Tax Module Upload1 Flashcards
Includes ownership of both surface and minerals below (and limited air above)
A Fee Simple Interest
Used to describe all right to oil and gas (and solid minerals) in the ground
A Mineral Interest
A non-operating interest retained by the assignor; entitled to specific portion of production
A Royalty Interest
In-Kind
Actual Production
In-Value
Proceeds from the sale of production
An interest that is free of any burder for exploation, development or production costs
Royalty Interest
An interest received by the assignee; burdened by costs for exploration and development
Working Interest
Non-operating interest retained by the working interest owner who assigns his obligation for development costs
Farmout
The WI owner exchanges a right to proceeds of production for cash or other consideration
Carve Out
Interest in which the life is limited to the life of te working intrerest in which it derived
Overriding Royalty Interest
Entitles the owner to a specified amount of proceeds of production as measure by net profic on the lease
Net Profits Interest
An interest that carries no burden of costs, but receives no money if the lease operates at a loss
Net Profits Interest
Entitles the holder to production for 1)specified time limit, 2)specified production, 3)specified money received
Production Payment
In order to deduct depletion, the interest must be an
Economic Interest
For an interest to be economic, it must represent
A capital interest in the minerals in place
For an interest to be economic, it must provide the right
To share in the minerals produced
For an interest to be economic, the owner must look only to
Proceeds from the sale for a return of capital
For an interest to be economic, the interest must exist
In some form of a legal relationship
A royalty interest is what type of interest
Economic Interest
A working interest is what type of interest
Economic Interest
An ORRI is what type of interest
Economic Interest
A NPI is what type of interest
Economic Interest
A production payment is only an economic interest when
Proceeds are pledged to the development of the property
A production payment is only an economic interest when
Production payment is retained by the lessor (landowner) as a part of the leasing transaction
Cornerstone of US oil and gas taxation
Unit-of-property concept
IRS Definition of Property
Each separated interst owned by the taxpayer in each mineral deposit in each separate tract or parcel of land
Each type of interest (working, royalty, ORRI, NPI, and production payments are treated as
Separate property
The exception to interests being treated as separate property is when acquisition consists of
The same type of interest from the same assignor, in contiguous tracts of land
If a taxpayer aquires more than one operating interest in a single tract, he must
Combine the interest and treat as a single property
If a taxpayer aquires more than one non-operating interest, he may
Only combine them with the permission of the IRS
What two interests can never be combined
Operating and non-operating
Separate oparting interest participating in pooling and unitization are treated as
Oen property for the period of the participation
Depletion is calculation on a
Property by property basis
Intangible drilling costs are calculated on a
Property by property basis
Geological and geophysical costs are accounted for on a
Property by property basis
Gain and loss on disposition are calculated on a
Property by property basis
Sale or exchange could constitute a
Capital Gain
A lease bonus or delay rental is what type of income
Orindary
A sharing arrangement is generally not a
Taxable event
Classifications of assignments of interest depend on
Type of consideration (payment) and interest transferred or retained
A transaction in which cash or its equivalent is received and cas is not pledged for development of property
Sale or exchange
When an owner of any type of interest assigns all of that interest
Sale or exchange
When an owner of any type of interest assigns and retains the exact same interest
Sale or exchange
If Sam sells his WI to Jane for cash, he has made a
Sale or exchange
If Sam sells 50% of his WI to Jane for cash but keeps the other 50% and same uses the cash to buy a new car, he has made a
Sale or exchange
Bill sells his royalty interest to JD minerals for cash, he has made a
Sale or exchange
If the WI owner carves out an NPI or ORRI to Jill for cash, he has made a
Sale or exchange
If the WI owner carves out a production payment to Jill for cash, he has made a
Loan (entered into a loan agreement)
An owner of an operating right assigns all or part of those rights and retains a continuous non-operating interest
Lease or sublease
For a lease or a sublease, income is recognized when
Cash is received
The assignment of any type of interest that is NOT a working interest is not a
Lease or sublease
Only the assignment of a working interest can be a
Lease or sublease
An interest defined as when the principle consideration for an assignment is the assumption of burden to develop
Sharing arrangement
If Same assigns Jane 50% of his WI in exchange for cas to be used exclusively for development, he has made a
Sharing arrangement
A farmout is a type of
Sharing arrangement
Does a sharing arrangement create a gain or a loss
No
A farmee must capitalize as leasehold cost
That portion of IDC and equipment costs applicable to the portion of the working interest that is retained by the farmor.
