Tax Advantages of Oil and Gas Investment

Investments in oil and gas offer important tax deductions. Although everyone is required to pay income taxes to help finance our government. The government provides tax deductions for situations that contribute to the general welfare of the country. You may have heard that oil and gas work interest drilling programs can help lower your tax bill. It’s true, so let’s analyze this further. What you will learn here is an introduction to the tax benefits provided by oil and gas operator interest drilling programs. After reading it, you should have a basic understanding of these deductions that can lower your tax bill. In this below article we will discuss about tax advantages of oil and gas investment.


The tax code states that a working interest (other than a royalty interest) in an oil and gas well is not considered a passive activity. This means that all net losses incurred in connection with wellhead production are active income and can be offset against other forms of income. Such as wages, interest and capital gains.


The IRS also provides a 15 percent depletion allowance against production revenue to allow for depletion of oil and gas reserves in a well. The Tax Act of 1990 allows certain entities to exempt 15 percent of their gross receipts from federal taxes to help smaller oil companies and direct investors.


The Energy Policy Law of 1992 repeals the priority items ATM, percentage consumption and IDC, for independent producers and royalty owners, not for integrated oil companies. All additional intangible drilling costs were specifically exempted as a “preferred item” on the Alternative Minimum Tax (AMT) return. The AMT was established to ensure that taxpayers pay a minimum amount or their “fair share” of taxes by recalculating income tax due, refunding specific deductions, or preferential tax items.

Great Investment with Great Tax Exemptions

When it comes to tax-advantaged investments for wealthy or sophisticated investors. One commodity continues to stand out above all others: oil. Backed by the US government, domestic energy production has created a litany of tax incentives for investors and small producers alike, and oil is no exception.

Investment Options in Oil and Gas

There are several different avenues available to oil and gas investors. These can be divided into four broad categories: mutual funds, partnerships, royalty interests, and work interests. Each has a different level of risk and different tax rules.

Investment funds

In the mutual fund method of investing. There is the least amount of risk for the investor since mutual funds invest in a basket of securities. However, investing in mutual funds does not provide any of the tax benefits listed above. Investors will pay taxes on all dividends and capital gains, just as they would other funds.


Different types of companies can be used for oil and gas investments. Limited partnerships are the most common, as they limit liability for the entire production project to the amount of the partner’s investment. These are sold as securities and must be registered with the Securities and Exchange Commission (SEC). The tax incentives listed above are available on a pass-through basis. The partner will receive a Form K-1 each year detailing their share of income and expenses.


Royalties are the compensation received by the owners of the land where oil and gas wells are drilled. Royalty income comes “on top” of the gross income generated by the wells. Owners typically receive between 12 percent and 20 percent of gross production. Of course, owning land with oil and gas reserves can be extremely profitable. In addition, the landowners do not assume any liability related to the leases or the wells. However landowners are also not eligible for any of the tax benefits enjoyed by those who own work or partnership interests. All royalty income is reported on Schedule E of Form 1040.

An investment in energy with tax advantages

Oil and natural gas from national reserves help make our country more energy self-sufficient by reducing our dependence on foreign imports. In light of this, Congress has provided tax incentives to encourage privately funded domestic oil and natural gas production. There are many tax benefits associated with drilling projects and these benefits can contribute significantly to the economy. No “loop holes”; these incentives. Congress inserted them into the Tax Code to make participation in oil and Gas Company’s one of the best tax-advantaged investments available to accredited investors seeking tax relief.

Tax Deduction of the Cost of Intangible Drilling

The intangible expenses of drilling (labor, chemicals, mud, grease, etc) are usually around (65 to 80 percent) of the cost of a well. These expenses are considered “Intangible Drilling Cost (IDC)”, which is 100 percent deductible during the first year. For example, a $100,000 investment could earn up to $80,000 in IDC tax deductions in the first year of business. These deductions are available in the year the money is invested. Even if the well doesn’t start drilling until March 31 of the year following the capital contribution.

Tax Exemption for Small Producers

The 1990 Tax Law provided for a number of special tax benefits for small businesses and individuals. This tax incentive, known as the “Depletion Percent Allowance,” is specifically intended to encourage participation in oil and gas drilling. This tax benefit is not available to major oil companies, retail oil traders, or refineries that process more than 50,000 barrels per day. It is also not available for entities with more than 1,000 barrels of oil (or 6,000,000 cubic feet of gas) in average daily production. The “Small Producers Exemption” allows 15 percent of gross receipts (not net receipts) from oil and gas producing properties to be exempt from tax.

Lease expenses

Lease costs (lease purchase, minerals, etc.), selling expenses, legal costs, management accounting. And lease operating costs (LOC) are also 100 percent tax deductible through depletion of cost.

Before you go, I hope that the above article related to tax advantages of oil and gas investment will be helpful and informational for you.

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