Are you aware of the many tax incentives offered for Oil investments?

Congressional Incentives Encourage Domestic Petroleum Development

Domestic reserves of Oil and natural gas help to make our country more energy self-sufficient by reducing our dependence on foreign imports. Acknowledging the importance of our country’s independence from foreign oil, Congress has provided tax incentives to stimulate domestic natural gas and oil production financed by private sources. Tax advantages enhance the economic strength of Drilling projects. Such tax incentives are completely legal and 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.

Intangible Drilling Cost Tax Deduction

The intangible expenditures of drilling are labor, chemicals, mud, grease, etc. These are usually about 65 to 80% of the cost of a well. Such expenditures are considered “Intangible Drilling Cost (IDC)”, which is 100% deductible during the first year of drilling. Under typical conditions a $100,000 investment would yield up to $75,000 in 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.) Visit IRS.gov for more information on IDC.

Tangible Drilling Cost Tax Deduction

“Tangible Drilling Costs (TDC)” are the total amount of the investment allocated to the equipment. TDC is 100% tax deductible. In the example above, the remaining tangible costs ($25,000) may be deducted as depreciation over a seven-year period. (See Section 263 of the Tax Code.) Visit IRS.gov for more information on asset deductions.

Active vs. Passive Income

The concepts of “Passive” income and “Active” income were introduced into the tax code by he Tax Reform Act of 1986. Principally the Act prohibits the offsetting of losses from Passive income activities against income from Active businesses. Working Interest in an oil and gas well is specified as an “Active” income, therefore, deductions can be offset against income from active stock trades, business income, and even salaries. (See Section 469(c)(3) of the Tax Code).

Small Producers Tax Exemption

Some special tax advantages for small companies and individuals were adopted in the 1990 Tax Act. This tax incentive, known as the “Percentage Depletion Allowance”, is intended to encourage participation in oil and gas drilling. This tax benefit is limited to small producers and 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 advantage offered to small producers is an allowance of 15% of the Gross Income from an oil and gas producing property to be tax-exempt.

Lease Costs

Lease costs which includes the purchase of leases & minerals as well as sales expenses, legal expenses, administrative accounting, and Lease Operating Costs (LOC) are 100% tax deductible through cost depletion.

Alternative Minimum Tax

“Alternative Minimum Taxable Income” consists of adjusted gross income, minus allowable Alternative Minimum Tax itemized deduction, plus the sum of tax preference items and adjustments. “Tax preference items” are preferences existing in the Code to greatly reduce or eliminate regular income taxation. Included within this group are deductions for excess Intangible Drilling and Development Costs and the deduction for depletion allowable for a taxable year over the adjusted basis in the Drilling Acreage and the wells thereon. Prior to the 1992 Tax Act, working interest participants in oil and gas ventures were subject to the normal Alternative Minimum Tax to the extent that this tax exceeded their regular tax. This Tax Act specifically exempted Intangible Drilling Cost as a Tax Preference Item.

Enhanced Recovery Credit

Pressure inside a well drops as oil is removed from a producing field. The flow of oil to the surface is decreased and the difficulty of removing it increases. New recovery methods may be employed to offset the increased difficulty but adds dramatically to the cost of continued production.

The enhanced recovery credit is designed to encourage continued extraction from existing fields when suffering a significant decline in production. The credit is equal to 15 percent of qualified costs on an enhanced recovery project incurred during a taxable year and may be claimed by taxpayers who own an operating mineral interest. The credit is available for projects where steam, carbon dioxide or some types of chemically enhanced water flooding are used to increase the pressure in a field. It is not available for water flooding, cyclic gas injection or horizontal drilling projects.

In the News: Tax Bill Gives Incentive to Marginal Wells

The US Senate and House of Representative have passed a tax incentive bill to help small oil and gas producers. This bill provides a tax credit of up to $9 per well per day for marginal wells. A typical marginal well pumps 15 barrels of crude or 90 thousand cubic feet of gas per day. There are 650,000 “marginal” or “stripper” oil and gas wells in the USA. Marginal wells provide as much as 25 percent of the nations’ crude supply (on par with Saudi Arabia ) and about 10 percent of gas stocks. In 2002 alone, 17000 oil and gas wells were permanently plugged with cement (13,600 oil wells and 3,900 gas wells). This tax bill will act as a safety net to save many of these wells, thereby reducing our reliance on the Middle East. The tax credit phases-in if the average crude price for a year is less than $18 a barrel or $2 per thousand cubic feet of gas. The maximum tax credit is $3 a barrel for the first three barrels of crude produced if prices plunge below $15 a barrel, and 50 cents per thousand cubic feet if gas prices average less than $1.67 per thousand cubic feet. crude oil is now above $54 a barrel on the New York Mercantile Exchange and gas futures are near $7 per thousand cubic feet.

From Houston Chronicle, October 12, 2004

Oil and Gas Investment Advantages

Intangible Drilling Costs

Intangible Drilling Costs (IDCs) are drilling expenditures related to expenses such as labor, fuel, chemicals, hauling, etc. IDCs usually represent 70% to 85% of the cost of a well and are eligible for the election to be deducted 100% against taxable income in the first year.

Tangible Drilling Costs

The costs of oil and gas drilling equipment such as casing, pump jacks, and wellheads are Tangible Drilling Costs (TDCs). Continuing with the example above, the remaining $7,500 (15% of the cost of the well) would be TDCs. These costs are capitalized and depreciated over a period of seven years.

Depletion Allowance Deductions

When a producing well is drilled, the venture can recover the capitalization cost of the oil and gas property through depletion deductions. There are two ways to calculate the allowable depletion deduction: the cost depletion method and the percentage depletion method – and the taxpayer may take a deduction for the greater of the two.

Active vs. Passive Income

The tax code specifies that a working interest (as opposed to a royalty interest) in an oil and gas well is not considered to be a passive activity. This means that all net losses are active income incurred in conjunction with well-head production and can be offset against other forms of income such as wages, interest and capital gains.

Why you should invest?

Participating in an oil and gas investment can generate several tax benefits from up-front deductions of Intangible Drilling Costs (IDCs), which represents the largest tax deduction in an oil and gas investment, to depletion allowances, which account for the reduction of oil reserves as the product is produces.
LSU economist Loren Scott, in a report commissioned by the state Department of Natural Resources, says last year alone about $2.4 billion in new business sales came from the shale area and roughly $3.9 billion in household earnings were created. An increase of 32,742 new jobs were linked to the shale last year throughout Louisiana.
Crude-oil production and imports that are not sent to other states are processed at Louisiana’s 19 refineries, clustered mostly along the lower Mississippi River and in the Lake Charles area. With a refining capacity of nearly 3 million barrels per day, Louisiana produces more petroleum products than any state but Texas. Louisiana is home to about 18 percent of the nation’s refining capacity.