A type of sharing arrangement where the operator will pay a disproportionate share of the development expense
Carried Interest
The carrying party in the carried interest sharing arrangement is entitled to
All income and deductions applicable to its working interest prior to payout
What act promulgated the Uniform Capitalization Rules
Tax Reform Act of 1986
What governs the capitalization of producing, acquiring and holding property
Uniform Capitalization Rules
The UCR applied to both direct and indirect costs allocable to
Real and tangible personal property
The UCR regulations do specifically exclude what costs from UCR
Intangible drilling, exploration and development costs
Costs for geologists, aerial photography, surface and subsurface mapping, loggin, core holes, and surveys are
Geological and Geophysical costs
Geological and geophysical costs that lead to an acquisition are
Capitalized as apart of the property
Geological and geophysical costs that do not lead to an acquisition are
Deducted in the year of the abandonment of the acquisition project
All costs related to project area costs are
Capitalized in the project area
When areas of interests are indentified, project area costs are
Allocated equally to each specific Area of Interest
When leases are acquired, area of interest costs are
Allocated to the leases baed on acreage
If only one lease is acquired, all costs must be
Allocated to the one lease acquired
IF no leases are acquired for the area of interest, G&G costs may be
Deducted in the year the efforts in that area of interest are abandoned
A payment for the privilege of deferring development of a property is called a
Delay rental
A delay rental is usually expressed as a
Fixed sum per acre
A delay rental is usually paid
Yearly for the primary lease term
The IRS treats delay rental as
Rent income
The IRS claims that delay rentals should be
Capitalized as pre-production costs
A payment made from the lessor to the lessee in consideration for granting the lease
Lease bonus
A lease bonus is usually expressed as a
Fixed sum per acre
A lease bonus is usually paid in
Lump sum or installments
For income tax purposes, lease bonuses are regarded as
Advanced royalties
Cost of equipment ordinarily consiered to have salvage value
Tangible drilling costs
Tangible drilling costs must be
Capitalized and depreciated
Tools, surface and production casing, well head equipment, tanks, pump, seperators are considered
Tangible drilling costs
The costs of casing is considered tangible drilling costs even though
The casing is cemented in place and is not recoverable (no salvage value)
Expenditures incident to and necessary for the drilling of wells and their preparation for production are considered
Intangible drilling costs
Wages, fuel, and supplies are what type of costs
Intangible drilling costs
Costs to prepare a site for drilling including ground clearing, drainage, road building, surveying, and geological work are
Intangible drilling costs
The costs to construct physical facilities nescarry to drill and prepare the well for production are considered
Intangible drilling costs
The costs of labor involved to install “salvageable” items required to complete a well are treated as
Intangible drilling costs
Taxpayers must make a one-time binding election to
Capitalize or expense IDC
The choice to capitalize or expense IDC is at the entity level and is made only once when the taxpayer
Drills its first well
If the election is to capitalize IDC, costs are depleted over
The life of the reserves
Foreign IDC must be capitalized and amortized either through
Depletion or straight -line (SL) 10yr life
Foreign IDC does not have the option to
Elect to capitalize or expense IDC
If the election is to deduct (or expense) IDC, each succeeding year, an election is made to
Either capitalize or deduct any ratio of IDC in that year
If the option is to capitalized a portion of the IDC, it must be amortized
Straight-line over 5 years (60mths)
A type of service well that puts water or gas back into a producing formation to aid in receovery is
Injection well
A type of service well that provides water to the drilling site is
Water well
A type of service well that is drilled to diposed of production water, handles, water produced after completion is a
Salt Water Disposal well
A type of service well drilled to obtain water or carbon dioxide used for seconary or tertiary recovery
Supply well
What two types of services wells are considered incident to the drilling of an oil and gas well
Injection well and Water Wells
Wells that are considered incident to the drilling of an oil and gas well that have no salvage value are
Allowed IDC treatment if they were drilled for the production of oil and gas
What two types of services wells are not considered incident to the drilling of an oil an gas well
Salt Water Disposal well and supply well
Wells that are not considered incident to the drilling of an oil and gas well are
Not allowed IDC treatment
Services wells that must be capitalized and depreciated are
Salt Water Disposal Wells and Supply Wells
For depletion purposes, regulation require a portion of “general and financial overhead” to be
Capitalized (including in the cost of producing properties)
Trada association dues, some interest expense, salaries of officers, general office expenses, legal expenses are
Expenses to be considered a general and finacial overhead for capitalization
Overhead must be allocated
Among properties
