One of the many ways a landowner or mineral owner can benefit from leasing minerals to an oil or gas company is a lease bonus. The oil and gas lease is a contract between the mineral owner with mineral rights and another party, usually an oil and gas company, which gives the latter rights to dig and extract the minerals.
The lease agreement includes the terms and conditions of the lease as to what rights the owner is giving to the company. More importantly, it also lays down what they will get in exchange, which is mineral royalties.
However, many lease agreements also include a lease bonus for the lessor (mineral owner). Let’s discuss this term in detail.
What is Oil and Gas Lease Bonus?
A lease bonus in the oil and gas industry is a one-time payment given to the lessor at the time of the execution of the lease. This is a payment on top of the regular royalties the lessor will receive in exchange for leasing mineral rights to another party.
As it’s an extra payment, it’s called a bonus. Not every lease agreement may have a bonus clause. In other words, it’s not mandatory for the lessee to pay the lessor a lease bonus, but it’s a common practice in the oil and gas industry.
Think of it as an upfront advance on the royalties. However, the royalties will also kick in with production or even before that, depending on the terms of the agreement.
Unlike royalties, a lease bonus is a guaranteed payment that you will receive as soon as the lease starts. In fact, most companies will pay it when you sign the lease.
On the other hand, royalty or rental payments are based on a variety of factors. In most cases, mineral owners only receive royalties if the well successfully starts producing minerals.
How is Oil and Gas Lease Bonus Payment Calculated?
The lease bonus in oil and gas contracts is based on the extent of mineral ownership of the lessor. It’s based on a net mineral acre basis. For instance, if you own 25 percent mineral interest in a 1000 acre land, the net mineral acre would come down to 250 acres.
The bonus is then decided on per dollar amount per mineral acre. So for instance, if the per mineral acre amount is $500, the lease bonus would come out to $125,000.
Since there can be multiple mineral rights owners signing the lease, the actual lease bonus, as well as royalties, are determined based on ownership percentage, as per net mineral acres. All of this is mentioned in the lease agreement.
Why Do Oil Companies Pay a Lease Bonus?
As an oil or gas company signs a lease with you, it gets exclusive access to the minerals. For the term of the lease, it locks your property with that company as you may not be able to sell it or lease it to another party until the lease is up.
Plus, royalties do not kick in until the well is completed and starts producing. So, it may take a while before you receive any monthly royalties. This lease bonus serves as an advance or gesture of goodwill, if you will, to cover up that gap between lease signing and royalty payments.
It’s also another way for oil and gas companies to entice the owners into signing a lease with them exclusively. With an upfront bonus payment, an owner may be more likely to sign the lease.
Lease Bonus and Royalties
During negotiations for lease terms and payments, an oil or gas company may be willing to increase either the lease bonus or the royalties, but not both in most cases. So not only should you demand a lease bonus as a mineral owner but also decide whether you want a bigger lease bonus or a higher royalty percentage.
Of course, a higher lease bonus can put hundreds of thousands of dollars or even more, depending on the mineral ownership, into your bank. On the other hand, having higher royalties is beneficial in the long run. Over time, it can lead to more passive income and wealth accumulation.
This is why it’s important for mineral owners to discuss the matter with an expert before signing the lease. That way, they can make an informed decision and negotiate royalties and bonuses according to their financial goals.
Oil and Gas Lease Bonus Tax Treatment
In the US, the oil and gas lease bonus is treated as regular income and taxed like it. This is similar to how royalties are taxed as income. The bonus is not treated as capital gain, so you cannot benefit from the lower capital gain tax rates.
The tax on the bonus lease is applicable only in the year your receive it. It will be included in your overall income for that year and taxed based on the bracket you fall in. This is according to federal income tax laws, not state laws.
In very rare cases, the lease bonus payment may be eligible for cost depletion but not percentage depletion.
There have been cases where mineral owners have argued that lease bonuses be treated as capital gains and taxed accordingly. But according to the latest case rulings, it remains income.
Even though the lease bonus is reported as rent by the oil and gas company paying it, it’s still considered passive rent by the government.
A lease bonus is a one-time bonus payment for signing a mineral lease agreement. It’s calculated based on mineral ownership. It typically takes up to 90 days for the lessor to pay this bonus to the lessee.
Some companies may offer a higher lease bonus in exchange for a lower royalty percentage. It’s up to the owner to decide what they prefer. Generally, it’s best to negotiate for higher royalties than the lease bonus as the latter is paid just one time while the former may continue for years. Also, lease bonus payment is subject to federal income tax.