Oil and Gas Tax Preferences

Oil and Gas Tax Preferences

Updated April 16, 2021
Oil and Gas Tax Preferences
The tax code contains a number of provisions that benefit
Expensing of Intangible Drilling Costs (IDCs): IDCs
the oil and gas sector. Some contend that these provisions
include expenses on items without salvage value (e.g.,
should be eliminated, arguing that using energy derived
wages, fuel, and drilling site preparations). Integrated
from oil and gas resources is inconsistent with
producers (producers who also have substantial refining or
environmental objectives. Others view these provisions as
retail activities) must capitalize 30% of IDCs and then
helping a sector that is vital to the U.S. and world economy.
recover those costs over a five-year period. The remaining
Certain provisions are designed such that they only become
70% of IDCs can be fully expensed (costs deducted in the
available when oil prices are low, providing relief when
year they are incurred). Nonintegrated producers can fully
market conditions are less favorable.
expense IDCs.
This In Focus (1) describes tax preferences for oil and gas;
Two-Year Amortization of Geological & Geophysical
(2) provides information on foregone revenue associated
(G&G) Expenditures: G&G expenditures are costs
with these tax preferences (“tax expenditures”); and (3)
associated with determining the location and potential size
discusses broader tax policy issues of importance to the oil
of a mineral deposit. Generally, these costs are viewed as
and gas sector.
capital costs, and as such would be recovered over the same
time frame as other capital costs. Most producers amortize
Oil and Gas Tax Preferences
G&G expenditures over two years. Major integrated oil
Several features of the income tax system reduce the tax
companies amortize G&G expenditures over seven years. A
liability of oil and gas companies. Special tax provisions
major integrated oil company, as defined in statute, has (1)
include exclusions, deductions, credits, deferrals, or
average daily worldwide production of crude oil of at least
preferential tax rates that reduce a taxpayer’s tax liability.
500,000 barrels; (2) gross receipts in excess of $1 billion in
Tax preferences for oil and gas reduce the after-tax cost of
its tax year ending during 2005; and (3) has at least 15%
investing in oil and gas exploration and production,
ownership interest in a crude oil refinery.
encouraging additional investment in this sector relative to
other economic sectors.
Expensing of Tertiary Injectants: Tertiary injectants are
gases or fluids used as part of a tertiary recovery method to
Percentage Depletion: Depletion deductions allow
increase crude oil production. Tertiary recovery methods
taxpayers to recoup the value of capital investments in
allow for continued production from wells nearing the end
mineral property. For exhaustible resources of extractive
of their production lives. Taxpayers can deduct tertiary
industries, depletion cost recovery allows taxpayers to take
injectant expenses, other than expenses for recoverable
deductions as the resource is extracted and sold. Cost
hydrocarbon injectants, in the year costs are incurred.
depletion is cost recovery based on the proportion of total
Expensing (deducting these costs in the year they are
estimated recoverable reserves produced or sold in the year.
incurred) provides a subsidy over standard cost depletion,
Deductions taken for cost depletion cannot exceed the
which might encourage firms to incur additional tertiary
taxpayer’s investment in the resource. Certain independent
injectant expenses.
oil and gas producers (producers who are not retailers or
refiners) may elect to claim percentage depletion as
Credit for Production from Marginal Wells: When oil
opposed to cost depletion. The percentage depletion
and gas prices are below certain thresholds, the marginal
allowance is 15% of gross income from the property, not to
well credit can be claimed for producing oil and gas from
exceed (1) 100% of taxable income from the property, and
marginal wells. The credit amount is $3 per barrel of
(2) 65% of the taxpayer’s taxable income. Oil and gas
qualified crude oil and 50¢ per 1,000 cubic feet of qualified
producers may claim percentage depletion on up to 1,000
natural gas (adjusted for inflation after 2005; $3.90 for oil
barrels of average daily production (or an equivalent
and 65¢ for gas in 2019). A marginal well is one that is a
amount of domestic natural gas). When oil prices are low,
marginal well for the purposes of claiming percentage
the deduction can be up to 25% of gross income for
depletion, or one that has average daily production of no
marginal wells (generally, wells for which average daily
more than 25 barrel-of-oil equivalents and produces at least
production is less than 15 barrels of oil or barrel-of-oil
95% water. The credit starts phasing out if the reference
equivalents or that produce only heavy oil). However, from
price for oil exceeds $15 per barrel or natural gas exceeds
2001 through 2019, percentage depletion for marginal wells
$1.67 per 1,000 cubic feet (mcf) for the preceding year
was limited to 15%. Percentage depletion can result in total
(adjusted for inflation after 2005; $19.52 for oil and $2.17
deductions exceeding the taxpayer’s investment in the well.
for gas in 2019). The credit is fully phased out if the
The ability to claim percentage depletion as opposed to cost
reference price exceeds $18 per barrel or $2.00 per mcf
depletion provides a benefit that is considered a tax
(adjusted for inflation after 2005; $23.43 for oil and $2.60
