Oil and Gas: Tax Advantages of Domestic Energy Investments

July 25, 2023

The United States has placed a high priority on domestic energy production for decades, and as a result, the federal government offers tax incentives for oil and gas investors that are unmatched anywhere in the IRS tax code.

In the following guide, we review the major tax benefits of investing in oil and gas for wealthy or affluent individuals. Keep reading to learn more. 

Intangible Drilling Costs

One major tax advantage of investing in oil and gas applies to intangible drilling costs. Intangible drilling costs encompass everything except the actual drilling equipment, including mobilization fees, drill pipe rental fees, rig and crew wages, site preparation costs, mud and cement, inspection and testing fees, land access fees, hauling services, and other similar costs. These expenses typically comprise 60 to 80 percent of the total cost of drilling a well and are 100% tax-deductible in the year incurred.

Tangible Drilling Costs

Another major tax break for oil and gas investment applies to tangible drilling costs. These are the direct costs of the drilling equipment. Tangible costs are also 100% tax-deductible, but they must be depreciated over seven years. 

Working Interest

A third tax break for the investment in these commodities comes from the IRS tax code declaring that a working interest in oil and gas is not considered passive income. This means all net losses incurred through well-head production are active income and can be offset against other income, including salaries, wages, interest, and capital gains. 

Small Producer Tax Exemptions

Perhaps the most enticing tax advantage for oil and gas investors is known as “depletion allowance”. This tax break excludes from taxation up to 15 percent of gross income from oil and gas wells. As indicated by the name, only small producers and investors are eligible. The IRS prohibits any company producing or refining more than 50,000 barrels of oil per day, entities that own more than 1,000 barrels of oil per day, or 6 million cubic feet of gas per day, from claiming the tax break. 

How to Invest in Oil and Gas

The four major categories of investment options for oil and gas are mutual funds, partnerships, royalties, and working interests. Let’s take a brief look at each of these investment options: 

  • Mutual Funds – Investors can choose mutual funds, which provide the least amount of risk, since investments are spread across a variety of securities. However, investments in mutual funds are not eligible for any of the tax benefits listed above. As such, you will pay taxes on all capital gains and dividends. 
  • Partnerships – Limited partnerships are commonly used for oil and gas investments as they minimize risk by limiting liability to the amount invested as a partner. The securities must be registered with the Securities and Exchange Commission (SEC). The abovementioned tax benefits are attainable on a pass-through basis. 
  • Royalties – Although royalties, or compensation paid to landowners on whose land the oil and gas wells are drilled, are not eligible for these tax breaks, they do comprise about 12 to 20 percent of the total gross revenue generated from the drilling ventures, and are thus profitable. In addition, landowners are not liable for the lease of the wells. 
  • Working Interests – Working interests, or operating interests, are the riskiest investment option and involve direct participation in drilling operations. Working interests are not considered securities and as such do not require a license to sell. These arrangements are comparable to general partnerships in which the participants have unlimited liability. 

Ultimately, oil and gas offer some huge tax-advantages to affluent individuals who are able to invest. 

The financial experts at Honest Buck can help you develop the best tax strategy for your Early Childhood Education business. We’re here to help you grow a more profitable childcare company. Contact us today. 

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