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How will tax reform affect my oil & gas income?

Since the passage of The Tax Cuts and Jobs Act (H.R. 1 – 115th Congress), clients have asked me about the effect of the new tax law on their oil & gas income. Tax reform contains several provisions of interest from the mineral/royalty owner’s perspective. Most notably, the existing valuable deductions for depletion are left intact and a new limit on state and local taxes will not directly effect oil & gas income. Although I am an attorney, this article is not legal or financial advice. Consult a professional about your particular situation. I aim to provide a basic overview of some provisions of interest to mineral owners for informational purposes only.

Depletion deductions:

The Internal Revenue Code allows a deduction for “depletion” specific to oil & gas income. This deduction was preserved in the new tax reform law. There are two different methods by which royalty owners may calculate depletion: percentage depletion, which is a flat 15% deduction; or cost depletion, which allows a taxpayer to deduct the fraction of the value, or “basis” in the property, equivalent to the proportion of mineral that was depleted by production during the tax year. The taxpayer must take whichever deduction is larger. Percentage depletion would be the larger deduction for many royalty owners because they do not have any basis in their property. However, in some situations, cost depletion could provide a much larger deduction. Click here to learn more about the valuable depletion deductions. 

Limit on state and local tax deductions:

As of the 2018 tax year, deductions for state and local taxes are limited to $10,000. The unfortunate consequence of this change is that if the total of a taxpayer’s property taxes and state income taxes exceed $10,000, then the excess is not deductible. (Texas has no state income tax, unlike some other sates where mineral owners may reside and pay taxes.) However, the limit on state and local tax deductions does not include state and local taxes applicable to oil & gas income because those taxes are considered business expenses. Therefore, even if a taxpayer is unable to deduct the full property taxes on their residence and/or their state income taxes, the taxpayer could still deduct the local property taxes and severance/ad valorem taxes attributable to their oil & gas income.

Conclusion:

The tax reform law is complex and this discussion is only a basic overview of some provisions of interest to mineral owners. There are additional changes included in the new tax law; however, those changes cannot be analyzed until the IRS promulgates the relevant guidance and regulations. Each taxpayer’s circumstances may vary. Contact us for a no-obligation review of your legal issue.

Patrick Flueckiger