expenditure.
for gas in 2019). The credit for crude oil has never been
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triggered. In 2016 and 2017, and again in 2019, a partial
$0.6 billion. Expensing of IDCs was estimated to reduce
credit (in the phaseout range) was available for natural gas.
federal tax revenue by $0.5 billion. Over the five-year
Qualified crude oil or natural gas production is limited to
budget window (FY2020 through FY2024), JCT estimates
1,095 barrels or barrel-of-oil equivalents, per well. The
that these provisions will reduce federal income tax revenue
number of wells on which a taxpayer can claim the credit is
by $2.9 billion and $2.3 billion, respectively.
not limited. The marginal well credit can be carried back
for up to five years (as opposed to the one year generally
Table 1. Oil and Gas Tax Expenditures
allowed for other components of the general business
(billions of dollars)
credit).
Provision
FY2020
FY2020-FY2024
Credit for Enhanced Oil Recovery (EOR): When oil
Percentage depletion
0.6
2.9
prices are below a certain threshold, the EOR credit can be
claimed for qualified EOR costs. The credit amount is 15%
Expensing of IDCs
0.5
2.3
of qualified domestic EOR costs. The EOR credit phases
Amortization of G&G
out over a $6 range once oil’s reference price exceeds $28
0.1
0.5
expenditures
per barrel (adjusted for inflation after 1991; $48.54 in
2018). The EOR credit was fully phased out every year
Expensing of tertiary
from 2006 through 2016. Low oil prices led to the EOR
injectants
-i-
-i-
credit becoming available in 2016 and 2017. A partial credit
Marginal wel credit
-i-
-i-
was available for 2018, but it was fully phased out in 2019
and 2020.
EOR credit
-i-
-i-
Passive loss exceptiona
-i-
0.1
Exception from Passive Loss Limitation: Generally,
passive activity loss rules provide that taxpayers cannot
Publicly traded partnership
0.3
1.8
deduct passive losses in excess of their passive activity
Source: Joint Committee on Taxation (JCT), JCX-23-20; and U.S.
income (passive activities are trade or business activities in
Department of the Treasury FY2021 Tax Expenditure estimates.
which the taxpayer does not materially participate). The
Notes: An “-i-” indicates a federal revenue loss of less than $50
exemption from the passive loss limitation allows passive
mil ion. Al tax expenditure estimates are forward looking and do not
activity losses from any working interest in oil or gas
reflect actual foregone revenue associated with the provision. Al tax
property to be deducted against active income.
expenditure estimates are from the JCT, unless noted.
a.
Estimate from the Treasury’s tax expenditure publication;
Corporate Income Tax Exemption for Publicly Traded
estimate is $10 mil ion per year or $50 mil ion over 5 years.
Partnerships (PTPs): PTPs are exempt from the corporate
income tax if 90% of their income is from qualified
Other Tax Provisions Important to the
activities. Instead, PTPs are taxed like partnerships, with
Oil and Gas Industry
the owner’s income passing through and being taxed at the
Many features of the U.S. tax system affect oil and gas
individual level. Unlike partnerships, ownership interests
industry taxpayers, beyond the more targeted tax
are traded on financial markets like corporate stock.
expenditure provisions. As a capital-intensive industry, the
Qualifying income generally includes mining and natural
oil and gas sector benefits from provisions that allow
resource income, and income related to the exploration,
immediate expensing or bonus depreciation. Full expensing
development, mining or production, processing, refining,
(100% bonus depreciation) is in effect through 2022, after
transportation, storage, and marketing of any mineral or
which it begins to phase out (reaching 0% by 2027).
natural resource.
Because the industry often relies on debt to finance
Oil and Gas “Tax Expenditures”
investment, limits on net interest expense deductions might
increase tax burdens for some taxpayers in the industry.
Special features of the income tax system that reduce tax
collections are called “tax expenditures.”
Volatility in oil prices can cause oil and gas companies to
The Joint
experience a net operating loss (NOL). Provisions that relax
Committee on Taxation (JCT) regularly publishes tax
NOL carryback rules or allow NOL carryforwards to be
expenditure estimates—the revenue losses attributable to
more generous can provide tax relief. The ability to use
special income tax provisions. Tax expenditure estimates
last-in, first-out (LIFO) inventory accounting methods can
for provisions that benefit the oil and gas industry are
be beneficial to the oil and gas sector, particularly when oil
summarized in Table 1.
prices are rising. Finally, many oil and gas companies are
multinationals with cross-border operations. Thus, the tax
The two largest oil and gas tax expenditures are the
treatment of foreign-source oil and gas income is important
reductions in federal tax revenue associated with allowing
to U.S. oil and gas companies.
taxpayers to claim percentage as opposed to cost depletion,
and the provision allowing taxpayers to expense certain
exploration and development costs, primarily intangible
Molly F. Sherlock, Specialist in Public Finance
drilling costs (IDCs). For FY2020, the JCT estimated that
IF11528
percentage depletion reduced federal income tax revenue by

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Oil and Gas Tax Preferences

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https://crsreports.congress.gov | IF11528 · VERSION 3 · UPDATED