Estate Planning for Marcellus Shale Owners

Many Pennsylvania owners of mountain acreage, summer homes, farms, and hunting camps are now benefitting from the Marcellus Share boom. Marcellus Shale landowners are anticipating significant royalties and bonus payments well into the future. Proper planning is necessary to preserve the value of the asset with a minimum of taxation including federal estate tax and Pennsylvania inheritance tax.


There are many unknowns about the Marcellus Shale. Production estimates continue to increase. It is now estimated at three times the lifetime production of the Barnett Shale in Texas. The U.S. Geological survey has increased its estimate of recoverable gas from Marcellus Shale to 84 trillion cubic feet – which is 42 times its 2002 estimate. Who knows what is the actual number?

Also unknown are the environmental effects including issues about hydraulic fracturing and horizontal drilling. What role future actions of the federal and state governments will have from a regulatory perspective are hard to predict, as are the effects of possible new taxes and fees. What effect will energy prices on the global markets have? What delays will be encountered due to government action? Will well-drillers go to other states? All of these imponderables affect the current and future value of the land and gas rights. There are many competing issues and considerations among the surface owners, environmental interests, and industry groups with millions of dollars at stake.


As an owner of gas rights, it is very important to plan for the taxation of the rights, to try to reduce the impact of taxes, to determine who should control the rights in the future and who should have the benefit of the income stream.

There are various issues including realty transfer tax, clean and green implications, income tax, and estate and inheritance tax. Obviously, negotiation of the lease is the first step. But that is only the beginning.

Estate planning in this area involves taking advantage of valuation discounts, making gifts, forming entities, perhaps a limited partnership and/or a limited liability company, and making lifetime transfers to individuals and/or various types of trusts.

Planning requires valuations of land and of sub-surface rights. Sooner is better. Since most commentators predict rising values and rising income, it is very important to have your planning, including any contemplated transfers, in place before your assets appreciate substantially. If possible your planning should be in place well before there is drilling activity near you. Once a royalty stream is established, the valuation of the asset increases dramatically, so it is important to act before that run-up in value.


For transfer of assets you expect to increase quickly in value, a Grantor Retained Annuity Trust (GRAT) might work. The Grantor transfers assets to the trust and the trust pays the Grantor an annuity in return. The amount of the annuity depends on that month’s Applicable Federal Rate (AFR) for such transfers (1.40% in November 2011) and the number of years of the annuity. Whatever is left after the annuity pays out goes to the remainder beneficiaries tax free.

The GRAT can have a near-zero calculated remainder (the gift part) but thanks to the growth have a significant actual remainder. The leverage of this IRS-approved technique increases with higher growth (great potential for that in Shale assets) and lower AFRs (they can’t get much lower 1.4%).


In Pennsylvania, gas and other mineral rights are completely severable from the surface rights. This means gas rights and royalties can be conveyed and valued separately from surface rights. This can allow separate planning for the sale and income and keep the farm, house or camp separate under separate control and use. This can be particularly attractive to those who want to develop the land and also do effective tax reduction planning for gas rights and royalty streams.

The taxable gift free pass

Until the end of 2012, the federal gift tax exemption is $5 million per donor. The $5 million “window” is guaranteed to be open for only two years – 2011 and 2012. This represents a tremendous opportunity to transfer valuable assets including gas interest and leases. With the tax proposals floating around Congress and the would-be Presidential candidates, it is impossible to predict what will be the tax rates or exemption levels in the future. Given the deficit and the general condition of the economy, I would suspect that taxes will increase, not decrease, including increases in estate taxes and a reduction in the estate tax exemption – but who knows?

Most advisors are recommending that their clients take advantage of the $5 million exemption now, while they can. This is very important for all assets but especially for very valuable assets or assets that are expected to appreciate greatly and/or generate large income streams. Until the end of 2012, gifts up to $5 million per person ($10 million for married persons) can be made with no gift tax. I cannot emphasize enough how important it is to take advantage of this high exemption with valuable assets like Marcellus share interest.

The non-taxable gift exclusion

The annual gift tax exclusion of $13,000 per donee pales in comparison. Not that these are not good planning techniques to use as well, but this (possibly) one-time chance to pass $5 million is important. The exemption also applies to the generation-skipping tax so one could transfer $5 million of property into a generation-skipping trust that will keep the valuable asset untaxed for generations Going once, going twice,…