Many Utica region landowners have Chesapeake leases assigned to Encino in late 2018. Others have entered new leases with Encino or Encino Acquisition Partners. Lessors with land in producing units should have received or will be receiving IRS Form 1099-MISC as required by federal law, which is to report royalties paid out by Encino to the 1099 recipient during 2019. The lessor is to report the amount shown on the 1099 on their 2019 tax return.

Extreme Alert. Encino may have sent with the 1099 a cover or explanatory letter, but be aware that the amount entered in Box 2 Royalties of the 1099 is probably the gross amount of royalty attributable to the Lessor’s interest in the production unit. The amount shown is likely not an amount equal to the royalty checks the Lessor actually received during 2019. The royalty checks received were for amounts remaining after deductions. You only owe taxes on the amount that you received in royalty checks, not the gross amount.

You should definitely provide your tax return preparer with copies of all the royalty statements and checks that you received during 2019, as well as the Encino 1099-MISC you received.

The amount shown in Box 2 of the 1099 will likely need to be entered on Line 4 of Part 1 of Schedule E of IRS 1040.

The cumulative amount of royalties you actually received should be reflected on Line 21 and the difference between those two numbers should be reflected on Lines 18 and 19 (depletion, or “other”). The “other” would constitute items listed in the deduction codes on the EAP Holdings royalty statements, referenced by number in the deduction column on the statements. Those include compression, dehydration, processing and the other varieties of producer deductions.

Why is Encino/EAP reporting your royalties this way? Who knows? It does not seem that other producers do this.   But do not make the mistake of paying income taxes on the gross amount reported, rather than the net amount you received.

And as to why they are taking deductions with a “no deduction” lease?  Good question!

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Alan D. Wenger is an oil & gas lawyer in Youngstown, Ohio, and chair of the Oil & Gas Law Practice Group at HHM.