The TCJA’s Effects On COAL AND OIL Investments

The Tax Cuts and Jobs Act contain procedures that will acutely influence tax reform on oil and gas investments, given the industry’s capital-intensive nature, high leverage, practice of reinvesting cash flow, and long project lead times. Future taxes planning will need into consideration the industry’s loss-generating downturn over the past few years, and that industry individuals owed alternative minimum taxes.

The commercial rate decreases from 35 percent to 21 percent starting in 2018 was a major boon for all those industries, but especially for coal and oil companies because the TCJA (P.L. Deduction of IDCs and percentage depletion have been considered important for the oil and gas industry long. However, the TCJA gives with one hand and takes with the other often, as it did with rules forbidding net operating loss carrybacks and limiting interest expense deductions. Also, the repeal of the section 199 domestic production activities deduction, a provision used by coal and oil companies in every subsectors, will reduce the benefit of lower taxes rates for companies generating qualified domestic production activity income.

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The TCJA’s decrease in tax rates and repeal of the organization alternative minimum tax may cause the oil and gas industry to reconsider how it structures its entities and revisit its practices regarding percentage depletion, taxes credits, and IDC. Further, specific references to oil and gas activities in a few international procedures of the TCJA might lead to disparate treatment of industry individuals, with respect to the activities that generate their income.

Under TCJA section 172, NOLs can no longer be carried back if generated in tax years ending after December 31, 2017. They can be carried forward indefinitely but can shelter only 80 percent of taxable income. NOLs generated in tax years ending on or before December 31, 2017, won’t be subject to the 80 percent limitation but can be carried only twenty years forward, not indefinitely. 30 per barrel in early 2016, so losing the ability to carry NOLs back to previous years shall have a large effect on the industry. Many companies generated NOLs in the last couple of years, and the carryback provisions allowed some to use NOLs to get refunds of tax paid in profitable years.

70 per barrel, which could encourage the use of indefinite NOL carryforwards allowed under the new rules. Loss of the ability to carry back an NOL is one of the bill’s more harmful aspects and could require more evaluation regarding deducting IDCs versus capitalizing them. Section 163(a) restricts the web interest expenditure deduction to 30 percent of altered taxable income, or income before interest; the NOL deduction; the section 199A passthrough deduction;, and (until 2022) depreciation, amortization, and depletion. Disallowed interest is carried forward indefinitely. That noticeable change will reduce the advantage of the lower tax rate for companies with high leverage.

Beginning in 2022, modified taxable income will be reduced by depreciation, amortization, and depletion, thus making the 30 percent threshold lower. Disallowed interest deductions may be carried forward. Taxpayers hold oil and gas investments individually, as well as with C corporations, partnerships, and S corporations. The 20-percent deduction under section 199A for passthrough entities will affect taxpayers whose projects are organized as partnerships owned by large private-equity groups, private traders, and families. Limits on the ability to take the deduction contain conditions or conditions particularly relevant to the industry. For example, the deduction is bound to income from a professional trade or business, which doesn’t add a specified service trade or business.

Engineers are not considered engaged in a specific service trade or business, so petroleum technical engineers should qualify for the deduction. Although the TCJA doesn’t list it as excluding investment-type income, it’s sensible to summarize that mineral royalty income is excluded from section 199A, given its classification as investment-type income in other areas of the code. The section 199A deduction is computed at the shareholder or partner level, not the relationship or S corporation level. Separately mentioned items determined at the owner level, such as depletion and IDCs, will impact the deduction. The deduction will also have an effect on each owner’s outside basis in its partnership interest or stock.