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FOSSIL’S JOINT VENTURE
DRILLING PROGRAMS
TAX INFORMATION FOR
JOINT VENTURE
DRILLING PROGRAMS
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Tax
Write Offs |
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Tax
Shelter Investment Information |
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Benefits
of Oil and Gas Partnerships |
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INVESTOR'S BUSINESS
DAILY
Drill for Year End Write Offs in Oil and Gas Drilling Programs
Exploring for a year-end tax deduction? Sinking some dollars
into an oil and natural gas drilling deal can be risky. But
such investments can offer robust returns as well as write-offs.
One benefit provided by the tax code is an upfront tax deduction.
"Often, a large portion of your investments may be deducted
in the first year," said Ronald Rutherford, a certified financial
planner in New York. In other types of business, more of the
costs must be written off over long time periods.
The amount you can deduct would vary according to details
of the transaction. But suppose you invest $25,000 in a drilling
deal this year. Say you get to deduct $18,000 from your 2007
income. In a top 39.6% federal tax bracket, that deduction
would save you more than $7,000 in tax payments. State tax
deduction might increase your total savings.
Depletion Allowance
If your drilling investments find oil or gas, you may get
revenue starting in late 2007 or 2008. Then your taxable income
will be reduced by depletion allowance. That's a second tax
break to encourage energy exploration. It assumes the well
in which you've invested loses value as the energy resource
is pumped out. You can treat part of your revenue as a nontaxable
refund of your original investments rather than as taxable
income. Imagine you're paid $4,000 in 2007 for your 2007 investments.
Because of the depletion allowance, you might have to report
only, say, $3,000 as taxable income. The exact amount will
vary each year, depending on factors such as the amount of
oil and gas produced and income reinvested. This shelter can
go on as long as the oil and gas keeps flowing.
A third reason to consider making this type of investment
is for the sake of diversifying your portfolio. When stocks
or bonds are weak, oil and natural gas prices may rise. Despite
these benefits, there are risks. Mainly, the driller might
not discover enough oil and gas.
Check Background
One precaution is to check the background of the management
running the drilling operation. Ask to see letters to investors
in prior deals to see if the operators actually sold oil or
gas and distributed cash. The type of drilling that's planned
can impact your return. "Wildcat" exploration looks for previously
undiscovered petroleum. On the other hand, "developmental"
drilling takes place near fields already producing oil and
gas. Such drilling probably won't produce a bonanza but very
likely will find some petroleum to sell.
"Ask to see a map of the area to be drilled," Rutherford said.
"There will be less risk if the wells are in the middle of
a producing oil or gas field rather than on the outskirts.
And check with your tax pro. "These programs raise issues
regarding the alternative minimum tax, the passive-activity
rules and the at-risk rules," says Robert Keebler, partner
in the accounting firm Virchow, Krause and Co. of Green Bay,
WI. "They should be addressed before you invest or you may
not receive the upfront deductions you expect," Keebler said.
Keebler points to another potential tax advantage concerning
Roth IRA conversions. Regular IRA's may be converted to Roth
IRA's. Deferred income taxes are due upon conversions.
AIGI Matters
But you can eventually withdraw all of the money in a Roth
IRA tax-free after the latter of five years of age 59 ½
, You are eligible to convert only in a year when your adjusted
gross income is $100,000 or less. "The first-year deductions
from a drilling income below $100,000 for the year," Keebler
said. "Nevertheless, the underlying economics are critical,
so you should pay attention to the investments potential as
well as the tax advantages."
Brokers and Advisers
Oil and gas drilling deals may be available through some brokers,
financial planners, accountants and other advisers or directly
from the sponsoring oil company. These investments typically
are structured as partnerships or joint ventures. Some may
require you to have a specific level of income or net worth
to participate. Don't ignore risks. Oil prices have soared
the past two years to record levels and so has the price of
natural gas. Although it seems highly unlikely at this time,
they can always plummet in the future and reduce your income.
Very few investments enjoy the pure tax shelter benefits by
investing in drilling for reserves of oil and natural gas.
In a successful drilling deal you may have your cake and eat
it too, from the upfront tax deductions to ongoing tax sheltered
cash flow.
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THE MOST FREQUENTLY
ASKED QUESTIONS …
AND ANSWERS REGARDING TAX BENEFITS FOR FOSSIL OIL & GAS
JOINT VENTURE DRILLING PROGRAMS
We would like to take this opportunity to briefly outline
answers to a few of the question we are often asked about
the tax considerations of participating in our joint venture
oil and gas drilling programs.
