Changes

|+ {{table number|1}}Federal income tax schedules and rules{{update after}}

|+ {{table number|1}}Federal income tax schedules and rules{{update after}}

|-

|-

! Taxable Income

! Taxable Income || Rate (%)

! Rate (%)

|-

|-

| Not over [[cost::50,000 USD]]

| Not over [[cost::50,000 USD]] || 15

| 15

|-

|-

| Over [[cost::50,000 USD]], less than [[cost::75,000 USD]]

| Over [[cost::50,000 USD]], less than [[cost::75,000 USD]] || 25

| 25

|-

|-

| Over [[cost::75,000 USD]], less than [[cost::100,000 USD]]

| Over [[cost::75,000 USD]], less than [[cost::100,000 USD]] || 34

| 34

|-

|-

| Over [[cost::100,000 USD]], less than [[cost::335,000 USD]]

| Over [[cost::100,000 USD]], less than [[cost::335,000 USD]] || 39

| 39

|-

|-

| Over [[cost::335,000 USD]]

| Over [[cost::335,000 USD]] || 34

| 34

|}

|}

Special tax treatment for expenditures classified as ''intangible drilling and development costs'', or IDCs, is available to the tax payer. U.S. Treasury Regulation 1.612-4 states that “all expenditures made by an operator for wages, fuel, repairs, hauling,…, incident to and necessary for the drilling of wells and the preparation of the well for the production of oil and gas” are IDCs. A well is considered to be prepared for production when the wellhead is installed. Table 1 shows the current tax treatment of IDCs. Again, tangible items such as surface casing and production casing are classified as tangible expenditures, and the tax free return of the expenditure is recovered through depreciation.

Special tax treatment for expenditures classified as ''intangible drilling and development costs'', or IDCs, is available to the tax payer. U.S. Treasury Regulation 1.612-4 states that “all expenditures made by an operator for wages, fuel, repairs, hauling,…, incident to and necessary for the drilling of wells and the preparation of the well for the production of oil and gas” are IDCs. A well is considered to be prepared for production when the wellhead is installed. Table 1 shows the current tax treatment of IDCs. Again, tangible items such as surface casing and production casing are classified as tangible expenditures, and the tax free return of the expenditure is recovered through depreciation.

===Lease operating expenses===

===Lease operating expenses===

:<math> \mbox{After-tax NCF} = (\mbox{Net revenue interest} \times \mbox{Production} \times \mbox{Wellhead price}) - \mbox{Wellhead taxes} - \mbox{Operating costs} - \mbox{Federal income taxes} - \mbox{Investments}</math>

:<math> \mbox{After-tax NCF} = (\mbox{Net revenue interest} \times \mbox{Production} \times \mbox{Wellhead price}) - \mbox{Wellhead taxes} - \mbox{Operating costs} - \mbox{Federal income taxes} - \mbox{Investments}</math>

All transactions in the equation are cash items, one of which is cash income taxes. The separation of the tax calculation from the NCF calculation is recommended because of the many complications in oil and gas taxation. Instead of combining the NCF calculation and the tax calculation, the federal income tax model for oil and gas transactions ([[:file:about-taxes_fig1.png|Figure 1]]) should be used to calculate the yearly taxes for the property, taking into consideration the appropriate tax treatment of each of the transactions. Once a cash tax liability (negative tax = tax savings) is calculated, this tax amount is subtracted, as shown in Equation 1.

All transactions in the equation are cash items, one of which is cash income taxes. The separation of the tax calculation from the NCF calculation is recommended because of the many complications in oil and gas taxation. Instead of combining the NCF calculation and the tax calculation, the federal income tax model for oil and gas transactions ([[:file:about-taxes_fig1.png|Figure 1]]) should be used to calculate the yearly taxes for the property, taking into consideration the appropriate tax treatment of each of the transactions. Once a cash tax liability (negative tax = tax savings) is calculated, this tax amount is subtracted, as shown in Equation 1.

|+ {{table number|2}}Income tax calculations for example development well. All amounts $M.

|+ {{table number|2}}Income tax calculations for example development well. All amounts $M.

