Oil & Gas Investment and tax incentives - Simplified

 Oil and Gas Tax Incentives

Oil and Gas is the largest industry in the US economy and contribute about 8% to US GDP and supports more than 10 millions direct and indirect jobs. In spite of new natural energy is in rise this industry is still looking strong enough for more years to come until another form of energy completely takes it over.

There are many benefits of investing in this industry, to name a few

High return on Investment opportunities

Passive income treated as active income

Diversification of income

Tax Incentives

I will focus on tax incentives in this article while touching other aspects in brief time to time.

Tax rules are same for this industry and apply equally but there are few incentives provided by the tax laws that oil and gas business can take advantage of.

Income from Oil and Gas can be active

As per tax rule, if you do not participate in a business, that is considered as passive income. In case of income that will not make any difference, but when there is a loss, the loss can only be off set with passive income, otherwise the loss will be carry forwarded to future years as passive loss (suspended loss). This is a big bummer, if you made a huge loss in passive investment and made a good amount of money in other business or from your wages, you will end up paying taxes on those profits and income but the loss will be carried over. However, the big advantage of this industry is, you can offset the loss from gas and oil with other income. A working interest in an oil or gas is considered as active activity. Generally it does not matter if the partner or the investor materially participates or not. This is a big advantage of oil and gas over real estate investment or other passive investments.

Deduct Intangible Drilling and Development cost

Intangible drilling cost is those associated with drilling and developing a well. Generally these are capitalized, but in gas and oil industry it can be written off during the year it is spent. This is one of the benefits of investing in oil and gas; these expenses can be written off fully as incurred. That will help keep the income low, and hence will avoid unnecessary tax burden.

Deduct tangible drilling cost

Likewise those capital expenditure made on equipment and machinery used in the drilling or development of wells can be written off without capitalizing them. You need not depend on deprecation method changes or tax breaks on depreciation on this matter. This will keep it simple and tax effective.

15% Depletion or Small Producer Tax Exemption

Only 85% of income from gas and oil is taxed. That means you can take 15% depletion deduction on the income you received from your business. Very interestingly Percentage depletion may be deducted even after the total depletion deductions have exceeded the cost basis. In other words you are allowed to take the depletion deduction as long as you make money from the business. There is a limit on it though Small Producers Tax Exemption or depletion allowance is only for the company producing less than 50000 barrels per day. The tax benefit is not available to large companies or taxpayers who are into oil selling business through retail outlets. It is also not available to investors owning more than 1,000 barrels of oil or 6,000,000 cubic feet of gas average daily production.

15% Depletion is limited to lower of the following

100% of your taxable income from the property figured without the deduction for depletion

65% of your taxable income from all sources, figured without the depletion allowance.

To simply it, if you are individual, the deduction will be limited to 65% of your total income or 100% of your income whichever is lower. Same principle applies to corporation also.

Business Structure

Partnership is one of the best business structures for small to medium oil and gas business as it allows bringing in as many investors as you like and it allows the rational distribution of income to partners. Investors can have interest in separate wells or multiple wells under the partnership. If you are not looking at multiple investors S-Corp may the better option. If you are aiming big, C-Corp might be the best choice.

Oil and Gas may be a good investment for those high income earners who do not have time to involve in the activity but at the same time make some passive income on side, which can be treated as active business even you are not involved in it. It is good way to diversify your investment portfolio. You have investment in real estate, investment in other sector, now it’s time to look for more avenues, if this is your situation oil and gas is a good place to find the diversification and also avail the fruits of tax benefits that are not available for other businesses.

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