Texas Oil & Gas Royalties 1099 MISC Depletion Deduction

Receiving royalty checks from Texas oil and gas production raises a few repeated questions every spring. How do I report the 1099 MISC for royalties, which expenses can I deduct, and how do I calculate the depletion deduction without leaving money on the table. As a Texas CPA firm, Alviso, CPA works with royalty owners across the state, from inherited mineral interests to new lease bonus income, and this guide lays out a practical path for reporting, documenting, and planning taxes around your wells.

What royalty owners actually receive

A royalty is a payment to the mineral owner for the right to produce oil or gas from a tract. If you hold a royalty or overriding royalty, you typically receive a monthly check and a check detail or owner statement. That statement shows the lease or unit name, the production month, volumes, price per unit, and deductions withheld by the operator. Common deductions include Texas severance taxes, sometimes ad valorem property taxes, and post production items such as gathering, compression, transportation, and marketing fees if your lease allows those costs to be shared. At year end, most operators issue a 1099 MISC to the payee for the total royalties paid during the calendar year.

Texas has no personal income tax, but federal income tax still applies. Operators rarely withhold federal tax from royalty checks unless backup withholding is triggered, so most owners will manage quarterly estimated tax payments on their own. Keeping every check stub and year end statement is essential for verifying your 1099 total, supporting your deductions, and computing depletion by property.

Texas 1099 MISC reporting

Royalty income is reported to the IRS on Form 1099 MISC, typically in the box labeled Royalties. That amount represents your gross royalty income for the year for that payor. You should reconcile the 1099 total to your monthly statements and note any state production taxes or other deductions withheld by the operator, because those often do not appear on the 1099 itself and are instead reported on the check detail. If your interest is held through an entity such as a partnership or trust, you may receive a Schedule K 1 rather than a 1099, and you would report the K 1 items rather than duplicating the 1099 totals.

Misclassification happens. Some owners receive a 1099 NEC by mistake, which can cause the IRS system to expect self employment tax. Royalties for a passive royalty interest are not self employment income. If you receive the wrong form, ask the operator to issue a corrected 1099 MISC. If you had federal income tax withheld, it should appear in the federal withholding box on the 1099. Backup withholding can apply if your taxpayer identification number on file is missing or incorrect. You can read more about backup withholding at the IRS website on backup withholding and Form W 9 compliance.

Helpful resources:

• IRS About Schedule E Form 1040 page

• IRS Publication 525 Taxable and Nontaxable Income

Royalties vs working interests

Understanding the difference between a royalty and a working interest is key because the tax treatment, forms, and even self employment tax can change. A royalty interest gives you a share of production revenue without responsibility for drilling or operating costs, while a working interest gives you a share of both revenue and costs, including authority and risk related to development. The IRS treats these differently for reporting and for self employment tax. Most individual owners in Texas hold royalty interests, not working interests. If you do hold a working interest, it can be reported on Schedule C and may be subject to self employment tax, while a royalty interest is reported on Schedule E and is not subject to self employment tax.

Feature	Royalty interest	Working interest
Typical form received	1099 MISC	Varies, sometimes 1099 MISC, K 1, or JV statements
Return reporting	Schedule E Part I	Often Schedule C for individuals
Self employment tax	No	Often yes
Deductible costs	Severance tax, ad valorem tax, and allowable post production deductions actually borne	Operating, production, and administrative costs, plus depletion and possibly intangible drilling costs
Depletion	Percentage or cost depletion	Percentage or cost depletion

Where to report on your federal return

Royalty income from Texas oil and gas goes on Schedule E Part I of Form 1040. You list each property or grouping of like properties and report the gross royalty income and deductions. Although you may see expenses netted on your check stubs, you can report the 1099 gross in income and then claim the related deductible items such as severance tax and property tax as expenses on Schedule E. Royalty income is not subject to self employment tax. For purposes of passive activity rules, oil and gas royalties are generally treated as portfolio income rather than passive activity income, so they do not unlock passive losses from other activities.

Texas does not require a state personal income tax return. If you live in another state, check your state rules for reporting royalty income earned in Texas, because most states tax residents on worldwide income even if there is no Texas filing.

Texas severance tax and property tax

Texas imposes production taxes, often called severance taxes, on oil and gas produced in the state. Operators usually withhold these taxes from your monthly royalty before paying you, and the amounts show on your check detail. Severance taxes are deductible as an expense on your federal return in the same year they are paid or withheld. Keep a running total by property because these amounts can be significant and often are not shown on the 1099 total.

