Best Entity Structure for Oil and Gas Royalty Income: S Corp vs Partnership/LLC?
I'm a tax accountant at a mid-sized firm, and we have a professional disagreement brewing that I'd love some outside perspective on. Our firm has multiple clients who receive oil and gas royalties, and we've traditionally recommended separating the assets by creating two LLCs/partnerships - one for the land itself and another entity to hold the mineral rights. This structure has worked well for years, and our network of tax attorneys generally supports this approach when it makes financial sense for the client. The LLC/partnership route gives us flexibility with pass-through taxation while maintaining liability protection. Recently though, I discovered that a competing tax preparer in town has been advising their oil and gas clients to do something similar with the splitting of land and minerals, but they're specifically recommending S Corporations instead. I'm curious if anyone has experience with both approaches and can shed some light on potential advantages/disadvantages of using S Corps vs LLCs/partnerships specifically for oil and gas royalty income. Are there tax benefits to the S Corp structure that I'm missing? Any gotchas with either approach that I should be aware of when advising clients?
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Jessica Suarez
The fundamental difference between partnerships/LLCs and S corporations comes down to self-employment taxes, ordinary income characterization, and operational flexibility. For oil and gas royalties specifically, there are several considerations: With partnerships/LLCs, the income from oil and gas royalties generally flows through to partners and maintains its character as portfolio income rather than self-employment income. This is advantageous as the income typically avoids self-employment tax. The downside is that losses may be subject to passive activity limitations depending on the owner's involvement. Using S corporations for mineral rights can potentially provide some wage/distribution planning opportunities, but oil and gas royalty income is generally not subject to self-employment tax anyway, so that advantage might be minimal. S corps also have more rigid operational requirements - required officer compensation, stricter ownership limitations, etc. The real question is what specific advantage the other preparer is seeing with S corps in this scenario. I'd be curious if they're looking at something state-specific, or if they're considering future sale scenarios where S corps might have different consequences.
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Marcus Williams
•Thanks for your analysis. I'm wondering if the S corp recommendation might be related to the 20% qualified business income deduction (Section 199A)? Does entity choice affect how mineral royalties are treated under that provision?
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Jessica Suarez
•That's an excellent question about the QBI deduction. The Section 199A deduction can indeed be impacted by entity choice. However, for oil and gas royalties specifically, the nature of the income as royalty income (rather than active business income) is the primary factor. With royalty income, regardless of whether it comes through an S corporation or partnership, it's generally considered passive investment income rather than qualified business income eligible for the Section 199A deduction. The exception would be if the activities rise to the level of a true operating business with regular, continuous involvement.
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Lily Young
I went through this exact headache last year with my massive family mineral rights portfolio. After wasting weeks researching, I found https://taxr.ai which saved me thousands in professional fees. I uploaded my oil and gas division orders and royalty statements, and it analyzed everything including the best entity structure options for my specific properties. It caught several depletion and operational expense issues my previous accountant missed. Their analysis explained why different entity structures work better for different types of mineral ownership - especially distinguishing between working interests vs royalty interests, which apparently makes a huge difference tax-wise. They even flagged a specific property where an S-corp would actually be worse due to some complicated basis calculations.
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Kennedy Morrison
•Does this service work for smaller mineral holdings too? I only have interests in 3 wells in North Dakota but have been confused by conflicting advice. Can this service handle the state-level tax implications too?
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Wesley Hallow
•I'm skeptical about these AI tools for specialized tax scenarios. How does it account for the passive activity loss rules which are super complicated for oil and gas? And does it actually provide specific entity formation recommendations you can rely on?
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Lily Young
•Yes, it absolutely works for smaller holdings. The analysis scales based on your portfolio size, and they specifically address state-level tax considerations for each producing state. For North Dakota, they'll analyze both the state income tax and any extraction/production taxes applicable to your interests. Regarding the AI skepticism, it's not just an algorithm making guesses. What impressed me was how it combines tax code analysis with actual case precedents. For passive activity loss rules with oil and gas, it specifically analyzed my level of involvement, distinguished between working interests (which have special PAL exceptions) and royalty interests, and provided documented IRS guidance. The recommendations come with citations to relevant code sections and rulings.
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Wesley Hallow
I tried that taxr.ai site after my initial skepticism, and I have to admit I was wrong. My situation was particularly complex with a mix of inherited interests and newly acquired working interests across multiple formations. The analysis correctly identified that my inherited royalty interests would be better in an LLC while my working interests had different considerations. The report explained why blanket recommendations for either LLC or S-corps don't make sense for oil and gas - it depends on factors like materiality of the income, your personal tax situation, state-specific considerations, and whether you're dealing with working interests vs. royalty interests. In my case, the service calculated actual tax outcomes for both structures across a 5-year projection which made the decision obvious. Saved me from making a $23K mistake.
