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This study was requested by Congressman Robert Shuster of the House Budget Committee. It was prepared by Robert Lucke of the Tax Analysis Division of the Congressional Budget (CBO) under the supervision of Rosemary D. Marcuss. In accordance with CBO's mandate to provide the Congress with objective and impartial analysis, the report contains no recommendations.
 
 

In the last few years, interest has grown in the use of royalty trusts as a means of distributing the income from oil and gas properties to investors. Income from mineral properties placed in such trusts is not liable for corporate income taxes, thus providing potentially large tax advantages for companies (and their shareholders) that use them. If many major oil and gas companies decided to form such entities, the implications for federal revenues might be fairly significant.

Most recently, attention has been focused on the efforts of Mesa Petroleum Corporation to induce the stockholders of the Gulf Oil Corporation to set up a trust consisting of a large share of Gulf's oil reserves. As a large shareholder of Gulf stock, Mesa is in a strong position to influence management decisions at Gulf. At this point, however, Gulf has resisted the efforts of Mesa, and does not currently contemplate setting up a royalty trust. As discussed below, the income tax consequences from the formation of a royalty trust are complex and raise several important tax policy issues. Because a royalty trust does not involve any new investment or development of oil or gas properties--it simply involves a change in legal ownership--any new wealth that is created for stockholders by the trust's formation is a result of lower net taxes paid to the Treasury over the life of the property.

This analysis reviews the mechanics of royalty trusts and the tax issues involved. The creation of an oil royalty trust is significantly affected by the tax law regarding corporate distributions of property and the differential tax treatment of corporate versus noncorporate entities. Section II describes how a typical oil royalty trust is formed and how it operates, and Section III discusses the relevant tax rules and their associated implications. Section IV presents an example of a hypothetical royalty trust and discusses the tax implications for various kinds of shareholders (for example, individuals or corporations). Lastly, Section V estimates the potential effect that widespread use of royalty trusts might have on revenues collected by the U.S. Treasury.

This document is available in its entirety in PDF.