Changes

==Calculating after-tax net cash flow==

==Calculating after-tax net cash flow==

The recommended approach to calculate after-tax net cash flow (NCF) is to use Equation 1, which is

The recommended approach to calculate after-tax net cash flow (NCF) is to use Equation 1, which is

:<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 (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.

 

It sounds simple and it actually is, once some experience is gained. Two worksheets are provided to help keep the numbers straight.<ref name=pt02r17 /> Tables 2 and 3 are the completed worksheets for the example development well in which the producer is an independent producer and royalty owner eligible for percentage depletion. Table 4 is the federal income tax calculations for the example multiwell extension project.

It sounds simple and it actually is, once some experience is gained. Two worksheets are provided to help keep the numbers straight.<ref name=pt02r17 /> Tables 2 and 3 are the completed worksheets for the example development well in which the producer is an independent producer and royalty owner eligible for percentage depletion. Table 4 is the federal income tax calculations for the example multiwell extension project.

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.

==Calculating allowable depletion==

==Calculating allowable depletion==

Determining the allowable depletion deduction is probably the most difficult calculation. 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==