May 1, 2020
Oil and Gas Tax Preferences
The tax code contains a number of provisions that benefit
depletion provides a benefit that is considered a tax
the oil and gas sector. Some contend that these provisions
expenditure.
should be eliminated, arguing that using energy derived
from oil and gas resources is inconsistent with
Expensing of Intangible Drilling Costs (IDCs): IDCs
environmental objectives. Others view these provisions as
include expenses on items without salvage value (e.g.,
helping a sector that is vital to the U.S. and world economy.
wages, fuel, and drilling site preparations). Integrated
In 2020, oil prices fell to historically low levels. Low oil
producers (producers who also have substantial refining or
prices have the potential to trigger certain oil and gas tax
retail activities) must capitalize 30% of IDCs and then
incentives, as discussed below. Expanding tax incentives
recover those costs over a five-year period. The remaining
for oil and gas is one policy option that could provide relief.
70% of IDCs can be fully expensed (costs deducted in the
year they are incurred). Nonintegrated producers can fully
This In Focus (1) describes tax preferences for oil and gas;
expense IDCs.
(2) provides information on foregone revenue associated
with these tax preferences (“tax expenditures”); and (3)
Two-Year Amortization of Geological & Geophysical
discusses broader tax policy issues of importance to the oil
(G&G) Expenditures: G&G expenditures are costs
and gas sector.
associated with determining the location and potential size
of a mineral deposit. Generally, these costs are viewed as
Oil and Gas Tax Preferences
capital costs, and as such would be recovered over the same
Several features of the income tax system reduce the tax
time frame as other capital costs. Most producers amortize
liability of oil and gas companies. Special tax provisions
G&G expenditures over two years. Major integrated oil
include exclusions, deductions, credits, deferrals, or
companies amortize G&G expenditures over seven years. A
preferential tax rates that reduce a taxpayer’s tax liability.
major integrated oil company, as defined in statute, has (1)
Tax preferences for oil and gas reduce the after-tax cost of
average daily worldwide production of crude oil of at least
investing in oil and gas exploration and production,
500,000 barrels; (2) gross receipts in excess of $1 billion in
encouraging additional investment in this sector relative to
its tax year ending during 2005; and (3) has at least 15%
other economic sectors.
ownership interest in a crude oil refinery.
Percentage Depletion: Depletion deductions allow
Expensing of Tertiary Injectants: Tertiary injectants are
taxpayers to recoup the value of capital investments in
gases or fluids used as part of a tertiary recovery method to
mineral property. For exhaustible resources of extractive
increase crude oil production. Tertiary recovery methods
industries, depletion cost recovery allows taxpayers to take
allow for continued production from wells nearing the end
deductions as the resource is extracted and sold. Cost
of their production lives. Taxpayers can deduct tertiary
depletion is cost recovery based on the proportion of total
injectant expenses, other than expenses for recoverable
estimated recoverable reserves produced or sold in the year.
hydrocarbon injectants, in the year costs are incurred.
Deductions taken for cost depletion cannot exceed the
Expensing (deducting these costs in the year they are
taxpayer’s investment in the resource. Certain independent
incurred) provides a subsidy over standard cost depletion,
oil and gas producers (producers who are not retailers or
which might encourage firms to incur additional tertiary
refiners) may elect to claim percentage depletion as
injectant expenses.
opposed to cost depletion. The percentage depletion
allowance is 15% of gross income from the property, not to
Credit for Production from Marginal Wells: When oil
exceed (1) 100% of taxable income from the property, and
and gas prices are below certain thresholds, the marginal
(2) 65% of the taxpayer’s taxable income. Oil and gas
well credit can be claimed for producing oil and gas from
producers may claim percentage depletion on up to 1,000
marginal wells. The credit amount is $3 per barrel of
barrels of average daily production (or an equivalent
qualified crude oil and 50¢ per 1,000 cubic feet of qualified
amount of domestic natural gas). When oil prices are low,
natural gas (adjusted for inflation after 2005; $3.82 for oil
the deduction can be up to 25% of gross income for
and 64¢ for gas in 2018). A marginal well is one that is a
marginal wells (generally, wells for which average daily
marginal well for the purposes of claiming percentage
production is less than 15 barrels of oil or barrel-of-oil
depletion, or one that has average daily production of no
equivalents or that produce only heavy oil). However, from
more than 25 barrel-of-oil equivalents and produces at least
2001 through 2019, percentage depletion for marginal wells
95% water. The credit starts phasing out if the reference
was limited to 15%. Percentage depletion can result in total
price for oil exceeds $15 per barrel or natural gas exceeds
deductions exceeding the taxpayer’s investment in the well.