|-

|-

! Year

! Year || 1991 || 1992 || 1993 || 1994 || 1995 || 1996 || 1997 || 1998

! 1991

! 1992

! 1993

! 1994

! 1995

! 1996

! 1997

! 1998

|-

|-

| Gross Inc. (Gl)

| Gross Inc. (Gl) || 1576.075 || 864.968 || 474.705 || 260.523 || 142.978 || 78.468 || 43.064 || 2.752

| 1576.075

| 864.968

| 474.705

| 260.523

| 142.978

| 78.468

| 43.064

| 2.752

|-

|-

|     – Operating Costs

|     – Operating Costs || 24.000 || 24.000 || 24.000 || 24.000 || 24.000 || 24.000 || 24.000 || 2.158

| 24.000

| 24.000

| 24.000

| 24.000

| 24.000

| 24.000

| 24.000

| 2.158

|-

|-

|     – Sev.Adv.Tax

|     – Sev.Adv.Tax || 126.086 || 69.197 || 37.976 || 20.842 || 11.438 || 6.277 || 3.445 || 0.220

| 126.086

| 69.197

| 37.976

| 20.842

| 11.438

| 6.277

| 3.445

| 0.220

|-

|-

|     – IDC Expense

|     – IDC Expense || 950.000 || 0.000 || 0.000 || 0.000 || 0.000 || 0.000 || 0.000 || 0.000

| 950.000

| 0.000

| 0.000

| 0.000

| 0.000

| 0.000

| 0.000

| 0.000

|-

|-

|     – IDC Amortization

|     – IDC Amortization || 0.000 || 0.000 || 0.000 || 0.000 || 0.000 || 0.000 || 0.000 || 0.000

| 0.000

| 0.000

| 0.000

| 0.000

| 0.000

| 0.000

| 0.000

| 0.000

|-

|-

|     – Depreciation

|     – Depreciation || 42.840 || 73.470 || 52.470 || 37.470 || 26.790 || 26.790 || 26.790 || 13.380

| 42.840

| 73.470

| 52.470

| 37.470

| 26.790

| 26.790

| 26.790

| 13.380

|-

|-

| Taxable Income Before Depletion

| Taxable Income Before Depletion || 433.149 || 698.301 || 360.258 || 178.212 || 80.750 || 21.401 || –11.171 || –13.007

| 433.149

| 698.301

| 360.258

| 178.212

| 80.750

| 21.401

| –11.171

| –13.007

|-

|-

|     – Depl. Allowance

|     – Dept. Allowance || 236.411 || 129.745 || 71.206 || 39.079 || 21.447 || 11.770 || 0.000 || 0.000

| 236.411

| 129.745

| 71.206

| 39.079

| 21.447

| 11.770

| 0.000

| 0.000

|-

|-

| Taxable Income

| Taxable Income || 196.738 || 568.556 || 289.053 || 139.133 || 59.303 || 9.630 || –11.171 || –13.007

| 196.738

| 568.556

| 289.053

| 139.133

| 59.303

| 9.630

| –11.171

| –13.007

|-

|-

| Cash Tax Before Credits and Minimum Tax

| Cash Tax Before Credits and Minimum Tax || 66.891 || 193.309 || 98.278 || 47.305 || 20.163 || 3.274 || –3.798 || –4.422

| 66.891

| 193.309

| 98.278

| 47.305

| 20.163

| 3.274

| –3.798

| –4.422

|-

|-

|     – Tax Credit

|     – Tax Credit || || || || || || || ||

|

 

|

 

|

 

|

 

|

 

|

 

|

 

|

 

|-

|-

|     + Minimum Tax

|     + Minimum Tax || || || || || || || ||

|

 

|

 

|

 

|

 

|

 

|

 

|

 

|

 

|-

|-

| ''' Final Cash Tax '''

| ''' Final Cash Tax ''' || ''' 66.891 ''' || ''' 193.309 ''' || ''' 98.278 ''' || ''' 47.305 ''' || ''' 20.163 ''' || ''' 3.274 ''' || ''' –3.798 ''' || ''' –4.422 '''

| ''' 66.891 '''

| ''' 193.309 '''

| ''' 98.278 '''

| ''' 47.305 '''

| ''' 20.163 '''

| ''' 3.274 '''

| ''' –3.798 '''

| ''' –4.422 '''

|}

|}

|+ {{table number|3}}Depreciation, depletion, and amortization calculations for example development well

|+ {{table number|3}}Depreciation, depletion, and amortization calculations for example development well

|-

|-

! Year

! Year || 1991 || 1992 || 1993 || 1994 || 1995 || 1996 || 1997 || 1998

! 1991

! 1992

! 1993

! 1994

! 1995

! 1996

! 1997

! 1998

|-

|-

| colspan=9 | AMORTIZATION

| colspan=9 | AMORTIZATION

|-

|-

| Capitalized IDCs, $M

| Capitalized IDCs, $M || 0.000 || || || || || || ||

| 0.000

|

 

|

 

|

 

|

 

|

 

|

 

|

 

|-

|-

| Amortization rate

| Amortization rate || 0.20 || 0.20 || 0.20 || 0.20 || 0.20 || || ||

| 0.20

| 0.20

| 0.20

| 0.20

| 0.20

|

 

|

 

|

 

|-

|-

| ''' IDC Amortization, $M '''

