Before I dive into the specifics of a quick and easy check that all royalty owners should do before filing your state & federal income tax return, let’s talk about what we mean when we say “royalty audit”. A royalty audit is simply the process of double checking your royalty statements against production data reported to the state oil and gas commission and posted oil & gas prices. In other words, it is the process of auditing the royalty payments from the operator to make sure they are correct (or that they at least seem correct given available data).
While most operators report royalties correctly, the fact of the matter is people can make mistakes and you need to stay on top of your royalties in order to proactively catch these mistakes.
In order to perform a quick year-end royalty audit, you only need your check stubs (also called royalty statements) for the year in question and any 1099-MISC forms received from the oil & gas company (or companies if you get paid by more than one) for that year.
In order to perform a full-blown royalty audit, need your check stubs (also called royalty statements) for the year in question, any 1099-MISC forms received from the oil & gas company (or companies if you get paid by more than one) for that year. It is also helpful to have a copy of your oil & gas lease, any Divsion Orders you may have signed, and a computer or other device to look up the production data that was reported to your state oil & gas commission and to look up historical oil & gas prices to compare for the months in question.
For what we are going to focus on today, you only need two things:
- Your Form 1099-MISC or equivalent document showing the royalties you were paid for the previous year (for each operator you receive royalties form).
- The check stubs from the operator(s).
If you didn’t receive a 1099, work with your accountant to determine what you should report to the IRS. Even small royalty interests usually receive a 1099 so you can also contact the company’s owner relations department to find out the status as it may have not been issued yet.
If your operator provides a running total of the cumulative royalties paid in each royalty statement, you first need to find your last check stub from that operator (from December or the last month you were paid).
Then, simply compare what is showing up in Box 2 of your 1099-MISC or the box titled “Royalties” with the total gross payment amount for the year shown on that last check stub (before any production/severance tax or state taxes are deducted from the check amount). The amount shown in Box 2 “Royalties” amount on your 1099 should match the gross payment amount that is reflected on your last check stub from that year.
Again, this assumes the operator provides this running total of the gross and net royalty amounts on your check stubs. If they don’t, you simply have to add up the Owner Gross amounts from each check stub to determine the total you were paid for the year.
You may notice that the amount shown under “Royalties” and the Gross payment amounts don’t match what was actually deposited into your account. That is ok because you are paid on the net payment amount which is the amount that is left after any taxes or other deductions are subtracted.
If the amount on your 1099 doesn’t match the total gross amount for that calendar year, then you need to dig deeper. Double check that you’ve included the amounts from all the check stubs for that year if the operator does not provide the totals for the year. Check your math. Tip: Use Google Sheets or Microsoft Excel to create a table with the dates of each check and gross and net amounts you can enter into separate columns. Then you can add up the amounts in each column to calculate the total gross amount and total net amount that you were paid. This allows you to double check each value you entered to make sure it is correct as sometimes you can mistype something into a calculator and not realize it.
If after double checking your math you still have a discrepancy, contact the operator’s owner relations department, and explain your issue or ask to speak with someone in their accounting department. Again, sometimes operators make mistakes and the 1099 that you receive can be incorrect. I’ve received a corrected 1099 from operators on more than one occasion.
This time of year presents the opportunity to perform a quick and easy royalty audit to at least make sure that what is being reported to the IRS matches what you were paid. Of course, this assumes that the operator paid you correctly and that is why it is helpful to perform a more in-depth royalty audit to compare the volumes and prices from your royalty statement to the volumes reported to your state oil & gas commission and the average prices reported by the EIA. That will have to be the subject of a future article or in the meantime, be sure to check out the member section of the NARO website to watch on-demand replays of past NARO Webinars on this topic.
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