Texas also imposes ad valorem property tax on producing mineral interests. In many counties, the appraisal district assesses a value to your mineral interest and bills the mineral owner. If you personally pay that bill, it is deductible as a property tax on income producing property and belongs on Schedule E with your mineral income. If the operator pays and nets it from your revenue, treat it like other deductions withheld on the check detail. To review Texas production tax rules and rates, visit the Texas Comptroller page for oil and gas production taxes.

• Texas Comptroller oil and gas production taxes

Depletion fundamentals for mineral owners

Depletion is the method used to deduct the cost of a wasting natural resource as production occurs. For oil and gas royalty owners there are two possible methods. Percentage depletion uses a statutory percentage of gross income from the property. Cost depletion uses a units of production approach that spreads your tax basis over the total expected recoverable units. You figure both methods each year for each property and claim the larger allowable deduction. Depletion is separate from depreciation. For cost depletion, your depletable basis is reduced each year by the amount of cost depletion claimed. Percentage depletion does not reduce basis, and for oil and gas it can continue even after basis is fully recovered, subject to limits.

Each property stands on its own for depletion. That means you compute depletion separately for every lease or unit, not just once across all your royalties. Good recordkeeping matters because you will need to track property level gross income, severance tax and other deductible costs, and basis information such as acquisition costs or fair market value at inheritance.

• IRS Publication 535 Business Expenses, Depletion chapter

• 26 U.S.C. 613A percentage depletion for oil and gas

Percentage depletion for oil and gas

For independent producers and royalty owners, percentage depletion for oil and gas is generally 15 percent of gross income from the property. Gross income for this purpose is the royalty income before severance tax and certain other taxes and does not include lease rentals that are not based on production. The deduction for a property is limited to the taxable income from that property after direct expenses, and there is also an overall limit that caps the total percentage depletion deduction to a percentage of your taxable income for the year. Many royalty owners find percentage depletion provides a larger deduction than cost depletion, especially for long lived properties or for inherited interests with a low cash investment.

A simple illustration helps. If your gross income from a property is 10,000 and your severance tax and other deductible expenses total 1,000, your taxable income from the property is 9,000. Percentage depletion at 15 percent would start at 1,500, but the property limit caps the deduction to the 9,000 of taxable income from that property, which is not an issue in this example. If you have a large portfolio of properties and strong other income, review the overall limit that can restrict percentage depletion to a portion of your total taxable income. If the overall cap applies, some owners time elective deductions or charitable contributions to manage the interaction.

Cost depletion using units of production

Cost depletion begins with your depletable basis in the property and spreads that basis over the total recoverable units. For a royalty owner, basis can come from the purchase price of the mineral interest, the value at inheritance, or other capitalized acquisition costs such as title or legal fees. You will need an estimate of the total recoverable barrels of oil or MCF of gas for the property. The deduction equals your adjusted basis times the fraction of units produced and sold during the year over the total recoverable units. Each year you reduce your basis by the cost depletion claimed. Once basis reaches zero, cost depletion ends. You can still compute percentage depletion if eligible, because percentage depletion can continue beyond basis for oil and gas royalty owners subject to the limits mentioned above.

An example. Suppose you inherited a small royalty with a federal step up basis of 40,000. Engineering reports or county appraisal data suggest the property will yield 200,000 MCF in total over its remaining life. If your share of production sold this year is 5,000 MCF, the cost depletion fraction is 5,000 divided by 200,000. Multiply that by your 40,000 basis for a 1,000 cost depletion deduction. Next year, you will use your reduced basis of 39,000 and the new expected total recoverable units, adjusted if needed for updated reserve information. You should maintain a property level schedule to track beginning basis, annual cost depletion, and remaining basis.

Choosing between percentage and cost depletion

You can compute both methods each year and elect the larger deduction per property. Many Texas royalty owners default to percentage depletion because it often exceeds cost depletion, especially when basis is low relative to annual income. Properties with a high purchase price or a recent step up in basis may favor cost depletion for a period of years. Lease bonus payments can qualify for depletion, often through percentage depletion, while delay rentals typically do not qualify. Because the law uses a property by property approach, your choice can differ across leases and can change from year to year as prices, production, and basis change. Keep your workpapers with the return so you or your CPA can repeat the method consistently and respond to any IRS inquiry.

