These tax benefits may enhance the economics of an oil and gas investment. With the passage of the Tax Reform Act of 1986 (the “Act”), oil and gas ventures remain one of the few tax-advantaged investments. The Act specifically exempts oil and gas Working Interest from being classified as “Passive Income.” The existence of tax advantages does not reduce the risks associated with oil and gas. In an oil and gas drilling project, a large portion of the investment is considered “Intangible Drilling Cost” (IDC), which may be 100% deductible during the year paid. The amount of tax deduction for IDC will vary depending on the nature of the drilling project. The total amount of the investment allocated to equipment, “Tangible Drilling Development and Completion Cost” (TDC) may be amortized and depreciated over 5-7 years.

 The 1990 Tax Act (the “1990 Act”) provided tax advantages for the typical investor in oil and gas drilling projects. This “Small Producers Exemption” allows 15% of any investor’s Net Income from an oil and gas property to be TAX FREE. The tax benefit is not available to large companies or taxpayers who sell oil or natural gas through retail outlets or those who engage in refining crude oil with runs of more than 50,000 barrels per day. It is also not available to investors owning more than 1,000 barrels of oil or 6,000,000 cubic feet of gas average daily production. The Joint Venture’s drilling operations will qualify for “Percentage Depletion” tax benefits. Each investor’s annual tax return should claim “Small Producers Exemption” if applicable.

The Tax Reform Act of 1986 introduced the concept of “Passive” income and “Active” income. The Act prohibits the offsetting of losses (Passive activities) against income from Active businesses. The Act provides that a Working Interest in an oil and gas drilling program is not a “Passive” activity, so accordingly, deductions
can be offset against income from business income, salaries, etc.