Domestic oil and natural gas development is the solution to the country’s energy crisis. In an effort to avoid reliance on unstable foreign markets and boost production at home, the United States Congress has created tax incentives for investors of private oil and natural gas production companies. Read on to get a more complete understanding on how and why these incentives can work for you.
Note: Only private US citizens residing in the US are eligible to benefit from these tax incentives. Any other entity is cautioned to consult their tax advisors before participating in an investment.
The Tax Reform Act of 1986 prevents individuals from using active business income to compensate for losses in passive activities. The act states that working interest in oil or gas investments is not a passive activity, and therefore deductions can be used to counteract active income from salaries, stocks, and business profits.
Investors in private oil and gas projects can benefit from a depletion allowance of 15% of his or her gross income from the project. A depletion allowance allows an investor to account for the reduction of reserves as oil and gas are produced. This means that nearly 15 cents per dollar of gross income is untaxed.
There are three main costs associated with drilling an oil and gas well: intangible, tangible, and lease or operation costs.
Intangible Drilling Costs, or IDCs, are the labor-intensive costs of the drilling process. Roughly 70-85% of an investment accounts for IDCs.
Tangible Drilling Costs, or TDCs, include capitalized and depreciated equipment. About 15-30% of an investment accounts for TDCs.
Lease/Well Operating Costs, or costs associated with lease or well operating expenses, are 100% tax deductible. This includes lease purchases and expenses, accounting and administration.
Under the Tax Cuts and Jobs Act of 2017, the tax code allows for investors to write off 100% of all investment costs in the current year — including tangible, intangible and lease costs — with a deduction limit of $1,000,000, regardless of the outcome of drilling the well.
Under the Alternative Minimum Tax, or AMT, taxpayers must compute taxes twice, once using the traditional method, and again using AMT. When calculating with AMT, tax preference items, such as deductions for excess intangible drilling costs, are added back to adjusted gross income, less the allowable AMT itemized deduction. Once the AMT calculation is completed, it is compared to the traditional tax calculation. The taxpayer must then pay the higher amount calculated through the two methods.
Input information of an investment you are considering, or information for a theoretical investment, to see what kinds of tax benefits an individual investor can expect. For more information, contact a Smart Oil and Gas representative toll-free at 833-645-4500.
The tax incentive information and tax calculator are not a forecast or projection. They merely provide, on a hypothetical basis, potential tax savings. The tax information contained herein was not intended or written to be used nor can it be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the recipient or any taxpayer or for promoting, recommending or marketing to another party any matter discussed herein. This information does not attempt to present a detailed explanation of the federal income tax treatment of an investment and is directed primarily to a prospective investor who is currently an individual and a citizen of the United States not residing abroad. Additional considerations not addressed in this information may apply to a prospective investor that is a corporation, estate, partnership, tax-exempt entity, trust or individual not a citizen of the United States residing within its borders and such persons are cautioned to consult their tax advisors before participating in an investment. The tax benefits of oil and gas exploration do not eliminate the risks. Each prospective investor should seek advice based on the taxpayer’s particular circumstances from an independent tax adviser.
The Insider’s Guide to Investing in Oil and Gas Wells is neither an offer to sell nor a solicitation of an offer to buy. The information contained therein is for informational purposes only.
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