| about the Author |
 Duane has over 17 years of professional experience and serves as the leader of the Tax Department in the Dallas office of HEIN & ASSOCIATES LLP. Throughout his career, he has specialized in providing tax compliance and strategic tax planning services for both domestic and international companies involved in all aspects of the energy industry, including oil and gas and utility companies. His energy experience includes three years working and living in Canada’s energy capital, Calgary, Alberta, where he provided assistance to multinational companies. While in Canada, he gained significant experience assisting multinational companies with cross-border transactions, tax-efficient structures, due diligence, and international acquisition and financing strategies. Duane’s hands-on approach provides clients with direct access to a seasoned tax professional on a day-to-day basis.
In addition to his energy industry experience, Duane has developed a focus in the manufacturing and distribution, and real estate industries. He assists both public and private companies with tax issues associated with partnership formations, including initial tax basis calculations, special allocation issues, and tax modeling. Duane assists clients with Internal Revenue Service and other tax authority examinations and regularly drafts requests for private letter rulings and other official ruling requests.
Prior to joining HEIN & ASSOCIATES LLP in 2004, Duane was a Senior Tax Manager for the Dallas office of Deloitte & Touche LLP. He is a regular speaker on a variety of topics, including cross-border transactions, basic international taxation, and oil and gas tax updates. Duane is currently a member of the Dallas Association for Corporate Growth (ACG). He received both his bachelor and master of accountancy degrees from the University of Oklahoma.
Duane can be reached at 972.458.2296 or dsnyder@heincpa.com.
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Budget Aims to Repeal Tax Incentives for
Oil & Gas Producers
By Duane Snyder, CPA, Tax Partner
In an Earth Day speech earlier this year, President Obama discussed our nation’s dependence on foreign oil, and stressed the importance of alternative energy sources. While encouraging individuals and businesses to look more seriously at alternative energy sources, the president spoke of "deficit reduction." He suggests reducing the deficit in the alternative energy area and increasing taxes on the oil and gas industry by repealing a number of the tax incentives available to oil and gas companies.
Unlike traditional investments in stocks, bonds and cash-based investments, investments in oil and gas producing properties are "wasting assets." That is, over a period of time, the oil and gas in the ground will be exhausted by either production or problems associated with production, and the producer will be forced to abandon his well. In contrast, stocks, bonds and cash-based investments, in theory, will continue to produce income perpetually in the form of interest, dividends, and an increasing market value. The president’s budget proposal maintains that there is no difference between a wasting and non-wasting asset. To achieve the tax increase on oil and gas producers, the budget takes the following steps:
- Repeal the expensing of intangible drilling costs (IDC). The expensing of IDC has been part of the Internal Revenue Code since 1913. IDC generally include costs that have no salvage value, but are necessary for the drilling of a well. The rationale for allowing current expensing of IDC is to attract capital into a highly risky investment. In recent years, the risk involved in finding oil and gas has been reduced by advances in technology, leading proponents to believe that the benefit of a current tax deduction is no longer necessary. The Independent Petroleum Association of America (IPAA) estimates that revoking the IDC expensing deduction may reduce investment in U.S. oil development by some $3 billion.
- Repeal percentage depletion for oil and gas. Percentage depletion has been a part of the Code since 1926. It permits a producer to deduct from gross income a percentage value (currently 15%) which represents, for tax and accounting purposes, the total value of the oil or gas deposit that was extracted in the producer’s tax year. The purpose of the percentage depletion allowance has been stated to provide a deduction similar to depreciation for the oil and gas industry. The percentage depletion rules were revised in 1975, and eliminated at that time for major oil companies. Small producers may still take percentage depletion on U.S. production on the first 1000 barrels per day of production (or on a similar amount of natural gas production), limited to 65% of the producer’s net income. The government estimates that eliminating percentage depletion will yield approximately $2.9 billion in deficit reduction for the period 2010 to 2014, and over $8 billion by 2019.
- Repeal manufacturing tax deduction for oil and gas companies. This item in the proposal will yield the greatest amount of deficit reduction, estimated at about $4.9 billion for the period 2010 to 2014, and up to $13 billion by 2019. This deduction has been a part of the Code since 2004 when it became law as part of the American Jobs Creation Act. It was intended to increase domestic employment in manufacturing, with the term "manufacturing" defined to include the oil and gas industries. The deduction was phased in over a number of years, beginning at 3% in 2005 and rising to a maximum of 6% for oil and gas companies.
- Increase the geological and geophysical amortization period for independent producers to seven years. Major integrated oil companies must amortize G & G costs over a seven-year period, while others are allowed to amortize these costs over a two-year period. The budget proposal would put independent producers on an equal footing with major companies. By reducing a current deduction, income will rise and more tax will be due, thereby reducing the deficit. This proposal will contribute about $1.2 billion in deficit reduction for the 2010 to 2019 period.
- Increase or impose the excise tax on Gulf of Mexico production. Producers operating in federal waters in the Gulf of Mexico pay up to a 16.67% royalty on revenue from existing production. New production (defined as that occurring after March 2008) is subject to an 18.75% royalty rate. Previously, the government wanted to encourage deep water drilling and allowed a zero royalty rate until the producer reached a set level of production. Production that is currently not paying any royalty would be subject to the new royalty provisions of the 2010 budget. This is the second highest dollar deficit reduction item in the budget proposal, yielding nearly $2.3 billion in the 2010 to 2019 period.
- Other provisions. The budget proposal contains the repeal of four additional items applicable to the oil and gas industry, including:
- Repeal of the enhanced oil recovery credit. This credit allows for a credit of 15% of allowable costs associated with the use of oil recovery technologies that enhance the production of older wells.
- Repeal of the deduction for tertiary injectants. This provision allows for the current deduction of tertiary injection expenses, including injectant costs. These costs are normally associated with enhancing the production of older wells.
- Repeal marginal well tax credit. This credit was added to the Code as the result of a recommendation by the National Petroleum Council in 1994 to keep low producing wells in production during periods of low prices. Low production wells are estimated to constitute up to 20% of U.S. oil production and up to 12% of natural gas production. It has not been necessary to use this credit to date because market prices have been sufficiently high.
- Repeal passive loss exception for working interests in oil properties. This provision exempts working interests in oil and gas exploration and development from being categorized as "passive income or loss," therefore permitting the deduction of losses in oil and gas projects against other active income. The deficit reduction contribution of this repeal would amount to only $19 million for the period 2010 to 2014.
The tax increases will generally apply to smaller producers, not large integrated oil and gas companies, as many of these incentives were taken from those producers in earlier tax bills.
Other articles in this newsletter:
Hydraulic Fracturing Exemption at Risk
Additional Federal Developments
Energy Industry Impacts State Economies
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4th Quarter, 2009