Q: What type of information do you receive from Fossil Oil
& Gas, L.L.C. to show you how to claim your tax deductions
from investing in our drilling programs?
A: Within a reasonable time after the close of each accounting
year, the Managing Venturer (Fossil) shall send to each venturer
a report (in the form of Schedule K-1 to IRS Form 1065) indicating
that person's distributive share of all tax items. The income
and deductions reflected on your K-1 is then used in preparing
your federal tax return.
Q: What IRS tax code determines if your investment in our
drilling programs is tax deductible?
A: Numerous code sections apply. Most importantly, under Section
469(c) (3) (the "working interest exception"), working interests
in oil and gas properties are not treated as "passive activities"
if the taxpayer owns the interest directly or through and
entity that does not limit his liability with respect to the
activity. Two elements must be met before a taxpayer qualifies
for the working interest exceptions to the passive activity
loss rules, so that losses will not be treated as losses from
passive activity. First, the property generating losses must
constitute a "working interest" as defined by the passive
loss rules. Second, the interest must not be held through
an entity that limits the liability of the taxpayer with regard
to the activity.
Q: Can individuals reduce their income from other sources
with deductions generated by Fossil's joint ventures that
own oil and gas working interests?
A: Generally yes, because the deductions generated Fossil's
Joint venture oil and gas working interests are not treated
as "passive losses". The Tax Reform Act of 1986 provides that,
in most cases, deductions generated after 1986 from investments
in which an individual does not materially participate are
treated as "passive losses" and cam be deducted only against
"passive income". Deductions classified as "passive losses"
cannot offset income such as wages, interest, or income from
many businesses in which the individual materially participates.
However, the law contains an exception, Section 469 (c) (3)
under which, among other things, deductions generated by oil
and gas working interest (as opposed to royalty interest)
owned through general partnerships are not considered "passive
losses," so partners and the joint venture subsequently generated
by such ventures will not be treated as "passive income."
Q: What are some of the tax deductions from Fossil's oil and
gas drilling programs?
A: Our oil and gas drilling programs are specifically designed
to generate various tax deductions from drilling, completing
and producing oil and gas wells. These deductions include
intangible drilling cost (IDC), depreciation, and operating
costs. In addition, when production is achieved, our ventures
claim a depletion deduction against their share of the venture's
income from oil and gas produced.
Q: What other deductions are generated by Fossil's oil an
gas drilling ventures?
A: Our ventures drill and at times operate oil and / or gas
wells. We are defined as being engaged in a "trade or business"
and therefore claim as a deduction, for federal tax purposes,
all ordinary and necessary expenses paid in carrying on our
"trade or business," such as costs of operating well, general
and administrative costs of the venture, and certain fees
paid to the managing venturer.
Q: What are Intangible Drilling Costs (IDC)?
A: These IDC costs include expenditures for wages, fuel, repairs,
hauling, supplies and other items that have no salvage value
and are necessary for the drilling of wells (i.e. hiring the
drilling contractor) and the preparation of wells for the
production of oil and gas. Intangible costs generally represent
a majority of the total cost of drilling, testing and completing
an oil and / or gas well.
Q: How do Intangible Drilling Costs (IDC) produce tax benefits
for our joint venture?
A: The joint venture drilling a well may elect to deduct intangible
drilling costs, so its investors can get an immediate benefit
from the expenditure. When the well drilled proves to be commercially
productive, an election to deduct IDC's will generally result
in a tax benefit to ventures (in the form of tax deductions)
in the year the well is drilled. However, if the oil and gas
property or an interest in the venture is later sold at a
gain, all or a portion of that gain may be classified as ordinary
income because of the recapture of these deductions.
Q: Can I deduct depreciation on tangible items purchased to
equip on oil or gas well?
A: Yes. While it is true oil and gas drilling ventures cannot
deduct the entire cost of items purchased to equip an oil
or gas well in the year of purchase, those costs are capitalized
and can be depreciated over a period of five or seven years
(depending on when the particular property is placed in service
and on its depreciable "class life"). Consequently, an investor
could deduct his share of the depreciation on items such as
casing, tubing and pumping units. If such equipment is later
sold for more that the depreciated value or if a venture sell
his venture interest, all or portion of the gain may be classified
as ordinary income because of the recapture of depreciation
deductions.
Q: What is "depletion" and how does it reduce or defer an
investor's taxes?
