Oil and natural gas from domestic reserves helps to make our country more energy self-sufficient by reducing our dependence on foreign imports. In light of this, Congress has provided tax incentives to stimulate domestic natural gas and oil production financed by private sources. Drilling projects offer many tax advantages and these benefits can greatly enhance the economics. These incentives are not “Loop Holes;” they were placed in the Tax Code by Congress to make participation in oil and gas ventures one of the best tax advantaged investments available to accredited investors seeking tax relief.
Intangible Drilling Cost Tax Deduction
The intangible expenditures of drilling (labor, chemicals, mud, grease, etc.) are usually about (65 to 80%) of the cost of a well. These expenditures are considered “Intangible Drilling Cost (IDC)”, which is 100% deductible during the first year. For example, a $100,000 investment could yield up to $80,000 in IDC tax deductions during the first year of the venture. These deductions are available in the year the money was invested, even if the well does not start drilling until March 31 of the year following the contribution of capital. (See Section 263 of the Tax Code.)
Tangible Drilling Cost Tax Deduction
The total amount of the investment allocated to the equipment “Tangible Drilling Costs (TDC)” is 100% tax deductible. In the example above, the remaining tangible costs ($20,000) may be deducted as depreciation over a seven-year period. (See Section 263 of the Tax Code.)
Active vs. Passive Income
The Tax Reform Act of 1986 introduced into the Tax Code the concepts of “Passive” income and “Active” income. The Act prohibits the offsetting of losses from Passive activities against income from Active businesses. The Tax Code specifically states that a Working Interest in an oil and gas well is not a “Passive” Activity, therefore, deductions can be offset against income from active stock trades, business income, salaries, etc. (See Section 469(c)(3) of the Tax Code).
Small Producers Tax Exemption
The 1990 Tax Act provided some special tax advantages for small companies and individuals. This tax incentive, known as the “Percentage Depletion Allowance”, is specifically intended to encourage participation in oil and gas drilling. This tax benefit is not available to large oil companies, retail petroleum marketers, or refiners that process more than 50,000 barrels per day. It is also not available for entities owning more than 1,000 barrels of oil (or 6,000,000 cubic feet of gas) average daily production. The “Small Producers Exemption” allows 15% of the Gross Income (not Net Income) from an oil and gas producing property to be tax-free.
Lease costs (purchase of leases, minerals, etc.), sales expenses, legal expenses, administrative accounting, and Lease Operating Costs (LOC) are also 100% tax deductible through cost depletion.
This page is displayed as general tax code information related to oil and gas investment. The following information and Internet URL is provided for your convenience and should not be construed as tax advice from Eagle Natural Resources.
The Online U.S. Tax Code may be accessed and queried at http://www.fourmilab.ch/ustax/ustax.html for the most current Oil and Gas information. Congressional Incentives Encourage Domestic Petroleum Development