The adjusted basis of those interests in oil and gas properties that have become totally worthless during the taxable year
Abandonment Costs
Abandonment costs can be deducted only if they meat the following two requirements
Loss must be evidenced by a close and complete transaction and loss must be fixed by an identifiable event
An identifiable event that can suffice to deduct abandoment costs include
Failure of leases to pay rent and letting the lease lapse
An identifiable event that can suffice to deduct abandoment costs include
A report showing that oil and gas in the formation is exhausted
An identifiable event that can suffice to deduct abandoment costs include
A report that shows there is no oil and gas in the formation
The formula for units of production depreciation is
Minerals sold over minerals est. recoverable at BOY times remaining basis in depreciable property
If 15,200 units were sold during the year, 643k units were recoverable BOY, and $123k of depreciable basis
2907.62
The deduction allowed for the extraction of minerals is called
Depletion
The depletion deduction allows for a tax-free return of
Capital consumed in the production of income
In order for the taxpayer to be entitled the depletion deduction, he must meet the following requirement
Economic interest, investment in a natural deposit, exhaustiable amount of minerals, actully or constructive sold
The formula for units of production depletion is
Minerals sold over minerals est. recoverable at BOY times remaining basis in depreciable property
The estimated recoverable reserves in the depletion computation includes
Proved, probable, and prospective reserves
Each year, the depletable basis is
Decreased by the previous years depletion
If both oil and gas are produced from the property, depletion is calculated on the
Major product and units of the lesser products are converted
Barrel of Oil Equivalent eqauls
6mcfs = 1bbl of oil
For tax purposes, both percentage and cost depletion are calucated each year and the correct deduction is the
Larger of the two
Percentage depletion is available to
Independent oil producers and royalty owners
Percentage depletion is not available to
Integrated oil companies
What are integrated oil companies
Producers with retail and/or refining opportunities
What type of depletion is only available to domestic oil and gas wells
Percentage depletion
The depletion deduction is not limited to
Depleteable basis
A taxpayer can deduct percentage depletion as long as a well
Produces
The percentage depletion rate is what percentage of gross income for the property
15%
The percentage depletion rate is limited to
100% of the taxable income from the property
The percentage depletion rate is limieted to 65% of
The taxpayers total taxable income
The percentage depletion deduction is limited to properties with sales of less than
1,000 BOE per day
A well is considered a marginal or “stripper” well if it produces
Less than 15bbls per day
A well is considered a marginal or “stripper” well the crude oil weighs
20 API or less (heavy)
Marginal or stripper wlls can receive one percentage point of additional depletion for every dollar the price is below $20 up to
25% of gross income from the property
When oil and gas property is disposed of at a gain, IDC or depletion previously deducted may need to be recapture as
Orindary income
Properties placed in service before 1987 are subject to the recapture of ordinary income as the lesser of
IDC previously deducted or the gain realized
Properties placed in service after 1986 are subject to the recapture of ordinary income as the lesser of
The IDC and depletion (but not % depletion in excess of the property’s basis) or the gain realized
When a gain is recognized on the dipsotion of real or personal property for which depreciation has been deducted
Part or all of the deduction must be recaptured as ordinary income
The amount of recapture for depreciation deductions is the lesser of
Prior depreciation subjec tto recapture or the gain realized
All depreciation deductions claimed for what type of property are subject to recapture
Personal Property
For corporations, real property that is subject to recapture is limited to the difference between
Straight-line and accelerated depreciation (straight-line depreciation is not subject to recapture)
For individuals, real property that is subject to recpature is taxed at
25% (computed similarly to personal property recapture)
The law provides that Alternative Minimum Tax will be computed by
Adding or subtracting adjustments and preference items to or from regular taxable income
The Alternative Minimum Tax is the
Excess liablity over regular taxable amount
The AMT tax rate only has two brackets at what percentage
26% and 28%
The AMT tax rate is only assessed on AMT over the
Exemption amount
How much credit is allowed for certain tertiary oil recovery projects
15%
In order for the project to receive the enhanced oil recovery credit it must be reasonable expected to
Significantly increase the amount of crude oil recovered
In order for the project to receive the enhanced oil recovery credit it must be located in
The United States
In order for the project to receive the enhanced oil recovery credit the first inject must occur
In 1991 or later
In order for the project ot receive the enhanced oil recovery credit the project must be
Certified by a petroleum engineer
Costs that qualify for the enhanced oil recovery credit are
Tangible property, IDC, and tertiary injectant expenses
