State and Local Ad Valorem Taxation of Mineral Interests Working Paper WP15CK1 Calvin A. Kent Ph.D. AAS Marshall University January 2016 The findings and conclusions of this Working Paper reflect the views of the author(s) and have not been subject to a detailed review by the staff of the Lincoln Institute of Land Policy. Contact the Lincoln Institute with questions or requests for permission to reprint this paper. [email protected] © 2015 Lincoln Institute of Land Policy Abstract Since subsurface minerals are usually severed from the surface (land) estate, unique problems are created for establishing the value of minerals for ad valorem taxation. All states having significant production of minerals levy either severance or property taxes (or both). The unique character of minerals makes valuation one of the most difficult processes for the assessor. The methods used vary by state. Because of the complexity, in many states the state government or private consultants determine value for local jurisdictions. The legal environment which governs the relationship between subsurface and surface owners influences the value and use of the land and the mineral. When full consideration is given, it is unlikely that the ad valorem taxation of mineral interests meets the criteria established by economists for what constitutes a “good tax”. This paper explores the ways used to value mineral interests, the legal environment and what this implies for tax policy. Keywords: Property taxes, ad valorem, severance, minerals, oil, gas, coal, state and local taxes, appraisal, assessment, tax incidence and shifting Conclusions 1. Most subsurface mineral interests have been split from the surface estate creating a separate legal taxable entity for ad valorem purposes. 2. Like surface land, minerals are fixed in geographic location and are not affected by the rate of property taxation. 3. Two methods are used for the ad valorem taxation of mineral interests: the severance approach and the reserves approach. 4. There is no single model which explains taxation of mineral interests in the states studied. 5. Valuation of mineral interests provides unique problems in the process of valuation. 6. Subsurface mineral interests have dominance over surface interests in that surface owners may not “unreasonably’ restrict the development of subsurface mineral rights. 7. While the exploitation of mineral interests predominates over surface interests under the rule of capture there are certain protections of surface owners’ rights including: correlative rights, negligence and trespass. 8. Most states have adopted “accommodations” legislation which further protects surface owners. 9. The presence of mineral interests influences the value of the surface land. 10. The unique features of mineral rights make valuation more difficult than for other types of property. 11. There have been no appraisal standards developed for use in mass appraisal of mineral property. 12. Of the three approaches to valuation (cost, comparative sales and income) the last is the principal method used for ad valorem taxation of mineral estates. 13. Among the states there are two methods for applying the income approach: “severance” and “reserves”. Under the former current or average income and production is used. Under the latter, mineral reserves in the ground is the base. 14. Among the most difficult steps in using the income approach is determining the discount rate. 15. In using the income approach adequate consideration must be given to determining allowable costs. 16. The question of “who pays the property tax on minerals?” is not settled as the taxes may or may not be shifted. 17. Ad valorem taxes on minerals do not conform to either the benefits received or capitalization theories of incidence. 18. Since there are insufficient sales of mineral interests in most cases, it is not possible for assessors to use statistical tools for assessment validation. 19. The ad valorem taxation of mineral interests does not conform to any of the established standards for a “good” tax. About the Author Calvin A. Kent PhD. AAS is Lewis Distinguished Professor of Business at Marshall University, Huntington WV and a former College of Business Dean and University Vice President. He is a member of the West Virginia Property Valuation Commission. For the International Association of Assessing Officers (IAAO) he is on the Leadership Council, Committee on Excellence in Assessment Administration in addition to being a nationally certified instructor for advanced appraisal courses and holder of the Assessment Administration Specialist (AAS) designation. Marshall/CBER 1 John Marshall Drive Huntington WV 25755 E-mail [email protected] Phone 304 5287228 Acknowledgements The author expresses his deep appreciation to the Lincoln Institute of Land Policy who awarded him a David C. Lincoln Fellowship under which this work was completed. The state and local officials below gave their time to explain the details of their tax systems. Alaska • Ronald Brown, State Assessor, Anchorage AK • Jim Greeley, State Oil & Gas Assessor, Anchorage AK Arkansas • Robert McGee, Division Administrator, Assessment Coordination Department, Little Rock AR 7/30/2014 California • Andrew Johnson, Supervising Appraiser, Oil and Gas Division, Kern Co. CA • Elizabeth Johnson, Geothermal Officer, Department of Conservation, State of California Colorado • Rick Davis, Senior Appraiser, El Pasco County Assessor’s Office, Colorado Springs CO • Christopher M. Woodruff, Weld County Assessor, Greely CO Ohio • Rebecca Luck, Division Council, Tax Equalization Division, Ohio Department of Revenue, Columbus OH Pennsylvania • John Frazier, CPE Chief Assessor, Green County. Waynesburg PA • Jeffrey Kern, President, Resource Technology Corporation, University Park PA Louisiana • Conrad T Comeaux, Lafayette Parish Tax Assessor, Lafayette LA • Celeste Moss, Public Service Assistant Director, Louisiana Tax Commission, Baton Rouge LA Texas • Rodney Kert, Director of Mineral Appraisals, Pritchard and Abbott, Ft. Worth TX 7/28/2014 • Angie Ballard, Jefferson County Appraisal District, Beaumont TX West Virginia • Mark Muchow, Deputy Secretary, Department of Revenue, State of West Virginia, Charleston WV • Kris Pinkerman, Assistant Director, Property Tax Division WV Department of Taxation and Revenue. Charleston WV Wyoming • Craig Grenvik, Administrator, Mineral Tax Division, Wyoming Department of Revenue, Cheyenne WY Also to commend Ayokunle Aanuoluwapo for his work as research assistant. Lisa Christopher provided excellent administrative assistance. Table of Contents Overview ......................................................................................................................................... 1 Methodology ................................................................................................................................... 2 Land Value Taxation and Ad Valorem Taxation of Mineral Interests ........................................... 4 Severance Funds ............................................................................................................................. 5 Development of Mineral Resources ................................................................................................ 6 Severed Mineral Interests ............................................................................................................... 8 Use of the Surface Land ................................................................................................................ 10 Rule of Capture ......................................................................................................................... 11 Correlative Rights ..................................................................................................................... 11 Accommodation Doctrine ......................................................................................................... 12 Negligence by Mineral Operator ............................................................................................... 14 Trespass ..................................................................................................................................... 14 Adjacent Property ...................................................................................................................... 15 Pooling or Unitizing .................................................................................................................. 15 Coal and other Hard Rock Minerals .......................................................................................... 16 Subsidence ................................................................................................................................. 17 Site Value Taxation and Mineral Rights ....................................................................................... 18 Approaches to Ad Valorem Taxation of Mineral Interests ........................................................... 19 Severance Approach .................................................................................................................. 19 Reserves Approach .................................................................................................................... 19 Unique Features of Minerals ..................................................................................................... 19 Appraisal Standards .....................................................................................................................