| ''' IDC Amortization, $M ''' || ''' 0.000 ''' || ''' 0.000 ''' || ''' 0.000 ''' || ''' 0.000 ''' || ''' 0.000 ''' || || ||

| ''' 0.000 '''

| ''' 0.000 '''

| ''' 0.000 '''

| ''' 0.000 '''

| ''' 0.000 '''

|

 

|

 

|

 

|-

|-

| colspan=9 | DEPRECIATION

| colspan=9 | DEPRECIATION

|-

|-

| Depr. basis (tangibles), $M

| Depr. basis (tangibles), $M || 300.000 || || || || || || ||

| 300.000

|

 

|

 

|

 

|

 

|

 

|

 

|

 

|-

|-

| 7-year MACRS rates

| 7-year MACRS rates || 0.1428 || 0.2449 || 0.1749 || 0.1249 || 0.0893 || 0.0893 || 0.0893 || 0.044

| 0.1428

| 0.2449

| 0.1749

| 0.1249

| 0.0893

| 0.0893

| 0.0893

| 0.044

|-

|-

| ''' Depreciation Expense, $M '''

| ''' Depreciation Expense, $M ''' || ''' 42.840 ''' || ''' 73.470 ''' || ''' 52.470 ''' || ''' 37.470 ''' || ''' 26.790 ''' || ''' 26.790 ''' || ''' 26.790 ''' || ''' 13.380 '''

| ''' 42.840 '''

| ''' 73.470 '''

| ''' 52.470 '''

| ''' 37.470 '''

| ''' 26.790 '''

| ''' 26.790 '''

| ''' 26.790 '''

| ''' 13.380 '''

|-

|-

| colspan=9 | DEPLETION

| colspan=9 | DEPLETION

The case for an integrated producer is an easier case since the producer can only take cost depletion.

The case for an integrated producer is an easier case since the producer can only take cost depletion.

[[file:about-taxes_fig2.png|thumb|{{figure number|2}}Depletion allowance calculation. Note that remaining reserves (U) are end of year. In cost depletion calculation, S = sales during year. (After <ref name=pt02r16 />.)]]

[[file:about-taxes_fig2.png|thumb|300px|{{figure number|2}}Depletion allowance calculation. Note that remaining reserves (U) are end of year. In cost depletion calculation, S = sales during year. (After <ref name=pt02r16 />.)]]

==Calculating allowable depletion==

==Calculating allowable depletion==

Determining the allowable depletion deduction is probably the most difficult calculation. [[:file:about-taxes_fig2.png|Figure 2]] is intended to help with this calculation. As shown in Figure 2, allowable depletion is the greater of cost depletion or percentage depletion. ''Cost depletion'' is calculated by taking the remaining depletable basis (unrecovered G & G costs and lease bonus) and multiplying by the fraction of the remaining reserves produced during the year (production during the year divided by reserves at the beginning of the year). All producers are eligible for cost depletion. Independent producers and royalty owners are also eligible for percentage depletion. ''Percentage depletion'' is the lesser of 15% of gross income or 100% of taxable income before depletion from the property. Prior to January 1, 1991, the Taxable Income limitation was 50% for each property. This change is the result of the Revenue Reconciliation Act of 1990. This recent change also demonstrates the “dynamics” of tax rules and the importance of seeking professional advice in this area. An example of another complication in the tax law is the 65% of taxable income limitation from all sources (not just limited to the producing property). The 65% taxable income limit from all sources is difficult to apply to single project economics and is ignored in the example problems presented.

Determining the allowable depletion deduction is probably the most difficult calculation. [[:file:about-taxes_fig2.png|Figure 2]] is intended to help with this calculation. As shown in Figure 2, allowable depletion is the greater of cost depletion or percentage depletion. ''Cost depletion'' is calculated by taking the remaining depletable basis (unrecovered G & G costs and lease bonus) and multiplying by the fraction of the remaining reserves produced during the year (production during the year divided by reserves at the beginning of the year). All producers are eligible for cost depletion. Independent producers and royalty owners are also eligible for percentage depletion. ''Percentage depletion'' is the lesser of 15% of gross income or 100% of taxable income before depletion from the property. Prior to January 1, 1991, the Taxable Income limitation was 50% for each property. This change is the result of the Revenue Reconciliation Act of 1990. This recent change also demonstrates the “dynamics” of tax rules and the importance of seeking professional advice in this area. An example of another complication in the tax law is the 65% of taxable income limitation from all sources (not just limited to the producing property). The 65% taxable income limit from all sources is difficult to apply to single project [[economics]] and is ignored in the example problems presented.

==References==

==References==

[[Category:Economics and risk assessment]]

[[Category:Economics and risk assessment]]