The tax benefits generated by a direct participation in oil and/or natural gas are substantial. The immediate deduction of the intangible drilling costs or IDCs is very significant, and by taking this up front deduction, the investor’s risk capital is effectively subsidized by the government by reducing the investor’s federal and possibly state income tax.

Tax Benefits: Initial Drilling Costs
Initial Drilling Cost is considered a complete write off, whether oil was discovered or not. Meaning that if the participation opportunity was not made, the potential working interest holder would have lost about 30% or more (depending on the tax bracket of the potential working interest holder) of the potential participation to the tax authorities without making any participation. Therefore, the actual drilling portion of the investment will cost only 70% of its nominal value.

• Completion Costs
  Up to $17,000 of total completion costs can be written off as a one time charge in any given year with the remaining balance depleted (deducted) over a period of 7 years reducing income tax expense paid to tax authorities.
• Income Tax
  All revenues from oil exploration and development projects are subject to a depletion allowance from the US government. Working interest holders will pay taxes on only 80-85% of total oil and gas income.

These are just a few of the tax benefits for oil and gas working interest holders. There are many other advantages such as that oil and gas working interest holders might be able to lower their respective tax brackets by making such participation opportunities.

Direct participation: Several tax benefits
Direct participation oil and gas investments generate several tax benefits. These benefits range from large up front deductions for intangible drilling costs (IDC), to tax credits for the development of certain types of tight formations. Deductions are generated mainly from the cost of non salvageable equipment or services conducted during the drilling phase, testing, and/or completion of the well. The following is a synopsis of the tax benefits generated by direct participation oil and gas investments.

1. Intangible Drilling Costs (IDC) When an oil or gas well is drilled, several expenses may be deducted immediately. These expenses are deductible because they offer no salvage value whether or not the well is subsequently declared to be dry. Examples of these types of expenses would be labor, drilling rig time, drilling fluids etc. IDCs usually represent 60 to 80% of the well cost. Investors usually put up the drilling portion of their investment before drilling operations commence, and the investor’s portion of the intangible drilling costs is generally taken as a deduction in the tax year in which the intangible costs occurred. The accounting method adopted however could affect the deduction period.

2. Intangible Completion Costs As with IDCs these costs are generally related to non salvageable completion costs, such as labor, completion materials, completion rig time, fluids etc. Intangible completion costs are also generally deductible in the year they occur, and usually amount to about 15% of the total.

3. Depreciation As opposed to services and materials that offer no salvage value, equipment used in the completion and production of a well is generally salvageable. Items such as these are usually depreciated over a seven year period, utilizing the Modified Accelerated Cost Recovery system or MACRS. Equipment in this category would include casing, tanks, well head and tree, pumping units etc. Equipment and tangible completion expenses generally account for 25 to 40% of the total well cost.

4. Depletion Allowance Once a well is in production, the participants in the well are allowed to shelter some of the gross income derived from the sale of the oil and/or gas through a depletion deduction. Two types of depletion are available, cost and statutory (also referred to as percentage depletion). Cost depletion is calculated based upon the relationship between current production as a percentage of total recoverable reserves. Statutory or percentage depletion is subject to several qualifications and limitations. This deduction will generally shelter 15 per cent of the well’s annual production from income tax. For “stripper production” (wells producing 15 barrels/day or less), the depletion percentage can be up to 20%.

5. Tax Credits Congress has enacted several tax credits in relation to oil or natural gas production. The enhanced oil recovery credit is applied to certain project costs incurred to enhance a well’s oil or natural gas production. This credit is up to 15% of the costs incurred to enhance production. The non conventional source fuel credit provides for a $3 per barrel of oil equivalent credit for production from the so called qualified fuels. Qualified fuels include oil shale, tight formation gas, and certain synthetic fuels produced from coal.

The Alternative Minimum Tax Historically the tax benefits from oil and natural gas production could potentially present the possibility for taxation under the Alternative Minimum Tax (AMT). In the early 1990’s however, Congress provided some tax relief for “independent producers”. An independent producer was defined as an individual or company with production of 1,000 barrels per day or less. Although there is still the potential for AMT taxation for excess IDCs, percentage or statutory depletion is no longer considered a preference item.

Lease Operating Expense This expense covers the day to day costs involved with the operation of a well. The expense also covers the costs of re-entry or re-work of an existing producing well. Lease operating expenses are generally deductible in the year incurred, without any AMT consequences.

Why Invest in Oil & Gas

• Return of Capital in as little as 12 to 24 months.
• Some of the world's wealthiest individuals and companies made their fortune in oil and gas, many of them here in Lubbock!
• Better than 10 to 1 Potential Return on Investment.
• Annual return of 33 to 50% on monies invested in many cases.
• Reduce risk by utilizing state-of-the-art technologies not available even 10 years ago.
• Drilling and Recompletions are the very best tax advantaged investments.
• Congress gives tax breaks to individual investors that are not available to large companies.
• Up to 100% tax deductible ... 65 to 80% (Intangibles) can be written off in first year.
• 15% of revenue is tax-free with depletion allowance.
• Small drilling and recompletion prospects are better than ever (and there are more of them).
• The large oil and gas companies have gone offshore and overseas in search of finding the "big" oil fields.
• Over 10,000 oil companies have left the U.S. fields since 1982. This leaves many opportunities.
• Petroleum demand in the U.S. requires nearly 60% of oil to be imported from foreign nations.
• Natural gas is difficult and expensive to store. U.S. consumption of natural gas has outstripped production in recent years, leading to soaring gas prices.
• Encourages domestic drilling with special tax breaks.
• Government mandating natural gas usage over oil and coal.
• Natural gas is now deregulated.
• Traditional sources of drilling money are no longer available, which is a bonanza for accredited investors. Oil and Gas prices are projected to stay at high levels for at least the next 15 years.