those receiving it? (In our case there are 13 grandkids and 9 great grandchildren so far..)

[chicagobear]

So anything above $14K is considered taxable income to those receiving it? (In our case there are 13 grandkids and 9 great grandchildren so far..)

No. Gifts and inheritances are not taxable to the recipient. The giver or estate pays any tax that might be due.

[skyvue]

I should add that my grandmother wants to know why she can't ask for cash when she get her check and simply hand over cash to each of her children? I didn't have a very good answer handy for her other than I was sure the bank would require her to fill out some sort of forms and the IRS would likely have a few questions for her when it came tax time.

I did suggest to my dad that a tax attorney would be advisable in this case but they think I am worrying too much about this.

[chicagobear]

I should add that my grandmother wants to know why she can't ask for cash when she get her check and simply hand over cash to each of her children? I didn't have a very good answer handy for her other than I was sure the bank would require her to fill out some sort of forms and the IRS would likely have a few questions for her when it came tax time.

I did suggest to my dad that a tax attorney would be advisable in this case but they think I am worrying too much about this.

She can do that. She is supposed to fill out a gift tax form with the IRS if her total gifts during the year to each person is over $13,000 this year and $14,000 next year so the IRS can keep track of how much of her lifetime exemption she has used up.

[Minot]

The math is obviously pretty simple ($700,000 / 7 kids = $100,000 each).

Grandma is going to have to pay capital gains tax on the $700,000. Depending on her basis, and also on how much of the cap.gains tax rate falls over the cliff, this could be a significant amount.

[Random Poster]

She has the opportunity to lease the mineral rights for her farm (140 of the 200 acres) so they can drill for natural gas. She really doesn't need the money, but the proceeds from leasing the ground would be $700K upfront with more money to come when and if the well actually produces gas and/or oil (she would get a percentage of the proceeds). The well most likely will not even be on her land but rather they would drill under her property horizontally from adjacent farms.

1) It sounds like your GM has not leased the land to anyone yet. True?

2) Bonus monies are nice (5K an acre, is it?), but royalties are where the real money can be. Pay attention to the royalty percentages (and how they are calculated).

3) Regarding your "Most likely" statement. Says who? The landman? There are several ways to ensure that there won't be a well drilled on your GM's property, but they must be documented in the actual oil and gas lease. Consult a knowledgeable oil and gas attorney.

My grandmother has 7 kids, all who are all still living. Once she gets the initial money from leasing the mineral rights, she said she doesn't want or need the money and thus wants to pass along to her children. The math is obviously pretty simple ($700,000 / 7 kids = $100,000 each).

What would be the most tax efficient method for her to pass along this $100K to each of her kids if she were to try to do it within a single tax year?

1) Why does she want the bonus money to come to her?

2) If the bonus is $700K before taxes, it won't be $700K after taxes.

3) I don't know about the tax-efficiency method of it (although I suspect it is pretty high), but why not have your GM (gift) deed the mineral rights to the 7 kids, and then have each of those kids execute an oil and gas lease and get the bonus money (and royalties) that way? If your GM wants the bonus to go to certain people (her, or to certain kids, or whatever), and the royalties to go to someone else, that can be accomplished through careful drafting of the mineral deed. Again, consult a knowledgeable oil and gas attorney.

[skyvue]

The math is obviously pretty simple ($700,000 / 7 kids = $100,000 each).

Grandma is going to have to pay capital gains tax on the $700,000. Depending on her basis, and also on how much of the cap.gains tax rate falls over the cliff, this could be a significant amount.

Interesting that you say this will be considered "capital gains"? I had thought this would be considered "ordinary income" and taxed at those rates?

[skyvue]

Random Poster,
As far as your lease specifiction questions are concerned, my grandmother is not leasing her land individually. She is part of a group that is leasing thousands of acres. They have oil and gas attorney's representing them as well as people in the industry itself. I feel good about the lease specifics as it seems she will be getting a good deal (per acre and percentage of royalties) based on what others have settled for in the area.

[JW Nearly Retired]

The math is obviously pretty simple ($700,000 / 7 kids = $100,000 each).

