Tax Advantages

Profit as an Owner of Producing Wells

By owning interest in existing properties, the risks associated with exploration are minimized. Producing oil and natural gas properties generate income for investors (owners) by selling the produced oil to refineries and natural gas to pipeline companies.

Direct Ownership Programs

Full Working Interest Owners share a direct ownership position. Monthly profits from the sale and transportation of oil and natural gas has become exceedingly attractive.

Energy Prices & Global Demand

The United States alone consumes about 20 million barrels of oil per day, most of which is imported. With countries like China and India rapidly expanding their infrastructure and economies, worldwide demand for oil and natural gas is increasing at a frantic rate. With no cost-effective and technologically-feasible substitutes for oil or gas, prices are expected to significantly outpace the market well into the distant future.

Learn how to earn a monthly income by directly owning proven oil and gas properties.

Oil and Gas Tax Benefits

Direct participation in oil and gas can generate several tax benefits. These benefits range from large up front deductions for intangible drilling costs (IDC), 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 investments.

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. IDCs usually represent 60 to 80% of the well cost. Investors usually put up the drilling portion of their investment before drilling operations commence, and the investor’s portion of the intangible drilling costs is generally taken as a deduction in the tax year in which the intangible costs occurred. The accounting method adopted however could affect the deduction period.

2. Intangible Completion Costs: As with IDCs 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 Modified Accelerated Cost Recovery system or MACRS. 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 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 per cent 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.

The 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 IDCs, percentage or statutory depletion is no longer considered a preference item.

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.

As is evident from this discussion, the tax benefits generated by a direct participation in oil and/or natural gas are substantial. The immediate deduction of the intangible drilling costs or IDCs 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 tax advisor.

Oil & Gas Tax Provisions In President Obama’s Proposed 2011 Budget

Intangible Drilling and Development Costs (IDC) – IDC tax treatment is designed to attract capital to the high risk business of natural gas and oil production. Expensing IDC has been part of the tax code since 1913. IDC generally include any cost incurred that has no salvage value and is necessary for the drilling of wells or the preparation of wells for the production of natural gas or oil. Only
independent producers can fully expense IDC on American production. Eliminating IDC expensing would remove over $3 billion that
would have been invested in new American production. Cost: $3,349,000,000 from 2010-2019.

Percentage Depletion – All natural resources minerals are eligible for a percentage depletion income tax deduction. Percentage depletion for natural gas and oil has been in the tax code since 1926. Unlike percentage depletion for all other resources, natural gas and oil percentage depletion is highly limited. It is available only for American production, only available to independent producers, only available for the first 1000 barrels per day of production, limited to the net income of a property and limited to 65 percent of the producer’s net income. Percentage depletion provides capital primarily for smaller independents and is particularly important for marginal well operators. Eliminating percentage depletion would remove over $8 billion that would have been invested in maintaining and developing American production. Cost: $8,251,000,000 from 2010-2019.

Geological and Geophysical (G&G) Amortization – G&G costs are associated with developing new American natural gas and oil resources. For decades, they were expensed until a tax court case concluded that they should be amortized over the life of the well. In 2005 Congress set the amortization period at two years. Later, Congress extended the amortization period to five years for large major integrated oil companies and then extended the period to seven years. Early recovery of G&G costs allows for more investment in finding new resources. Extending the amortization period would remove over $1 billion from efforts to find and develop new energy in America. Cost: $1,189,000,000 from 2010-2019.

Marginal Well Tax Credit – This countercyclical tax credit was recommended by the National Petroleum Council in 1994 to create a safety net for marginal wells during periods of low prices. These wells – that account for 20 percent of American oil and 12 percent of American natural gas – are the most vulnerable to shutting down forever when prices fall to low levels. Enacted in 2004, the marginal well tax credit has never been needed. Cost: $0.

Enhanced Oil Recovery (EOR) Tax Credit – The EOR credit is designed to encourage oil production using costly technologies that are required after a well passes through its initial phase of production. For example, one of the technologies is the use of carbon dioxide as an injectant. Given the increased interest in carbon capture and sequestration, carbon dioxide EOR offers the potential to sequester the carbon dioxide while increasing American oil production. Currently, the oil price threshold for the EOR tax credit has been exceeded and the oil value is considered adequate to justify the EOR efforts. However, at lower prices EOR becomes uneconomic and these costly wells would be shutdown. Cost: $0.

Manufacturing Tax Deduction – Congress enacted this provision in 2004 to encourage the development of American jobs. All US manufacturers benefitted from the deduction until 2008 when the oil and natural gas industry was restricted to a six percent deduction while other manufacturers will grow to a nine percent deduction. Many producers’ deductions are capped by the payroll limitation in the law. Cost: $13,293,000,000 from 2010-2019.

Excise Tax on Gulf of Mexico Production
– American independent producers hold 90 percent of the OCS leases in the Gulf of Mexico. Offshore federal lands produce 27 percent of America’s oil and 15 percent of America’s natural gas. Producers pay royalties as high as16.67 percent on their production. A portion of this production is produced without royalty payments until it reaches a set volume that was designed to encourage – and effectively so – development of deep water areas. Creating a new tax designed to add a $5 billion burden on US offshore development will drive producers from the US offshore reducing new American production of natural gas and oil. Cost: $5,283,000,000 from 2010-2019.

Passive Loss Exception for Working Interests in Oil and Gas Properties
– The Tax Reform Act of 1986 divided investment income/expense into two baskets – active income/loss and passive income/loss. The Act exempted working interests in oil and natural gas from being part of the passive income basket and the treatment of IDC’s, in particular, was deemed to be an active loss that could be used to offset any type of active income. If, in the future, income/loss, arising from the ownership of oil and natural gas working interests, is treated as passive income/loss, the primary reason for individuals to invest in oil and gas working interests would be significantly diminished. Cost: $49,000,000 from 2010-2019.


Keep in touch with us

We can Help You. Call Us + 1 800 388 5852