Texas Energy Group
19019 HWY 71 West
Spicewood, TX 78669
Ph. (512) 263-8106
Fx. (512) 263-8136
Investor Relations
Ph. 877-TXENRGY
(877-893-6749)
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 | Tax Benefits |
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The United States is the 3rd largest oil producer in the world. But we're the single largest consumer, producing 8% of the world's oil and consuming 25%. As this graph from the Department of Energy illustrates, the United States consumes much more oil than we produce, a trend that is expected to continue well into the foreseeable future. As our demand continues to rise while our production simultaneously continues to decline, the ever-widening gap creates an inexhaustible rise in our dependence on foreign oil imports. And the United States' crucial dependency on foreign oil imports makes us very vulnerable.
Unfortunately, there are but two viable means of reducing our dependency on foreign imports. The first is to reduce our oil consumption. So far, this one shows very little promise. The second is to increase domestic production. This one does have potential.
So, in an effort to stimulate domestic natural gas and oil production financed by private sources, Congress provided tax incentives in the 1990 Tax Act that significantly enhance the economics of investing in oil & gas. But these incentives are not "loop holes." They were placed in the Tax Code by Congress to make participation in oil and gas ventures one of the best tax advantaged investments available. The new Tax Code specifically states that a working interest in an oil & gas well is not a "passive" activity. Therefore, deductions can be offset against any income. This includes active stock trades, salaries and business income. (section 469(c)(3) of the Tax Code). |
Percentage Depletion Allowance The first tax incentive to consider is known as the Percentage Depletion Allowance, also known as "Small Producers Exemption." This incentive allows 15% of the gross income from an oil and gas producing property to be tax free. So, for every $1 million in gross income we earn, $150,000 will be tax-free. (Tax Code Section 613A)
Tangible Drilling Costs (TDCs) are expenses that include hard assets such as the wellhead & production equipment. They tend to account for around 20% of the total investment and may be depreciated 7 years. (Tax Code Section 263) At 20%, a million dollar investment would deduct $200,000 over a 7-year period to generate a total tax savings of around $70,000 and an annual savings of $10,000 to reduce the net investment by 1%.
Intangible Drill Costs The most significant tax provision is the deduction for Intangible Drill Costs (IDCs). This includes labor intensive items like services, labor, chemicals, mud, leases and rentals. IDCs account for around 80% of total expenses and are 100% deductible during the first year (regardless of whether or not the well was completed that year). So, a million dollar investment could deduct around $800,000 right away, which would generate a net tax savings of around $280,000 in year one, reducing the net investment by 28%.
With all of the deductions applied, here's how a $1 million investment would look.
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By applying the net tax savings to our original investment, we lower our net cost basis from $1 million to $710,000. So, upon the return of the initial $1 million gross investment, we've actually earned a net profit of $290,000 or 41%. And since the IRS still considers our investment to be $1 million, our first $290,000 in earnings is 100% tax-free.
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