By Ryan G. Bartholomee, CPA, R. Byron Ratliff, CPA, and Carol G. Warley, CPA, JD
West Texas Intermediate NYMEX crude oil prices have dropped over 50 percent since June 2014. In this lower oil price environment, any oil-related assets (whether they are mineral rights, royalty interests, overriding royalty interests, working interests, or especially stock in oil companies) should have a substantially lower value now than they did six months ago. It is important to keep in mind that the current global oil supply exceeds global oil demand by approximately 1 to 2 percent. This oversupply might be corrected within a year or so (possibly sooner as geopolitical tensions mount and threaten supply). Capital expenditure budgets should continue to be reduced for 2015 for exploration and production companies. Lower fuel prices should serve to stimulate our national economy, which happens to be the largest consumer of oil-related products on the globe. Sixty-nine percent of our country’s gross domestic product comes from consumer spending. It is estimated that these lower gasoline prices add $1,000 annually to each household’s discretionary spending. The oil industry is cyclical in nature as demonstrated by the dramatic price swings of 2008.
Wealthy clients with such assets might consider gift tax planning transactions due to the lower valuations. There might be an opportunity to use some or all of a person's gift/estate tax exemption ($5,430,000 per person in 2015) to gift oil-related assets now. This is especially true for assets that won’t require additional development capital (such as mineral rights, royalty interests, overriding royalty interests and oil company stock), and if one believes that oil prices will be higher again at some point in the future due to the oil industry’s cyclical nature. Note that oil company stock may be lower in value right now relative to other oil-related assets because the comparable sales of mineral interests have not fallen in value as quickly as the majority of oil stock prices have. Also, note that it is generally unwise to gift undeveloped leased acreage or even proven undeveloped or behind-pipe reserves because of the issue of additional capital that will be required for development and the risk associated with the assets that the value will not be there after development.
If the client does not anticipate having a taxable estate at his or her death in excess of the gift/estate tax exemption as indexed for inflation, it is obviously better for heirs to receive the stepped-up basis in oil-related assets by receiving the assets as an inheritance.
For example, if a married client had oil-related assets valued at $15 million and a total net worth of $20 million that they estimate might grow to $30 million by their death, then it may make sense from a tax standpoint for that couple to consider gifting oil-related assets to heirs now utilizing a portion of, or even all of, the $5.43 million per person estate tax exemption. This would result in up to $20.86 million of the $30 million passing to heirs without being subject to federal estate taxes (assuming the $10 million in growth comes only from the gifted oil-related assets and any other growth in the estate is offset by spending and charitable giving).
If, however, a married client had oil-related assets valued at $1 million (with a basis of $0 because of percentage depletion) and a total net worth of $2 million that they estimate might grow to $3 million by their death (so the oil-related assets are worth $2 million at their death), then it is better for the oil-related assets to be transferred through inheritance to heirs rather than as a gift while the client is living. This is because the stepped-up basis the heirs would receive (the fair market value at the time that the asset is inherited of $2 million in this example) eliminates taxes on unrealized gain (a $2 million unrealized gain in this example given that the couple had no basis in the properties) or would provide significant tax shield from cost and percentage depletion if the heirs decided to retain the properties.
Of course, there are many non-tax factors to consider in estate planning, and the above examples are extreme and simplified to illustrate a point. Perhaps we will soon look back and see this time as a rare gift and estate tax-planning opportunity for a small percentage of wealthier clients with substantial oil-related assets.
 U.S. Energy Information Administration, Short-Term Energy Outlook, January 13, 2015, http://www.eia.gov/forecasts/steo/uncertainty/
 CNN Money, OPEC vs. U.S.: Who Will Blink First On Oil?, by Travis Hoium of The Motley Fool, January 13, 2015, ¶ 5, http://money.cnn.com/2015/01/13/investing/falling-oil-prices-us-opec/
 U.S. Energy Information Administration, 2012 World Oil Consumption, accessed January 18, 2015 http://www.eia.gov/countries/index.cfm?view=consumption
 YCHARTS, US Personal Consumption Expenditures: 69.00% of GDP for Nov 2014, accessed January 18, 2015, https://ycharts.com/indicators/personal_consumption_gdp
 Value Walk, The Bright Side of Cheap Oil, by LPL Financial, January 14, 2015, ¶ 2, http://www.valuewalk.com/2015/01/bright-side-cheap-oil/
 Rev. Proc. 2014-61, Section 3.33, p. 19, http://www.irs.gov/pub/irs-drop/rp-14-61.pdf