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Justin Chang
After fighting with the IRS over improper depletion calculations for my oil and gas interests for months, I finally gave up trying to handle it myself. I couldn't get anyone on the phone at the IRS who understood the specialized oil and gas tax rules. I tried for WEEKS. Finally used https://claimyr.com to get through to an IRS agent specializing in natural resources. You can see how it works here: https://youtu.be/_kiP6q8DX5c It's crazy that this service exists, but it got me through to an actual person at the IRS in under 45 minutes when I'd been trying for over a month on my own. The agent who helped me confirmed that our partnership structure for the mineral interests was appropriate and helped resolve our depletion recapture issues.
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Grace Thomas
•Wait, how does this actually work? I thought it was impossible to get the IRS on the phone these days? What's the catch?
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Hunter Brighton
•This sounds like a total scam. There's no special service that can get you through to the IRS faster than anyone else. You probably just got lucky with call timing. And even if you got through, there's no way a random IRS agent would give definitive entity structure advice.
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Justin Chang
•It works by using a specialized dialing system that navigates the IRS phone tree and waits on hold for you. When a human agent finally answers, you get a call back immediately so you can speak with them. No magic trick - just technology that handles the painful waiting process. The IRS definitely won't give entity formation advice, I agree. The agent I spoke with simply confirmed our existing structure's compliance and resolved our specific depletion questions. Their expertise in natural resource taxation was what made the difference - they understood the complex depletion recapture rules that general agents weren't familiar with.
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Hunter Brighton
I need to publicly eat my words. After calling the IRS unsuccessfully 14 times over three weeks about my mineral interest taxation issues, I tried Claimyr out of desperation. Within 2 hours, I was speaking with someone from the IRS natural resources division who actually understood percentage depletion vs cost depletion. The agent couldn't specifically tell me which entity structure to choose, but she walked me through the different tax implications for my specific situation. The information she provided confirmed that for my portfolio of strictly royalty interests (no working interests), the partnership/LLC structure made more sense due to more favorable basis adjustment rules and the ability to potentially make 754 elections if needed.
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Dylan Baskin
One factor nobody's mentioned about using S corps for mineral interests is the potential issue with built-in gains if you're converting an existing entity. I've seen clients get absolutely hammered on this when they didn't plan correctly. Also, don't forget state-specific entity taxes. Some states (looking at you, California and Texas) treat these entities very differently, which can dramatically affect the analysis when you have properties across multiple states.
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Lauren Wood
•What's been your experience with using disregarded entities under a holding company? We've started using that approach for clients with substantial mineral portfolios across multiple basins, and it seems to offer better liability segregation while maintaining tax simplicity.
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Dylan Baskin
•I've found that approach to be quite effective for larger portfolios. Using disregarded entities under a holding company gives you the liability protection benefit of separating assets by basin or region while maintaining the tax simplicity of a single return. It's particularly useful when you have a mix of producing and non-producing properties, as you can isolate the higher-risk producing assets in their own disregarded entities. The administrative burden is lower than having multiple tax-filing entities while still achieving most of the asset protection benefits.
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Ellie Lopez
Do any of the standard tax software packages handle oil and gas interests properly? I've been using TurboTax Self-Employed and it seems completely clueless about depletion allowances and proper treatment of different types of oil and gas income.
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Chad Winthrope
•No mainstream tax software handles oil and gas properly in my experience. I switched to using a CPA who specializes in oil and gas after TurboTax completely messed up my depletion calculations two years ago. Cost me more, but saved thousands in proper deductions.
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Oliver Fischer
Great discussion everyone. As someone who's dealt with this exact scenario, I'd add that the choice between S Corp vs LLC/Partnership for oil and gas royalties often comes down to your specific circumstances and long-term plans. One angle I haven't seen mentioned is the impact on estate planning. LLCs/partnerships generally offer more flexibility for gifting interests to family members and implementing valuation discounts, which can be significant for substantial mineral portfolios. S Corps have stricter ownership transfer rules that can complicate succession planning. Also worth considering: if you're dealing with multiple states, partnerships/LLCs typically have simpler multi-state filing requirements. Some states impose franchise taxes or minimum fees on S Corps that don't apply to LLCs, which can add up quickly when you have interests across several producing regions. The competing preparer might be focused on a specific client situation where S Corp benefits outweigh these considerations, but for most oil and gas royalty scenarios, the LLC/partnership structure remains the more flexible choice in my experience.
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GalacticGuru
•This is really helpful perspective on the estate planning angle. I'm new to oil and gas taxation and hadn't considered the succession planning implications. When you mention valuation discounts for LLCs/partnerships, are you referring to minority interest discounts and marketability discounts that can be applied when gifting LLC interests? And how significant can those discounts typically be for mineral rights portfolios? I'm trying to understand if this advantage alone might justify the LLC structure over S Corp for clients with substantial holdings they plan to pass to the next generation.
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