The deductions for the enhanced oil recovery costs are reduced by the amount of the
Credit
A nonrefundable credit called a Nonconventional Fuels Credit is allowed for the production and sale of
Energy from alternative sources
The Nonconventional Fuels Credit is how much for each equivalent barrel of fuel sold during the year
$3 (adjusted for inflation)
Oil from shale and tar sands is
Eligible for the Nonconventional Fuel Credit
Gas from geo-pressired brine, Devonian shale, coals seams, and tight formations are
Eligible for the Nonconventional Fuel Credit
Gas from biomass is
Eligible for the Nonconventional Fuel Credit
Synthetic fuels produces from coal is
Eligible for the Nonconventional Fuel Credit
The credit for tight formation gas is always
$3 not adjusted for inflation
The requirements to qualify for the Nonconventional Fuel Credit
US production and production sold to an unrelated person
When both the foreign country and the US are assessing income taxes, the US allows
A credit for the foreign taxes paid to avoid double taxation
Each year the taxpayer can chose to treat qualifying foreign taxes as
A deduction or as a credit against US tax
Sometimes what is called an income tax in a foeign country is actually
A payment for goods, services, or a right to extract minerals
Sometimes what is called an income tax in a foeign country is actually
A royalty to a foreign government
The At Risk Provision prohibits the deduction of a loss in the activity of oil and gas exploration if
The loss exceeds the total amount the taxpayer has at risk in the activity
The amount At Risk (as used in the At Risk Provision) is the sum of
Cash and adjusted tax basis of the property contributed to the activity and personal indebiteness related to the activity
The conduct of any trade or business in which the taxpayer does not materially participate throughout the year is called a
Passive Activity
What does “materially participate throughout the year” mean in regards to passive activities
Involved in the business in a regular and continuous basis
Passive losses can only be offset against
Other passive losses
Unused passive losses can be
Carried forward indefinitely
Unused passive losses can be dedcuted
In full on dispostion of the entire interest in the activity
The income of loss for limited partners is considered
Passive Activity
Passive losses from working interest activities cannot be offset against
Income from thosse non-operating interest (royalties)
Income from non-opearting intersts are treated as
Portfolio income
IRS Code Subchapter K governs
The taxation of partnerships
Taxpayers who are particpants in joint venture or other unincorporated organizations may
Elect to be excluded from partnership treatment
In order for a taxpayer for be excluded from partnership treatment the organization must be created for
Investment purposes only and for joint production, extraction, or use of property but not for selling production
In order for participants in oil and gas joint ventures to qualify for the Subchapter Kelection they must own the property as
Co-owners
In order for participants in oil and gas joint ventures to qualify for the Subchapter Kelection they must have the right to
Separately take production in-kind of dispose of their share of oil and gas produced
In order for participants in oil and gas joint ventures to qualify for the Subchapter K election they may not
Jointly sell the oil and gas extract. Each participant has the right to chose.
In order to make the election to be excluded from parntership treatment, the taxpayer must
Attached a statement to partnership return in the first year of operations
In the absence of an election, it is deemed to have been made if it can be
Shown from facts and circumstances that is was the intent of the members to be excluded
In order for the exclusion for partnership treatment to granted, all participants
Must agree to be excluded
There is no need to file a partnership return if the participant
Has elected to be excluded from Subchapter K
Working interest owners can elect different tax treatments on their own separate return if
The owner has elected to be excluded from Subchapter K
In circumstances where owners might want to make special allocations of income and expense, the owner would
Want to be treated as a Subchapter K partnership
Gas balancing in which each producer recognizes gross income based on his total sales from the property, including any takes
Cumulative Gas Balancing
The type of gas balancing required by the IRS unless special persmisison is received is
Cumulative Gas Balancing
Gas balancing in which each producer accounts for sales based on their respective ownership rights under the JOE is
Annual Gas Balancing
In cumulative gas balancing, the overproducer reports income from their share of production plus
Any sales of gas from other working interest
In cumulative gas balancing, a deduction is allowed
When a balancing payment is made to an underproducer
In cumualtive gas balancing, an underproducer
Reports any payments as income
In annual gas balancing, inbalancing must be eliminated
Annually through a balancing payment
The following interests are what type of interests: Royalty, working , ORRI, and NPI
Economic Interests
Economic interests may claim
Depletion
What is the only type of interest allowed for the deduction of depletion
Economic interest
For tax purposes, the term leasehold reflects the cost of acquisition that must be
Capitalized