A: Depletion allows the owner of producing oil and / or gas
well to recover his capitalized cost through tax deduction
over the period in which the oil and/or gas is produced. Consequently,
a venture generally cannot deduct in the first year the entire
purchase price of an oil or gas leasehold interest or other
oil or gas property interest. However, when a producing well
is drilled, the venture can recover the cost of the oil and
gas property through depletion deductions. An investor's depletion
deduction is computed individually by the joint venture. A
venture makes this computation based on the portion of the
properties adjusted tax basis that the venture allocates to
they venture. If the property is later sold at a profit or
a venture sells his venture interest, all or a portion of
the profit bay be classified as ordinary income because or
the recapture of deductions. If the venture drills a dry hold
and the lease is worthless, the total capitalizations of the
oil or gas venture can be deducted in the year it is determined
to be worthless.
Q: What is the difference between cost depletion and percentage
depletion?
A: Cost depletion allows a recovery each year of a portion
of the capitalized cost, including the cost of the oil and
gas lease, of a producing well over its life. The portion
of those costs that can be recovered each year is based on
the percentage of the estimated recoverable oil and gas reserve
sold during each year.
Percentage depletion, on the other hand, is computed on the
basis of the income from the property rather than the cost
of the property. Percentage depletion often results in a larger
deduction than the cost depletion because it may be taken
over the entire productive life of the property, even through
the total deduction claimed exceeds the capitalized cost of
the property. Percentage depletion, however, is generally
only available to independent producers who received an interest
in the property before the property was considered to be "proven
property" for federal income tax purpose. Certain other restrictions
also apply.
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TAX
WRITE OFFS WORKSHEET
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Example of an investor
in the Fossil – 2007 Year-End Multi-Well Joint
Venture potential tax benefits. Each investor’s
tax liabilities are different. Consult with your personal
tax advisor regarding the potential benefits of oil
and gas Joint Venture participation. The example below
assumes an investor in a 35% Federal Income Tax Bracket,
2.9% Medicare Tax and a 3% State Income Tax.
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Investment
in 3 Units ($10,000 per Unit) in Fossil – 2007 Year-End
Multi-Well Joint Venture Program - View
Our Current Project
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$30,000
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First
Year Deductions:
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Intangible
Drilling Cost (76%) & other deductible expenses pursuant
to IRS Section 469 (c)(3)
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($30,000
x 75%) = $22,500
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Tangible
Well Equipment (9%) Written off per IRS Section 179
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($30,000 x 9%) = $2,700
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First
Year Deductions on Tax Return
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($22,500
+ $2,700) = $25,200
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First
Year Tax Savings from Investing
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($25,200
x 40.9%) = $10,307
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Net
out of Pocket Cost for a $30,000 Investment Unit
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($30,000
- $10,307) = $19,693
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SUMMARY
Therefore,
a joint venture participant can save approximately $10,300
in direct tax savings per Joint Venture Unit ($30,000).
Financial
Statements and Tax Returns. At the expense of the
Joint Venture, the Managing Venturer shall engage a
certified public accountant to prepare the Joint ventures’
annual income tax return as required by Code requirements
relating to sales and exchanges of interests in the
Joint Venture, and annual financial statements, which
shall include:
(a)
a statement of income or loss for the full year;
(b) a statement of changes in financial position;
(c) a statement of cash flow and distributions for
the full year; and
(d) a detailed statement of assessments and borrowing,
if any. |
Within a reasonable time after the close of each accounting
year, the Managing Venturer shall transmit to each person
who was a Venturer (or investor) during such accounting
year, a copy of such financial statements and a report
(which may be in the form of Schedule K-1 to IRS Form
1065 or the Venture may issue 1099’s in lieu of
Schedule K-1) indicating such persons’ respective
share of Federal Income Tax Items, Amount Realized,
tax preference items and investment credits, if any,
for such year.
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PERSONAL WORKSHEET
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Amount of
Investments
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_________Line 1
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Multiply
Line 1 by 76% = Approximate amount of Intangible Drilling
Cost
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_________Line 2
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Multiply
Line 1 by 9% = Tangible Equipment Deduction pursuant to
IRS Section 179
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_________Line 3
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Add Lines
2and3 = First Year Deductions
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_________Line 4
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Enter your
overall Tax Bracket (Federal, State and Medicare)
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_________Line 5
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Multiply
Line 4and5 = First Year Tax Saving
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_________Line 6
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Subtract
Line 6 from Line 1 = Net Out of Pocket Investment
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_________Line 7
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copyright © 2008 Fossil Oil & Gas Management, LLC.. All rights reserved
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