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Welcome AMT reform for independent producers.

The Energy Policy Act of 1992 (EPA) (PL 102-486) included a provision that eliminates many of the alternative minimum tax (AMT) preferences and adjustments that applied specifically to independent oil and gas producers. Independent producers, as defined by Sec. 613A, are basically those nonintegrated oil and gas producers not engaged in significant retailing or refining activities. Since 1986, independent producers have paid AMT in increasing numbers, due both to falling oil and gas prices and to the addback of a significant portion of their regular tax deductions (required under the AMT).

Prior to the EPA, Sec. 57(a) required percentage depletion in excess of the adjusted basis of the mineral leasehold and excess intangible drilling costs (IDC) that exceeded 65% of annual net oil and gas income to be added back to regular taxable income as preference items for calculating AMT. Excess IDC is defined as IDC (on productive wells only) that exceeds the amount of IDC that would have been allowable if the costs had been capitalized and recovered ratably over 120 months or had been depleted using a permitted cost depletion method. In addition, Sec. 56(g), dealing with the adjustments based on adjusted current earnings (ACE), required the amortization of IDC incurred in tax years beginning after Dec. 31, 1989 over the 60-month period prescribed by Sec. 312(n)(2)(a). Sec. 56(g) also limited allowable depletion on property placed in service in tax years beginning after Dec. 31, 1989 to cost depletion.

Since the AMT provisions were creating burdensome tax liabilities for many small domestic oil and gas producers, Sec. 56(h), "Adjustments based on energy preferences," was added to the Code in 1990. Though well-intentioned, the alternative tax energy preference deduction (ATEPD) was complicated, required a multistep calculation, and was limited overall to 40% of alternative minimum taxable income (AMTI). A taxpayer had to determine if a particular well was exploratory and whether its production was marginal before the various AMT deductions equal to a portion of preference IDC, preference depletion, ACE IDC adjustment and ACE depletion adjustment could be calculated. Many qualifying small producers did not claim the deduction, either due to its relative obscurity or its unavoidable complexity. Even the Treasury, though scheduled to issue guidance on the ATEPD through regulations, was hesitant to undertake the project.

In a significant overhaul and simplification of Sec. 57(a)(1) and (2) and Sec. 56(g)(4)(D)(i) and (F), the EPA made four important changes to an independent oil and gas producer's AMT calculation. For tax years beginning after Dec. 31, 1992, percentage depletion computed in accordance with the independent producer and royalty owners' exemption of Sec. 613A(c) will no longer be treated as a tax preference item. Importantly, percentage depletion carryforwards deducted in tax years beginning after Dec. 31, 1992 appear not to be treated as tax preference items due to the language of Sec. 613A(d), which specifically states that the amount disallowed (in an earlier year by reason of the taxable income limitation) shall be treated as an amount allowable as a deduction under Sec. 613A(c) for the following tax year.

The second change to Sec. 57(a) is that, for tax years beginning after Dec. 31, 1992, IDC will no longer be treated as a tax preference item for nonintegrated producers. The benefit is limited, however, by new Sec. 57(a)(2)(E)(ii), which provides that the reduction in AMTI by reason of eliminating what would have been preference IDC under prior law cannot exceed 40% of AMTI (30% for tax years beginning in 1993) determined without regard to the elimination of the old IDC preference and to AMT net operating loss deductions. AMTI for this purpose will reflect the fact that allowable percentage depletion is now fully deductible for AMT purposes, resulting in a lower AMTI than expected in some cases. However, for most producers (other than those with high current year IDC relative to net income from oil and gas properties), the limitation of Sec. 57(a)(2)(E)(ii) should not come into play.

The third and fourth modifications to the calculation of AMT affect the Sec. 56(g) ACE adjustment. For IDC paid or incurred in tax years beginning after Dec. 31, 1992, an adjustment for ACE purposes will no longer be required. It is significant that the repeal of the ACE adjustment is for IDC paid or incurred after Dec. 31, 1992; to the extent IDC has been capitalized pursuant to Sec. 56(g)(4)(D)(i) in previous years, 60-month amortization under ACE can continue to be claimed until the cost is fully recovered. If this specific effective date language had not been included, a portion of the amounts paid for IDC prior to 1993 would never have been recovered (other than through minimum tax credit carryforwards, when available). For tax years beginning after Dec. 31, 1992, an ACE adjustment also will not be required for any depletion deduction allowed under the independent producer and royalty owners' exemption. Note that beneficial effective date language was again used, by not limiting the repeal of the percentage depletion ACE adjustment to only that property placed in service after Dec. 31, 1992. Therefore, percentage depletion will now be allowed for ACE purposes for property placed in service prior to 1993 even though cost depletion was previously required to be used. Finally, since no longer necessary, the ATEPD of Sec. 56(h) has also been repealed.

These refreshing tax thanges for independent oil and gas producers represent positive, simplifying legislation in the much needed area of AMT reform.
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Author:Lewis, Tara W.
Publication:The Tax Adviser
Date:Jul 1, 1993
Words:935
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