Grandma is going to have to pay capital gains tax on the $700,000. Depending on her basis, and also on how much of the cap.gains tax rate falls over the cliff, this could be a significant amount.

Interesting that you say this will be considered "capital gains"? I had thought this would be considered "ordinary income" and taxed at those rates?

Hope you are wrong about "ordinary income". Taxes on that would consume nearly half of the $700,000. IMO, it would be cap gains. Land acquired long ago with very low basis. Partly sold today (oil/gas) for $700k. Isn't that a cap gain? If I sell my house for a big profit I owe cap gains taxes don't I? But I have no real knowledge on this. Grandma had better consult a real tax expert before she starts writing $100k checks!

IMO, she also needs an estate tax attorney to see if there is any way to keep inheritance taxes from destroying the farm.

As far as how to gift the money. She can gift $14k per year to as many people as she wants without triggering gift taxes or using any of her lifetime exclusion. So, for example, she could gift $14/year to each kid and another $14/year to their spouse..... totals $196k/year. That would probably consume all of the $700k left after cap gains taxes in 3 years. If there are a lot of grandchildren then it could go even faster.
JW

[Minot]

The math is obviously pretty simple ($700,000 / 7 kids = $100,000 each).

Grandma is going to have to pay capital gains tax on the $700,000. Depending on her basis, and also on how much of the cap.gains tax rate falls over the cliff, this could be a significant amount.

Interesting that you say this will be considered "capital gains"? I had thought this would be considered "ordinary income" and taxed at those rates?

IRS Publication 17, chap. 12:
Sale of property interest. If you sell your complete interest in oil, gas, or mineral rights, the amount you receive is considered payment for the sale of section 1231 property, not royalty income. Under certain circumstances, the sale is subject to capital gain or loss treatment as explained in the Instructions for Schedule D (Form 1040). For more information on selling section 1231 property, see chapter 3 of Publication 544.

[Watty]

I would consult an estate tax attorney.

+1


It is not realistic to think that you could get good advice on a message board to such a potentialy complex situation.


At best you might get some good suggestions about questions at ask the attorney.

[sscritic]

IRS Publication 17, chap. 12:
Sale of property interest. If you sell your complete interest in oil, gas, or mineral rights, the amount you receive is considered payment for the sale of section 1231 property, not royalty income. Under certain circumstances, the sale is subject to capital gain or loss treatment as explained in the Instructions for Schedule D (Form 1040). For more information on selling section 1231 property, see chapter 3 of Publication 544.

The OP wrote "lease" of mineral rights, not "sale" of mineral rights. I don't know if the OP was using the correct term or not, but I usually think a lease is a lease and a sale is a sale. Can a lease be a sale of a complete interest? I found this guide from the IRS, the Oil and Gas Handbook:

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 U.S. 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 section 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)

http://www.irs.gov/irm/part4/irm_04-041-001.html

This sounds like a lease bonus.

$700K upfront

So how are royalties taxed?

[Rubiosa]

What does your farmer/uncle say about all this? Is the hydraulic fracking going to damage his irrigation water?

[user5027]

I smell a political turn.

[skyvue]

What does your farmer/uncle say about all this? Is the hydraulic fracking going to damage his irrigation water?

No, they are not worried about that. There is risk from any drilling but the actual occurence of what your talking about are extremely rare these days. If the ground water (spring) were totally ruined it would not be devastating as there are other sources of water on the property already. It is a cattle farm, not a crop farm, so there is no real irrigation going on.

[skyvue]

To clarify, she is "leasing" her mineral rights not "selling" them. I belive that is an important distinction and determines how they are taxed. According to several sources I found, it appears the $700K upfront payment will be ordinary income.

http://ohioagmanager.osu.edu/wp-content ... -SHEET.pdf

[JW Nearly Retired]

According to several sources I found, it appears the $700K upfront payment will be ordinary income.

http://ohioagmanager.osu.edu/wp-content ... -SHEET.pdf

That's regretable. Isn't there any different way to structure that? I'm surprised if there isn't some option to spread it out over a number of years to reduce the giant tax hit?

IMO, you need professional advice. Most everyone here means well and we are a really great place to check with, but we are still just an internet forum. I don't think anybody here has actual experience with such a oil and gas lease royalties "problem".
JW