The alternative minimum tax (AMT), even with 1990 relief measures, has become a cost that cuts capital available for U.S. oil and gas exploration and development.
That's the conclusion of accounting firm Coopers & Lybrand.
"It's entirely possible for a driller to show a net loss for the year and still have to pay the AMT because he incurred deductible expenses drilling an oil well, " said John Swords, Dallas, Coopers & Lybrand director of energy taxation.
HOW IT WORKS
When an independent producer sets a drilling budget for the year, the amount of money available is reduced by the amount of AMT payable, Swords pointed out.
Swords outlined the case of a hypothetical independent with 1991 oil income of $400,000 lease operating expenses of $350,000, interest income of $100,000, and itemized deductions of $60,000. If that producer's oil property status is not marginal - in that its wells produced more than 15 b/d - it has $50,000 income before depletion and a 50% depletion allowance, leaving net income from oil operations for 1991 at $25,000. In calculating the producer's regular income tax Swords estimated the hypothetical company's taxable income at $59,631 and regular tax liability at $12,277.
However, in calculating AMT, the $25,000 depletion deduction becomes a preference item considered as taxable income under AMT. Under AMT, the producer's tentative minimum tax is $16,376,
Assume the producer has the same amount of production from at least 10 wells, putting them into marginal oil property status. The producer then qualifies for the special energy deduction Congress passed in 1990, Swords said. Consequently, the special deduction cuts the depletion preference by 50%, putting the preference amount at $12,500, below the deduction limit and reducing additional AMT liability to $1,099.
AMT DESPITE A LOSS
Swords cites the example of a nonmarginal development well drilled and completed at yearend but not producing in 1991. 1
He said, "Because the oil producer spent $100,000 and had other oil and gas income of $25,000, we find his net oil and . gas income is a $75,000 loss. However, under AMT, since intangible drilling costs become a preference item, he now finds that his preference amount is $96,187, compared with a preference amount of $25,000 if he had not drilled the well.
"With that size of a preference, the oil producer finds that he owes," $9,885 in AMT even though he showed a net tax loss for the yen. In effect, he had an additional cost of almost $10,000 for deciding drill his well.
If the hypothetical producer's properties: are deemed marginal, AMT liability falls to $6,885. If the property qualifies as exploratory, AMT liability falls to $3,900,
"What these scenarios that anytime an independent drills a well and thus experiences deductions for IDC those deductions turn into preference items which tax must be paid," Swords said. "The exception is if to is a dry hole. But otherwise, the AMT becomes just another expense against the drilling budget. "While the special energy deduction provided in the 1990 Tax Act is somewhat helpful, the complexity involved in determining to what extent it is beneficial almost precludes a consideration of any benefit during the year, when the drilling decisions are being made."
Copyright 1992 Oil & Gas Journal. All Rights Reserved.