Lease bonuses, delay rentals, and shut in payments

Oil and gas owners sometimes receive money up front for signing a lease. A lease bonus is usually taxable in the year received and reported on Schedule E. In many cases, lease bonuses are eligible for depletion because they represent payment for the right to extract minerals, but the exact treatment can depend on the terms of the lease and whether production begins. Delay rentals are payments to keep the lease in force without current production and generally are treated as rental income that is not subject to depletion. Shut in payments compensate owners when a well capable of production is shut in temporarily. Shut in payments are typically royalty like and may be eligible for depletion if tied to production rights. Review the lease language and your check stubs to classify each payment correctly.

Common 1099 and reporting issues

Several recurring items can complicate Texas 1099 MISC oil and gas royalty reporting. Operators may report net amounts rather than gross, which makes reconciling the 1099 to your check stubs more important. If you see a mismatch, keep a schedule of monthly gross and deductions and attach it to your tax file. Some payors issue a 1099 NEC instead of a 1099 MISC, which can lead to a notice for self employment tax. Request a corrected form if that occurs. Owners of interests pooled across counties sometimes receive separate 1099s for different properties. In other cases, you will receive one consolidated 1099 with a year end owner statement that breaks down income and deductions by property. If you hold your mineral interests through a partnership, S corporation, estate, or trust, you should receive a Schedule K 1 and report the K 1 share on your return. Do not duplicate the same income from both a 1099 and a K 1 for the same payments.

If you sold a mineral interest during the year, you might receive a 1099 S or proceeds reporting from the title company. The sale is usually a capital transaction with gain or loss reported on Schedule D. Keep those records separate from your ongoing royalty reporting so depletion and operating data are not mixed with the sale.

Estimated taxes for royalty owners

Because Texas operators do not withhold federal income tax on royalties as a standard practice, many owners make quarterly estimated tax payments to avoid underpayment penalties. The IRS safe harbor rules allow you to avoid penalties if you pay at least a percentage of your current year tax or an amount based on your prior year tax, with a higher threshold for higher income taxpayers. A simple way to manage this is to look at last year’s total tax and divide it into four equal payments using Form 1040 ES vouchers, then adjust up or down as your royalty income changes during the year. If you or your spouse receive W 2 wages, you can also increase wage withholding through an updated Form W 4 and let withholding carry the load, which is often easier than paying separate estimates.

For the mechanics, see the IRS page for Form 1040 ES. If royalty income is seasonal, set aside a percentage of each check in a separate savings account and pay estimates on the regular dates to stay ahead of surprises. Owners who start receiving checks late in the year can often avoid penalties by paying a larger fourth quarter estimate or by increasing year end wage withholding.

• IRS About Form 1040 ES

Record keeping for deductions and depletion

Accurate, property level records are the backbone of Texas oil and gas royalty depletion deduction planning. Keep a digital folder for each operator and a subfolder for each property. Save monthly check stubs, year end owner statements, division orders, lease agreements, legal correspondence related to title or curative work, and any reserve estimates from appraisal districts or operators. Track severance taxes, ad valorem property taxes you pay directly, and any post production costs that you bear under your lease. For cost depletion, maintain a schedule of depletable basis by property, including acquisition documents such as mineral deeds, probate documents, or closing statements. For inherited interests, keep the estate appraisal or other evidence of fair market value at the date of death.

At tax time, summarize the year by property. For each property, list gross royalty income, severance tax, property tax, and any other deductible items. Compute percentage depletion and cost depletion, pick the larger allowable amount, and record the method used. Store the depletion computation with your return. These steps make it far easier to catch 1099 errors, support deductions, and switch methods in later years if the facts favor a different approach.

Special ownership situations

Many Texans hold minerals through a family trust, an LLC, or a family limited partnership. In those cases, the entity reports income and expenses and issues a Schedule K 1 to the owners. The K 1 carries your share of income, deductions, credits, and depletion. Depletion is still determined property by property at the entity level. If you hold a working interest through an entity that materially participates, additional rules apply for self employment tax, at risk limitations, and possibly intangible drilling costs. That set of rules differs from pure royalty reporting and deserves tailored advice.

Texas is a community property state. Married owners should review how title is held to decide whether to split income and deductions on their joint return. Inheritances in Texas are usually separate property, but income from separate property can have special treatment under marital property rules. For inherited minerals, the step up in basis at the date of death can significantly change cost depletion and gain if you later sell. Keep probate documents, appraisals, and the date of death statements from operators in your permanent file.

