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Monday, April 5, 2010
Income Tax Returns for Oil and Gas
Producers: Computing the IDC Preference in the
Alternative Minimum Tax
It’s the time of the year when
many oil and gas producers begin to gather the information necessary to prepare
their corporate and partnership federal income tax returns. For some producers currently deducting
intangible drilling and development costs (IDC), the IDC preference in the
rules implementing the Alternative Minimum Tax (AMT) can present a number of
computational issues. Several of those
issues are mentioned below.
To start, independent producers
and integrated oil companies annually can elect under section 59(e) of the
Internal Revenue Code (Code) to capitalize some or all of their IDC and recover
the capitalized amount over a 60-month period instead of deducting the IDC
currently. IDC capitalized and amortized
pursuant to this election is not considered in the IDC preference computation
for AMT purposes. So independent
producers and integrated oil companies must determine whether making this
election is beneficial in the overall AMT computation. Independent producers consider this election
in conjunction with a beneficial exclusion described below.
IDC deducted currently is subject
to the IDC preference under section 57, but independent producers receive an
important benefit for this computation.
The IDC preference generally is excluded from the Alternative Minimum
Taxable Income (AMTI) computation for independent producers, but the reduction
in AMTI by reason of this exclusion cannot exceed 40 percent of the AMTI for
the year that would have resulted had the exclusion not applied. Thus, independent producers deducting IDC
currently still need to compute the IDC preference to determine, what amount,
if any, is added back to regular taxable income to compute AMTI.
The IDC preference is computed
with respect to all of the oil and gas properties of the taxpayer, and is the
amount by which the amount of the “excess intangible drilling costs” arising in
the taxable year is greater than 65 percent of the taxpayer’s “net income from
oil, gas, and geothermal properties.”
Thus, the IDC preference is minimized by decreasing “excess intangible
drilling costs” and increasing “net income from oil, gas, and geothermal properties,”
whenever possible.
Note that in determining the
amount of “excess intangible drilling costs,” IDC incurred in drilling a
“nonproductive well” is excluded. The
Code and regulations sections dealing with the IDC preference do not define a
“nonproductive well,” but clearly a well plugged and abandoned prior to
completion meets the definition.
However, legislative history to the IDC preference and other Code and
regulations sections referring to “nonproductive wells” indicate that the
definition of a “nonproductive well” should include more than just a well that
is plugged and abandoned with no production.
Indeed, these authorities indicate that a well not expected to produce
oil or gas in commercial quantities also should be considered a “nonproductive
well.”
The last issue concerns the
computation of “net income from oil, gas, and geothermal properties.” Section 57 provides that the starting point
for this computation is the amount of gross income from the independent producer’s
oil and gas properties as determined for purposes of computing the percentage
depletion deduction. All deductions
allocable to the oil and gas properties reduced by the amount of “excess
intangible drilling costs” are subtracted from this amount of gross income to
arrive at “net income from oil, gas, and geothermal properties.” The issue here is determining those
deductions that are not allocable to the oil and gas properties and excluding
those deductions from the computation.
There is little direct guidance from the courts and the IRS on this
issue, but legislative history to the IDC preference indicates that the rules
for computing “taxable income from the property” for percentage depletion
purposes are to be applied. Over the
years, the courts and the IRS have addressed what kinds of deductions are
excluded in computing “taxable income from the property.” For example, deductions for charitable
contributions and some kinds of insurance can be excluded. Other deductions more closely related to the
producer’s business, however, need to be reviewed more closely.
Conclusion
Oil and gas producers deducting
IDC currently should determine whether any wells completed in 2009 can be
considered “nonproductive wells” for purposes of the IDC preference in the
AMT. Producers also should consider
whether any of their 2009 deductions can be excluded from the computation of
“net income from oil, gas, and geothermal properties” for IDC preference
purposes.
For more information, please contact
John T. Bradford at jtbradford@liskow.com or go to www.liskow.com.
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