Tax Advantages

(Illustration purposes only, consult with your tax advisor). 

ACTUAL COST AFTER TAX DEDUCTIONS

$400,000 GROSS ANNUAL INCOME  (2018)

$100,000 INVESTMENT   

$300,000 TAXABLE INCOME  (AFTER DEDUCTIONS) 

(38%) TAX RATE (FEDERAL,STATE & MEDICARE) if applicable

$152,000 TAX LIABILITY REFLECTS ($400K)   

$114,000 TAX LIABILITY, REFLECTS ($300K)   

$38,000 TAX SAVINGS (IRS)   

($62,000) ACTUAL COST, AFTER TAX SAVINGS ($100,000) INVESTMENT

In addition, receive 15% tax shelter from oil production revenue

30 barrels oil  x  9 wells  x  30 days  x  12 months  x  $50 average oil  x  4.333% working interest  =  ($210,583)  gross annual income  -  ($31,587)  15% tax shelter (15% depletion allowance)

When it comes to tax-advantaged investments for wealthy or sophisticated investors, one commodity continues to stand alone above all others: oil. With the U.S. government's backing, domestic energy production has created a litany of tax incentives for both investors and small producers, and oil is no exception.

Several major tax benefits are available for oil and gas investors that are found nowhere else in the tax code. Below, we'll cover the benefits of tax- advantaged oil investments and how you can use them to fire up your portfolio.

Direct participation in oil and gas can generate several tax benefits. These benefits range from large up front deductions for intangible drilling costs (IDC’s), to tax credits for the development of certain types of tight formations. Deductions are generated mainly from the cost of non-salvageable equipment or services conducted during the drilling phase, testing, and/or completion of the well. The following is a synopsis of the tax benefits generated by direct participation oil and gas participation. 

There are many oil and gas participation opportunities to create and build wealth in the oil and gas/energy sector. Participate in oil and gas drilling programs, while considered high risk, can offer significant returns and substantial tax advantages. Additionally, domestic oil and gas development helps make our country more energy self-sufficient and reduces 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. Participation in oil and gas can have many tax advantages which greatly enhance the economics of oil and gas Direct Participation Program’s.

Oil and Gas Tax Benefits

Direct Participation can generate several tax benefits. These benefits range from large up front deductions for intangible drilling costs (IDC’s), to tax credits for the development of certain types of tight formations. Deductions are generated mainly from the cost of non-salvageable equipment or services conducted during the drilling phase, testing, and/or completion of the well. The following is a synopsis of the tax benefits generated by direct participation in oil and gas developments:

(1) Intangible Drilling Costs (IDC): When an oil or gas well is drilled, several expenses may be deducted immediately. These expenses are deductible because they offer no salvage value whether or not the well is subsequently declared to be dry. Examples of these types of expenses would be labor, drilling rig time, drilling fluids etc. IDC’s usually represent 65 to 80% of the well cost. Participants’ usually put up the drilling portion of their participation called the Drill Test funds before drilling operations commence, and the participants’ portion of the intangible drilling costs is generally taken as a deduction in the tax year in which the intangible costs are realized. The accounting method adopted however could affect the deduction period.

(2) Intangible Completion Costs (ICC): As with IDC's these costs are generally related to non salvageable completion costs, such as labor, completion materials, completion rig time, fluids etc. Intangible completion costs are also generally deductible in the year they occur, and usually amount to about 15% of the total.

(3) Depreciation: As opposed to services and materials that offer no salvage value, equipment used in the completion and production of a well is generally salvageable. Items such as these are usually depreciated over a seven year period, utilizing the accounting depreciation method known as the Modified Accelerated Cost Recovery system . Equipment in this category would include casing, tanks, well head and tree, pumping units etc. Equipment and tangible completion expenses generally account for 25 to 40% of the total well cost.

(4) Depletion Allowance: Once a well is in production, the active participants in the well are allowed to shelter some of the gross income derived from the sale of the oil and/or gas through a depletion deduction. Two types of depletion are available, cost and statutory (also referred to as percentage depletion). Cost depletion is calculated based upon the relationship between current production as a percentage of total recoverable reserves. Statutory or percentage depletion is subject to several qualifications and limitations. This deduction will generally shelter 15% of the well’s annual production from income tax.  For “stripper production” (wells producing 15 barrels/day or less), the depletion percentage can be up to 20%.

(5) Tax Credits: Congress has enacted several tax credits in relation to oil or natural gas production. The enhanced oil recovery credit is applied to certain project costs incurred to enhance a well’s oil or natural gas production. This credit is up to 15% of the costs incurred to enhance production. The non conventional source fuel credit provides for a $3 per barrel of oil equivalent credit for production from the so called qualified fuels. Qualified fuels include oil shale, tight formation gas, and certain synthetic fuels produced from coal.

(6) Alternative Minimum Tax (AMT): Historically the tax benefits from oil and natural gas production could potentially present the possibility for taxation under the Alternative Minimum Tax (AMT). In the early 1990’s however, Congress provided some tax relief for “independent producers”. An independent producer was defined as an individual or company with production of 1,000 barrels per day or less. Although there is still the potential for AMT taxation for excess IDC's, percentage or statutory depletion is no longer considered a preference item.

(7) Lease Operating Expense: This expense covers the day to day costs involved with the operation of a well. The expense also covers the costs of re-entry or re-work of an existing producing well. Lease operating expenses are generally deductible in the year incurred, without any AMT consequences.

Conclusion: As is evident from this discussion, the tax benefits generated by direct participation in oil and/or natural gas are substantial in nature. The immediate deduction of the intangible drilling costs or IDC's is very significant, and by taking this up front deduction, the risk capital is effectively subsidized by the government by reducing the participant’s Federal, and possibly State income tax. Each individual participant of course, should consult with their licensed tax advisor.