The Impact of the New Tax Law on the Oil and Gas Industry

March 17, 2021

A new tax law takes effect in 2018 that will result in significant changes across the board for both individuals and businesses. Oil and gas is one of the industries that can expect to experience substantial changes as a result of the Tax Cuts and Jobs Act (TCJA). The tax law adjustments will have effects that are both negative and positive – and companies can help prepare themselves by learning about the changes to the law, and by taking active steps to make tax season as easy and stress-free as possible.

Positive Effects that Companies in the Gas and Oil Industries Can Expect

Effective after December 31, 2017, the top corporate tax drops from 35 to 21 percent. This reduction is ultimately a huge win for oil and gas companies overall –  so companies organized as c-corporations can expect to pay a lesser amount in taxes.

This bill also changes pass-through business income. Effective after December 31, 2017, noncorporate taxpayers may deduct up to 20 percent of domestic qualified business income from a partnership, s corporation or sole proprietorship.  The deduction is generally limited to the greater of 50 percent of W-2 Wages paid by the business, or the sum of 25 percent of the W-2 wages paid plus 2.5 percent of the unadjusted basis of certain property the business used to produce qualified business income.  Qualified property is depreciable tangible property held by and available for use in the qualified trade or business at the close of the tax year. This means that oil and gas companies with a significant amount of oil and gas equipment will be able to advantage of the second part of the limitation. Unfortunately, qualified property does not include depletable assets. This is a huge blow to the oil and gas industry as depletable assets often make up the bulk of a balance sheet.

The tax bill increases the bonus depreciation allowance to 100 percent which will help oil and gas companies pay for new investments in oil and gas equipment and for general assets used around the office. However, the new bill removes bonus depreciation for property that is primarily used in the transportation of gas or steam by pipeline. So, any oil and gas companies who are in the process of building any new pipelines will be adversely affected by this provision.

Finally, the new tax bill does not lower incentives for finding alternative fuel sources. It keeps in place the conventional energy tax credits for enhanced oil recovery and the production of oil and gas from marginal wells.

Adverse Effects that Companies in the Gas and Oil Industry Can Expect

Effective for taxable years after December 31, 2017, Section 163(j) is now applicable to every business, including partnerships, S-Corporations, and sole proprietorships. Section 163(j) impacts the deduction amount for interest expense, capping it at interest income plus 30 percent adjusted taxable income, which is computed without regard to:

  • Any item of income, gain deduction, or loss that is not properly allocable to a trade or business
  • Any business interest or business interest income
  • The amount of any net operating loss NOL deduction
  • The 20 percent deduction for qualified business income of a pass-through entity under code sec. 199A
  • Allowable deductions for depreciation amortization or depletion

The tax bill also modified like-kind exchange rules. Effective December 31, 2017, like-kind exchanges are limited to real property. There is no official guidance on oil and gas leases; however, oil and gas leases are generally considered real property and should qualify for like-kind exchange treatment. The same cannot be said for oil and gas equipment which no longer qualify. An exception to this law is provided if the property in the exchange is disposed of or received by the taxpayer on or before December 31, 2017, which allows them to avoid this limitation. 

The new bill also eliminates the taxpayer’s ability to carryback NOL. Effective in taxable years after December 31, 2017, taxpayers will no longer be able to carryback a NOL which is potentially the most damaging aspect of the bill to the oil and gas industry.  Many oil and gas companies have volatile income and losses due to the nature of oil and gas prices. Taxpayers with oil and gas investments will no longer be able to get the taxes they paid in prior years back if they have a large loss in the current year.  The 199A pass-through deduction is not taken into account when computing NOL for a loss year. The bill also modifies rules for calculating NOL for corporations. The NOL for corporations is limited to 80 percent of taxable income for losses arising in taxable years beginning in 2018 and after.

Another provision that has far-reaching consequences is the addition of Code Sec. 461(1)(B), the disallowance of excess business loss. The “excess business loss” is the excess of business deductions over business income. Taxpayers can now only take $250,000 ($500,000 for married) of excess business losses in a taxable year. The remainder is carried over as a NOL separate from other NOLs the taxpayer may have. This will not affect passive oil and gas investor as it will individuals who actively manage their oil and gas business, as passive losses are disallowed regardless. Active oil and gas managers who in the past were able to take all of their losses will no longer be able to take those losses. This may require additional tax planning around capitalizing IDC or restructuring partnerships and s-corps as c-corps.

Finally, the new tax bill repeals the domestic production activities deduction (DPAD) which rewards companies that have produced products in the U.S., including oil and gas companies.

Steps that Gas and Oil Companies Can Take Now to Prepare for Future Tax Repercussions

If you work in the gas and oil industry, here are a few steps you can take now to prepare for the effects of the new tax laws. First, have your tax professional review the bill and measure your company’s specific circumstances against it to assess the impact of each provision. Also, you’ll want to have your finance team and accountants work together to gather all the data required from the tax reform. Collect this data and make the computations as soon as possible. Finally, establish your company’s priorities when it comes to which provision to use. That way, you can be sure you’re getting the best deal possible thanks to the recent changes in the laws.

If you’re in charge of finances for a gas or oil company, you can expect the new tax laws to have a major effect on your business. However, this can be positive if you take the time to learn about the changes and prepare for them. By adequately versing yourself in how the new bill will affect you, you will ensure that none of the changes catch you by surprise and that you reap all possible benefits that are available to your organization.

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