Section 199A of the Tax Cuts and Jobs Act of 2017 provides a 20% deduction on “Qualified Business Income” (QBI) earned by pass-through entities. This is music to the ears of those who invest in oil and gas royalties.
QBI and Pass-Through Entities
QBI is net income from a trade or business, which includes royalties. Pass-through entities are those businesses that are not taxed separately from their owners. While there can be benefits to doing so in some circumstances, individual taxpayers do not need to set up an LLC or form of separate entity. Individual oil and gas royalty owners can be considered sole proprietors, which qualify as pass-through entities for the purpose of the new deduction.
Since royalties are QBI and most owners of oil & gas interests will qualify as recipients of pass-through entity income, they will be able to reduce their taxable income from those assets by 20% starting in 2018. That means, for example, that ordinary income from a partnership previously taxed at the maximum 37% rate is now expected to be taxed at the significantly lower rate of 29.6%.