Selling all or part of a mineral interest

When you sell a mineral or royalty interest, the transaction is generally treated as a capital sale. Your gain or loss equals the selling price minus your adjusted basis and selling costs. If you previously claimed cost depletion, your basis is lower, which increases gain on sale. Percentage depletion does not reduce basis, so it does not create a separate recapture item at sale. The title company may issue a 1099 S for the sale proceeds. Report the sale on Schedule D and attach Form 8949 if required. Keep the sale paperwork separate from your royalty accounting to maintain a clean depletion schedule for the properties you keep.

Texas focused tips that save tax

Several practical habits help Texas owners maximize the Texas oil and gas royalty depletion deduction and reduce headaches during filing season. Reconcile 1099 MISC totals to your year end owner statement. Capture severance tax totals by property because those are deductible and easy to miss. Save county tax bills and proof of payment for ad valorem taxes on your minerals. Compute both percentage and cost depletion every year for each property, even if you think percentage will win, because a new well, a recompletion, or a step up in basis after an inheritance can change the outcome. Finally, plan your estimated taxes early in the year, and if you are new to royalties, set aside a portion of each check so the quarterly payments do not surprise you.

How a Texas CPA adds value

A CPA who works with Texas mineral owners builds a system around your properties so nothing is missed. At Alviso, CPA we set up a property level schedule for income, severance tax, property tax, and depletion. We check every 1099 against your owner statements. We compute both percentage and cost depletion per property, verify limits, and keep the schedules that carry forward each year. We also run a year round estimate plan so you hit the safe harbor without large surprises and review whether wage withholding should be adjusted to absorb the royalty tax. If you own interests through an entity, we align K 1 reporting to your personal return and keep the basis records that will matter later if you sell.

If you would like a professional review of your last return or help with the current year, contact Alviso, CPA for a Texas mineral owner tax checkup and a depletion calculation built from your actual data.

Frequently asked questions

Do oil and gas royalties go on Schedule E?

Yes. Individual owners of royalty interests report the income and related deductions on Schedule E Part I. This income is not subject to self employment tax.

What is the percentage depletion rate for oil and gas?

For most royalty owners, percentage depletion is 15 percent of gross income from the property, subject to property level and overall limits. You should compute cost depletion as well and claim the larger allowable amount for each property.

Are Texas severance taxes deductible?

Yes. Texas production taxes withheld by the operator are deductible on your federal return. They usually appear on your monthly check stubs, not on the 1099 total, so keep a property level tally for the year.

Do I pay self employment tax on royalties?

No, not for a passive royalty interest. Self employment tax can apply to a working interest where the owner participates and bears operating costs. The distinction matters, so check your interest type on your division order or deed.

Can I take depletion on a lease bonus?

Often yes. Lease bonus payments are generally taxable in the year received and may be eligible for depletion. Delay rentals are usually treated as rent and not depletable. Review the lease and payment descriptions on your check stubs to classify items correctly.

What if my 1099 MISC is wrong?

Ask the operator for a corrected form and keep your monthly statements to support the correct totals. If the operator issued a 1099 NEC for a royalty, request a corrected 1099 MISC so the IRS system does not expect self employment tax.

How do I avoid underpayment penalties with new royalties?

Use Form 1040 ES to make quarterly payments based on last year’s total tax or a projection for the current year. If you or your spouse have W 2 wages, increasing withholding through Form W 4 can be an easier way to cover the royalty tax without separate payments.

Source links and references

For deeper reading and confirmation of the rules discussed above, consult these primary sources and guidance pages:

• IRS Publication 535 Business Expenses, Depletion

• IRS Publication 525 Taxable and Nontaxable Income, Royalties

• IRS About Schedule E Form 1040

• IRS About Form 1040 ES Estimated Tax

• Texas Comptroller oil and gas production taxes

• 26 U.S.C. 613A Percentage depletion for oil and gas

Texas mineral owners can report royalties correctly, capture every permitted deduction, and claim the largest allowed depletion deduction with confident recordkeeping and a consistent method. With Alviso, CPA as your partner, you get property level schedules that tie to your 1099s, a clear choice between percentage and cost depletion each year, and a quarterly plan so taxes do not crowd out your cash flow. If you have questions about your 1099 MISC, severance and property tax deductions, or how to compute depletion for a specific lease, reach out and we will help you build a clean file that stands up year after year.