Purchase price, lease bonus, finders fees, commissions, legal fees, delay rentals, and G&G costs
Leasehold costs
A taxpayer claims a half of a year’s depreciation for the first taxable year regardless of when then property was actually put into service
Half-year convention amortizaiton
For tax years beginning before August 8, 2005, G&G costs are
Capitalized if they lead to an acquistion or otherwise deducted in the year occurred
IRC SEC 167 came into affect
after August 8, 2005
Tax years after August 8, 2005, amortize G&G costs over
24 months using half year convention
Costs paid or incurred after May 17, 2006 and before December 20, 2007 by a “major integrated oil company”
Are amortized over 5 years
Costs paid or incurred after December 19, 2007 and before December 20, 2007 by a “major integrated oil company”
Are amortized over 7 years
A “major integrated oil company” is not eligible for
Percentage depletion
A “major integrated oil company” produces more than
500,000bbls of crude oil per day
A “major integrated oil company” has more than ________________ in gross receipts for the taxable year ending in 2005
$1billion
IDC for tax purposes includes only costs incurred in drilling and competion to the point of placing
Valves on the wellhead (christmas tree) to control production
Labor to install flow lines, separators, and storage tanks are
Not IDC
Labor to install flow lines, separators, and storage tanks are
Capitalized with the cost of equipment
Rig removal costs and location restoration, even though incurred after the christmas tree is placed on is
Still counted as IDC
A taxpayer may elect to ______________ OR ___________________ IDC
Capitalized or deduct
The election to capitalized or deduct IDC must be
Made in the first year IDC is incurred
The act of ______________ expenses in the first year counts as an election, but most taypayers attach a statement to return
Deducting
The election to _____________ is usually binding to all subsequent years
Capitalize
Failing to deduct IDC is an election to
Capitalize
Expenditures not related to drilling but connected to the installation of tangible equipment are allocated to the
Equipment account
Expenditures not related to drilling but connected to the installation of tangible equipment are recovered through
Depreciation
If the 1st year election is to deduct IDC currently, the taxpayer makes a subsequent annual election to
Capitalize oany or all of the IDC incurred in that year
The part of the IDC that is allocated to be capitlalized is amoritized over __ months beginning in the month the costs were incurred
60 months
Integrated oil and gas companies that have elected to deduct IDC may deduct only ______ % at the time IDC is incurreced
70%
The remaining 30% not allowed to be deducted by integrated oil companies must be
Capitalized and amorized over 60 months beginning in the month incurred
How many months must the remaining 30% of the IDC not allowed to be decucted by integrated oil companies be amoritized
60 months
The government ruling describing items NOT included in IDC
Treas. Reg. Sec 1.612-4
According to Treas. Reg. Sec 1.612-4, capitals items not included in IDC is property that is considered to have
Salvage value
According to Treas. Reg. Sec 1.612-4, capitals items not included in IDC is actual materials used in the
Construction of a well and on the property
According to Treas. Reg. Sec 1.612-4, capitals items not included in IDC is costs of
Drilling tools, pipe, casing, tubing, tanks, engines, boilers
According to Treas. Reg. Sec 1.612-4, capitals items not included in IDC is any costs not
Used in the processes of drilling and completing a well such as structures used in the construction of storage or treatment facilities
Rev. Ruling 70-414 futher explains the items that are
Excluded from IDC
According to Rev. Ruling 70-414, expenditure incurred in installing production facilities are
Excluded from IDC
A well is considered completed when casing, including the ___________, has been installed
Chrtistmas Tree
Treas. Reg. 1.612-4c defines the cost of items that are not
IDC
The development costs (drilling, testing) accociated with a dry hole should be
Deducted as dry hole costs
Leasehold costs associated with a dry hole may be deductible depending on if the lease is found to be
Worthless
Tax law governs that tangible drilling costs are the cost of equipment plus the physical cost of
Installation
Tangible equipment costs are capitalized and recovered via IRS guidelines using a useful life of
7 years
The Safe Harbor Election allows the taxpayer to
estimate probable or prospective reserves
Once the Safe Harbor is elected, the company’s estimate of total recoverable units is equial
105% of proved reserves
The Safe Harbor Electionis ___________________ in the first year
Non-revocable
What is another name for percentage depletion
Statutory
Allowable depletion is the _____________ of either cost or percentage depletion
Higher
Independent oil producers and royalty owners are limited to a depletion deduction of only
65% of total (taxpayer) income
The excess of 65% of total taxpayer income for the depletion deduction can
Be carried forward indefinitely
Independent oil producers and royalty owners are limited to _____________ BOE per day
1,000
Percentage depletion is not available to
Integrated oil companies
Once the cost basis is zero, ____________ depletion is no longer available
Cost
What type of depletion continues as long as the property produces
Percentage depletion
