Tax Incentives in Oil and Gas - Eno Petroleum Corporation
Eno Petroleum Corporation is NOT a tax advisor, CPA, or tax attorney and is NOT certified to give any tax advice. The information contained in this website is for informational purposes only. Eno Petroleum Corporation offers no professional tax advice.
In The Tax Act of 1986 Congress extended special favor to those who participate in oil and gas ventures. The tax act allows for Intangible Drilling Costs (IDC’s - labor, chemicals, mud, grease, etc.), which are typically 70% to 90% of the cost to drill a well, to be written off the taxable year, expensed against ordinary income. 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 461 (i) (2) of the Tax Code)
Furthermore, Tangible Drilling Costs (TDC’s – well equipment, storage tanks, pump jacks, etc.), typically 10% to 30% of the cost to drill a well, are 100% tax deductible as a depreciation expense over a seven year period using the Accelerated Cost Recovery System (ACRS). (See Section 263 of the Tax Code)
Lease costs (purchase of leases, minerals, etc.), sales expenses, legal expenses, administrative accounting, and Lease Operating Costs (LOC’s) are also 100% tax deductible in the year they were incurred.
For tax years ending after August 8, 2005, any Geological and Geophysical (G&G’s) expenses paid or incurred in connection with the exploration for, or development of, oil or gas within the United States (as defined in Code section 638) may be amortized ratably over the 24-month period beginning on the date the expenses are paid or incurred. (See Section 167 (h) (1) of the Tax Code)
Combined, these incentives add up to a 100% write off against ordinary income.
Additionally, 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, and so forth. (See Section 469 (c) (3) of the Tax Code)
If you’re involved in a dry-hole well you qualify for a 100% write-off of all costs, intangible and tangible alike, in the first year. Dry-hole costs are typically deducted on Schedule C or Form 1065 and are NOT subject to the usual $3,000 limit. These costs, when reported, should still be broken down by intangible, tangible and lease costs.
Another benefit, a small producer’s tax exemption known as the “Percentage Depletion Allowance” allows for 15% of the Gross Income (NOT Net Income) from an oil and gas producing property to be tax-free. Enacted by the 1990 Tax Act, this exemption was specifically designed to encourage participation in oil and gas drilling. This tax benefit is not available to any entities or individuals owning more than 1,000 barrels of oil or 6,000,000 cubic feet of gas average daily production.
These tax incentives can be used even if you’re paying the Alternative Minimum Tax (AMT). If you’re not in AMT then these write offs should not put you there. The 1992 Tax Act specifically exempted Intangible Drilling Cost as a Tax Preference Item. “Tax Preference Items” are preferences existing in the Tax 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 within.