To become more self-reliant in the gas and oil industry, Congress created tax incentives and deductions to attract investors. This industry has become more popular over the years due to the increase in profits from the new tax regulations. This increase in investors, in turn, has increased our oil and gas supply, so the United States would have a bigger reserve and would not have to depend as much on foreign countries for supplies. Investing in the oil and gas industry has become a more promising investment over the years, but before investing your own money, you should consult your accountant to make sure you’re choosing the right path for your financial portfolio.
Investing in the oil and gas industry can be a lucrative endeavor, if investors understand the risks involved. Investing in the oil and gas industry involves long-term commitments, as the process of drilling, extraction, and transportation can take several months or even years. Investors must also consider the volatility of the market, as the price of oil and gas can fluctuate dramatically due to a number of factors, including global political events and natural disasters. Additionally, investors must be aware of the tax implications of investing in the oil and gas industry, as the Internal Revenue Service provides several deductions and credits that can help reduce tax liabilities. There are several main components to consider for tax time when investing in the oil and gas industry.
- Congressional Incentives
As previously mentioned, Congress has provided numerous tax advantages to those who invest in the industry. These advantages help further enrich our economy and supply. Talk to your CPA professional about one of the countless opportunities available.
- Intangible Drilling Cost (IDC) Tax Deduction
100% of Intangible Dilling Costs are deductible during the first year. Labor, services, and non-salvageable materials are included in this deduction. Any tangible cost can be deducted using a depreciation method.
For Example, this investor is receiving $147,000 in deductions which supplies an in-pocket tax credit of $63,000, equaling the $210,000 initial contribution:
|Intangible Drilling Costs
|Intangible Expenses Deduction
|Tangible Equipment Costs
|Depreciation over 7 Years
|Tangible Depreciation Deduction
|First year deductions
- Depreciation Tax Deduction
Opposed to intangible services, machinery and other equipment (casing, tanks, wellheads, well trees, and pumping units) holds value and will depreciate over time instead of being deducted all at one time. Accountants will use the Straight-Line Method or the Modified Accelerated Cost Recovery System (MACRS). Typically, up to 40% of the cost for the well will be accounted for by equipment.
- Small Producer’s Tax Exemption – Depletion Allowance
Not available to large oil companies, the 1990 Tax Act enables small companies (those who produce 1,000 barrels/day or less) to save some of the gross income accumulated from sales through another tax deduction. Also known as the “Percentage Depletion Allowance”, this incentive allows those who have small daily production rates to have 15% of their gross working interest income to be tax-free.
- Active/Non-Passive Versus Passive Income
The Tax Reform Act of 1986 is a federal law that was enacted to reduce the tax burden on individuals and businesses while also closing loopholes in the US tax code. Specifically, the Act includes regulations related to the oil and gas industry, such as defining active/non-passive versus passive income and providing incentives to small oil and gas producers. It also provides deductions and credits for investors in the oil and gas market.
- Alternative Minimum Tax (AMT)
The Alternative Minimum Tax (AMT) is a tax that is imposed on certain oil and gas producers who have large capital investments. The AMT is calculated on the investor’s total taxable income and is intended to prevent investors from taking advantage of the many tax benefits available to the oil and gas industry. The tax rate for the AMT is typically higher than the regular income tax rate, so investors should be aware of the potential impact of this tax on their income. After 1992, however, Congress provided relief to those in the industry by exempting intangible drilling costs from AMT application. This assisted the industry investors even further.
Ways to Invest in the Industry
Just like there are numerous tax considerations when looking to invest in the oil and gas industry, there are also numerous ways to invest in it. With each investment option, there are risks and other levels of taxation. Investors can participate in the industry through a mutual fund, partnership, royalty, or working interests. These investments can be tailored to the individual investor’s needs and risk tolerance. It is important to research and understand the different investment options before deciding.
- Mutual Funds
This investment route has the least amount of risk, but smaller rewards as well. The dividends and capital gains received will all be taxed without any of the previously mentioned incentives.
Partnerships are the most seen way to invest. Every year, they will receive a form detailing their exact involvement in income and expenses.
There are no tax benefits or liability eligibility with royalty involvement. Royalties are strictly payments received for allowing the oil and gas companies to utilize the land for drilling.
- Working Interests
This investment route has the most risk and involvement for the industry. These investors directly participate in drilling activities and are considered self-employed. They have unlimited liability.
Investing in the oil and gas industry has become increasingly attractive due to the tax incentives in place. Since 1986, numerous tax rulings have been enacted to entice investors to participate in the oil and gas industry. These Tax Acts helped to reduce the tax burden on the oil and gas industry and encouraged further investments in the sector. This has helped to ensure that the industry remains competitive with the rest of the economy. Before making any decisions on investing, it is best to consult with your accountant to establish what is the best path for you. Contact Kislay Shah CPA at firstname.lastname@example.org or call 646-328-1326 for a consultation to discuss your financial future.