$1.67 per 1,000 cubic feet (mcf) for the preceding year
The ability to claim percentage depletion as opposed to cost
(adjusted for inflation after 2005; $19.11 for oil and $2.13
for gas in 2018). The credit is fully phased out if the
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reference price exceeds $18 per barrel or $2.00 per mcf
budget window (FY2019 through FY2023), JCT estimates
(adjusted for inflation after 2005; $22.93 for oil and $2.55
that each provision will reduce federal income tax revenue
for gas in 2018). The credit for crude oil has never been
by $2.4 billion.
triggered. In 2016 and 2017, a partial credit (in the phaseout
range) was available for natural gas. Qualified crude oil or
The JCT’s tax expenditure estimates for the marginal well
natural gas production is limited to 1,095 barrels or barrel-
credit and EOR credit are de minimis, or less than $50
of-oil equivalents, per well. The number of wells on which
million from FY2019 through FY2023. If oil prices remain
a taxpayer can claim the credit is not limited. The marginal
low, the anticipated revenue loss associated with these
well credit can be carried back for up to five years (as
provisions may increase.
opposed to the one year generally allowed for other
components of the general business credit).
Table 1. Oil and Gas Tax Expenditures
(billions of dollars)
Credit for Enhanced Oil Recovery (EOR): When oil
prices are below a certain threshold, the EOR credit can be
Provision
FY2019
FY2019-FY2023
claimed for qualified EOR costs. The credit amount is 15%
Percentage depletion
0.4
2.4
of qualified domestic EOR costs. The EOR credit phases
out over a $6 range once oil’s reference price exceeds $28
Expensing of IDCs
0.5
2.4
per barrel (adjusted for inflation after 1991; $48.54 in
Amortization of G&G
2018). The EOR credit was fully phased out every year
0.1
0.4
expenditures
from 2006 through 2016. Low oil prices led to the EOR
credit becoming available in 2016 and 2017. A partial credit
Expensing of tertiary
-i-
-i-
was available for 2018, but it was fully phased out in 2019.
injectants
Marginal well credit
-i-
-i-
Exception from Passive Loss Limitation: Generally,
passive activity loss rules provide that taxpayers cannot
EOR credit
-i-
-i-
deduct passive losses in excess of their passive activity
Passive loss exceptiona
-i-
0.1
income (passive activities are trade or business activities in
which the taxpayer does not materially participate). The
Publicly traded partnership
0.2
1.7
exemption from the passive loss limitation allows passive
Source: Joint Committee on Taxation (JCT), JCX-55-19; and U.S.
activity losses from any working interest in oil or gas
Department of the Treasury FY2021 Tax Expenditure estimates.
property to be deducted against active income.
Notes: An “-i-“ indicates a federal revenue loss of less than $50
million. All tax expenditure estimates are forward looking and do not
Corporate Income Tax Exemption for Publicly Traded
reflect actual foregone revenue associated with the provision. All tax
Partnerships (PTPs): PTPs are exempt from the corporate
expenditure estimates are from the JCT, unless noted.
income tax if 90% of their income is from qualified
a. Estimate from the Treasury’s tax expenditure publication.
activities. Instead, PTPs are taxed like partnerships, with
the owner’s income passing through and being taxed at the
Other Tax Provisions Important to the
individual level. Unlike partnerships, ownership interests
Oil and Gas Industry
are traded on financial markets like corporate stock.
Many features of the U.S. tax system affect oil and gas
Qualifying income generally includes mining and natural
industry taxpayers, beyond the more targeted tax
resource income, and income related to the exploration,
expenditure provisions. As a capital-intensive industry, the
development, mining or production, processing, refining,
oil and gas sector benefits from provisions that allow
transportation, storage, and marketing of any mineral or
immediate expensing or bonus depreciation. Full expensing
natural resource.
(100% bonus depreciation) is in effect through 2022, after
Oil and Gas “Tax Expenditures”
which it begins to phase out (reaching 0% by 2027).
Because the industry often relies on debt to finance
Special features of the income tax system that reduce tax
collections are called “tax expenditures.”
investment, limits on net interest expense deductions might
The Joint
increase tax burdens for some taxpayers in the industry.
Committee on Taxation (JCT) regularly publishes tax
Low oil prices will likely cause a number of oil and gas
expenditure estimates—the revenue losses attributable to
companies to experience a net operating loss (NOL).
special income tax provisions. Tax expenditure estimates
Provisions that relax NOL carryback rules or allow NOL
for provisions that benefit the oil and gas industry are
carryforwards to be more generous can provide tax relief.
summarized in Table 1.
The ability to use last-in, first-out (LIFO) inventory
accounting methods can be beneficial to the oil and gas
The two largest oil and gas tax expenditures are the
sector, particularly when oil prices are rising. Finally, many
reductions in federal tax revenue associated with allowing
oil and gas companies are multinationals with cross-border
taxpayers to claim percentage as opposed to cost depletion,
operations. Thus, the tax treatment of foreign-source oil and
and the provision allowing taxpayers to expense certain
gas income is important to U.S. oil and gas companies.
exploration and development costs, primarily intangible
drilling costs (IDCs). For FY2019, the JCT estimated that
percentage depletion reduced federal income tax revenue by
Molly F. Sherlock, Specialist in Public Finance
$0.4 billion. Expensing of IDCs was estimated to reduce
Joseph S. Hughes, Research Assistant
federal tax revenue by $0.5 billion. Over the five-year
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Oil and Gas Tax Preferences


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