July 17, 2014
Oil and Gas Tax Issues in the Tax Reform Act of 2014 and the
President’s FY2015 Budget Proposal
Overview and Current Law
Last-In, First-Out (LIFO) Inventory Accounting Methods.
Energy-Specific Tax Expenditures. The Joint Committee
LIFO allows taxpayers to assume that the last item that
on Taxation (JCT) and the Department of the Treasury have
entered inventory is the first sold. A higher value of cost of
identified a number of “tax expenditure” provisions that
goods sold reduces taxable income.
benefit the oil and gas sector.
Other Tax Issues. In addition to being able to claim certain
Percentage Depletion. Independent producers can recover
tax expenditures, the oil and gas sector is subject to special
costs using percentage depletion instead of cost depletion.
excise taxes. An 8-cent per barrel tax is currently used to
The deduction is generally 15% of gross income, but can be
finance the Oil Spill Liability Trust Fund (OSLTF). This
up to 25% for marginal wells. The deduction is subject to
tax is set to increase to 9-cents per barrel after 2016, before
income and production limitations.
expiring at the end of 2017.
Expensing of Intangible Drilling Costs (IDCs). IDCs
Oil and gas companies that operate overseas would also be
include expenses on items without salvage value (e.g.,
affected by changes in U.S. taxation of multinational
wages, fuel, drilling site preparations). Integrated producers
corporations.
must capitalize and amortize 30% of IDCs over a 5-year
period, while non-integrated producers can fully expense
Proposed Reforms
IDCs.
The Tax Reform Act of 2014 (TRA14) and the President’s
FY2015 Budget both propose to repeal a number of oil and
Amortization of Geological and Geophysical (G&G)
gas related tax provisions, and would make other tax policy
Expenditures. Independent producers can recover G&G
changes that would affect the industry (see Table 1).
expenditures over an accelerated 2-year period (major
integrated producers must use a 7-year amortization period
A broad goal of tax reform is to eliminate various tax
to recover G&G costs).
expenditures and modify other tax code provisions to
generate revenues to allow for reduced tax rates. TRA14
Expensing of Tertiary Injectants. A deduction is allowed for
and the President’s Budget would raise additional revenues
the cost of tertiary injectants.
from the oil and gas sector. These revenues would offset the
cost of reduced statutory tax rates. Another goal of recent
Credit for Production from Marginal Wells. A $3 per barrel
tax reform proposals, including TRA14, is to better align
or $0.50 per thousand cubic feet (Mcf) credit for oil and gas
cost recovery for tax purposes with economic depreciation
produced from marginal wells. The credit is phased-out
to reduce economic distortions.
when oil and gas prices exceed certain thresholds (the credit
has been phased out every year since being enacted).
The Tax Reform Act of 2014 and the President’s
Credit for Enhanced Oil Recovery (EOR). A 15% credit for
FY2015 Budget would eliminate various tax provisions
eligible EOR costs. The credit is phased-out for oil prices
affecting the oil and gas sector in exchange for
above a set threshold.
statutory rate reduction.
Passive Loss Limitation Exception for Working Interests in
Oil and Gas. Exception to passive activity loss rules for
working interests in oil or gas property.
Several oil and gas tax provisions are related to cost
recovery. Both TRA14 and the President’s Budget would
Generally Available Tax Expenditures. The oil and gas
repeal percentage depletion, preventing taxpayers from
sector also benefits from a number of other tax provisions,
recovering more than was invested. Cost depletion, which
where benefits are not restricted to the oil and gas sector.
closer approximates economic depreciation, would be
While there are many of this type of provision, there are a
allowed. The President’s Budget would also repeal
couple that are of particular interest.
expensing of IDCs, expensing of tertiary injectants, and the
2-year amortization period for G&G expenditures. TRA14
Domestic Production Activities Deduction (Section 199).
would not change these cost recovery provisions.
Section 199 provides a deduction for income from domestic
production activities to reduce the effective tax rate for
domestic manufacturers. The deduction is 9% for most
industries, but limited to 6% for the oil and gas sector.
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Oil and Gas Tax Issues in the Tax Reform Act of 2014 and the President’s FY2015 Budget Proposal
Table 1. Tax Reform Proposals Affecting the Oil and Gas Industry
Source: The Tax Reform Act of 2014, the Joint Committee on Taxation, and Department of the Treasury.
Both TRA14 and the President’s Budget would repeal the
sands). The President’s FY2015 Budget also proposes a 1-
credit for EOR and the credit for production from marginal
cent increase in the tax.
wells. These credits are predicted to be phased-out given
current oil price projections. Thus, repeal of these credits
Before 1996, a 9.7-cents per barrel tax on oil was collected
would not generate revenues in the budget window.
for the Hazardous Substance Superfund Trust Fund. The
President’s Budget proposes reinstating the Superfund
LIFO would be repealed in both TRA14 and the President’s
excise tax on crude oil and imported petroleum products.
Budget. Repealing LIFO for corporations could generate
enough revenue to reduce the corporate tax rate by roughly
The President’s Budget also proposes to modify the rules
0.3 percentage points. TRA14 also proposes repealing the
and regulations for “dual capacity taxpayers,” or taxpayers
Section 199 deduction for all industries. Repealing the
that are subject to a foreign levy but also receive a specific
Section 199 deduction for corporations could pay for
economic benefit from the foreign entity. The
approximately 0.7 percentage points in corporate tax rates.
administration believes that, in certain cases, oil and gas
(For estimates on rate reduction that could be paid for by
companies may be claiming foreign tax credits for
eliminating certain tax provisions, see CRS Report
payments that are compensation for specific economic
RL34229, Corporate Tax Reform: Issues for Congress, by
benefits (e.g., access to natural resources). TRA14 would
Jane G. Gravelle.) The President’s Budget would only
also change how multinational oil and gas companies are
repeal Section 199 for fossil fuels (oil, gas, and coal),
taxed, as part of a general shift towards a “territorial” tax
leaving the deduction in place for other industries.
system. Part of this reform would include changes to the
foreign tax credit system. TRA14, however, does not make
TRA14 and the President’s Budget would both extend the
changes that specifically target dual capacity taxpayers.
oil spill liability trust fund (OSLTF) excise tax beyond
2017. Both also propose modifying the definition of crude
Molly F. Sherlock, Specialist in Public Finance
oil to include other sources of crudes (e.g., oil from tar
IF10206
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Oil and Gas Tax Issues in the Tax Reform Act of 2014 and the President’s FY2015 Budget Proposal
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