One Investment That Could Offer Substantial Tax Savings For 2015

Posted: Nov 02, 2015 12:01 AM
One Investment That Could Offer Substantial Tax Savings For 2015

Scenario: You have had a financially successful 2015 such that if you don’t take deliberate action now, you will be faced with an unfavorable tax burden next spring.

What are your options? Are there any ways you could off-set the income, gains or profits to reduce your tax burden? To better explore the question, the two types of taxable income have to be defined and considered.

The Tax Act of 1986 established Active vs. Passive actions to create income. Most of us make active income, i.e. salaries, commissions or sales of products or services. Passive income might include royalties or rental income, but is classified by the IRS as coming from a source in which you are not materially involved. However, typically you can only use passive expenses to offset passive income and active expenses to offset active income. Generally there are more passive deductions than active.

That quandary leaves many investors or businesspeople with passive write offs they can’t use or vice versa. However, the same Tax Act also established one passive action that can be used to offset active income, and it’s the only one that exists in the Tax Code, and that is investing in domestic oil and gas development, specifically Intangible Drilling Costs (IDC).

Intangible costs comprise approximately 80-percent of a well’s budget, and simplistically are classified as everything on a drilling rig site that won’t drive off when the well is finished. Drilling mud is one IDC and is a sizeable portion of a well’s total cost. Other intangibles include labor and materials and supplies. Intangible costs can be deducted 100% in the year they are incurred against active income, creating the potential for substantial tax savings for those who qualify.

Congress added this incentive to encourage domestic investment, which had been in a slump for most of the 80s. The problem then was most of the “easy” oil and gas had long been extracted plus the technology for finding resources paled in comparison to what is available today.

Fast forward to 2004 in the prairies northwest of Dallas Ft. Worth and Texas oilman George Mitchell’s relentless pursuit of combining hydraulic fracturing with horizontal drilling. After nearly a decade of experimentation, Mitchell finally cracked the code of the right blend to create fissures in shale rock, allowing oil and natural gas to flow freely.

The rest is history, and this technology has virtually eliminated the speculative “dry hole,” as wells drilled through shale formations generally produce some volume of oil and gas.

For those with tax strategies to consider for 2015, this is how oil and gas investments made prior by December 31 could impact your taxes:

Tax Scenario *

2015 Taxable Income after adjustments: $300,000

State Tax – 6% - $18,000

Federal Tax – 35% - $105,000

Total Tax: $123,000

Tax Scenario with IDC write off:

2015 Taxable Income after adjustments: $300,000

IDC Deduction from oil and gas investment: $50,000

Taxable Income after IDC: $250,000

State Tax – 6% - $15,000

Federal Tax – 35% - $87,500

Total Tax: $102,500

Tax Savings: $20,500

*Note that this is purely an example and not reflective of a particular tax situation. Consult your tax advisor for your specific tax implications of any investment.

In order to take IDC benefits, an investment would have to be made and expenses incurred in 2015, so now is the time to explore this if it something that would fit your criteria.