Navigating Excess IDC

As an operator of a working interest, I can deduct all of my Intangible Drilling Costs (IDCs) immediately, right? Well… yes, and also, no. The correct answer is “it depends.”

IDCs are deductible when paid, provided the taxpayer has made the proper election in the initial year the taxpayer incurred IDC, and in certain instances when they are prepaid, as long as the taxpayer, who is not an integrated oil company, is not subject to alternative minimum tax (AMT). Excess IDC is a tax preference item and is calculated as the difference between IDCs deducted during the taxable year and the amount that would have been allowed as an amortization deduction in the taxable year if the IDCs were capitalized.  The IDC preference amount is the amount of Excess IDC that is greater than 65% of AMT net income from oil, gas, and geothermal production. The costs would need to be added back to alternative minimum taxable income as a preference item if the taxpayer is subject to alternative minimum tax. This issue can be common in years with high IDCs or low taxable income.

There are, however, a couple of ways to circumvent or ease the burden of excess IDC.

• Because IDCs from nonproductive properties are not included in the calculation of Excess IDC, we suggest doing a thorough evaluation of the properties incurring IDC to determine whether or not they are economical.   The IRS does not provide any specific guidance on how to determine whether or not a property is nonproductive; taxpayers are advised to look into the details of the wells that are:
   
  1. Costly and are not expected to produce much profit, if any.
     
     
  2. Not a dry hole, but not far off from being one.
     
     
  3. Producing very little; it needs to be a very low performer.
     
     
  4. Not deemed to make ECONOMIC sense to continue putting resources into the well.
     
     
• The taxpayer can evaluate annually and determine whether to capitalize and amortize all or some of the IDC expenses. In some instances, a taxpayer can both deduct IDC and amortize IDC. This can be an intricate and delicate calculation to determine how much IDC should be capitalized to remove the taxpayer’s AMT burden as it relates to IDC.

Taxpayers may also wish to amend previous income tax returns to alleviate the AMT burden by one of the methods above. In the first case, an amended return may be filed for removal of properties from the Excess IDC calculation because they are deemed nonproductive. Taxpayers cannot, however, amend any previous returns to elect to capitalize any or all of the IDC as this is considered an election and tax returns may not be amended for elections.

HoganTaylor Energy Services

If you would like more information about the Marginal Well Tax Credit and how it could potentially benefit your business, please contact the author of this article, Paige Buxton Graham. You may also contact Jeff Koweno, Energy Practice Lead, or any other member of the HoganTaylor Energy practice.

INFORMATIONAL PURPOSE ONLY. This content is for informational purposes only. This content does not constitute professional advice and should not be relied upon by you or any third party, including to operate or promote your business, secure financing or capital in any form, obtain any regulatory or governmental approvals, or otherwise be used in connection with procuring services or other benefits from any entity. Before making any decision or taking any action, you should consult with professional advisors.