Aja 6-2-99-2d

YOU MAY BE ENTITLED TO GREATER DEDUCTIONS FOR STATUTORY DEPLETION WHEN IN THE "ALTERNATIVE MINIMUM TAX"

By Thomas A. Aja, C.P.A.

Plante & Moran, LLP

Traverse City, MI

Oil & gas investments are among the most tax-advantaged types of investments that one can make. One of the most favorable tax provisions available to oil & gas investors is the statutory depletion (often referred to as "percentage depletion") deduction allowed by I.R.C. Section 613.

Here's a little background. A taxpayer is allowed to compute his taxable income using the greater of cost depletion or percentage depletion. Cost depletion is similar to tax depreciation in that both are figured based upon one's cost basis in the property. Percentage depletion is figured by applying a specified percentage (generally 15%) to one's gross revenue from oil & gas, and is available even if one's cost basis in the property has been fully recovered. Thus, we sometimes think of percentage depletion as a tax deduction that is created "from thin air," and as such it is a very rare breed in the tax law.

In order to limit the deductibility of statutory depletion in certain situations, the tax law imposes certain deduction limitations. One of the limitations is the "65% of taxable income" limitation imposed by I.R.C. Section 613A(d). Under this limitation, the statutory depletion deduction is limited to 65% of one's taxable income (from whatever source, not just from oil & gas). If a taxpayer is so limited, the amount of the disallowed statutory depletion is allowed to be carried forward, fortunately. However, for the taxpayer who is caught unaware of this limitation, and who was planning on a current year deduction of the full amount of the statutory depletion, this 65% of taxable income limitation can be frustrating.

To add to this frustration, many of our oil & gas clients find themselves subject to the alternative minimum tax (A.M.T.). In short, the A.M.T. results from a tax calculation that is parallel to the regular tax calculation. It is intended to serve as a "safety net" so that taxpayers do not avail themselves of the various tax breaks allowed for regular tax purposes to such an extent that they pay little or no tax in relation to their gross income. In figuring the A.M.T., the taxpayer starts with his regular taxable income, but is then required to add back all or a portion of certain deductions that had been allowed for regular tax purposes. The result is an increased tax base, known as "alternative minimum taxable income" or A.M.T.I., used for figuring A.M.T.

When one's A.M.T.I. is significantly greater than one's regular taxable income, a question arises as to how to apply the "65% of taxable income" limit when figuring the alternative minimum tax. In other words, should the 65% limit be applied to regular taxable income or to alternative minimum taxable income, when figuring the alternative minimum tax? Obviously, the taxpayer would be better off figuring this limit based upon 65% of the A.M.T.I. in such situations because this would allow greater current year utilization of the statutory depletion deduction. Although we have noted that many tax preparers do not take this taxpayer-favorable position, we believe that there may be support in the tax law for doing so. In IRS letter ruling 9320003, the IRS stated that "all Code provisions that apply in determining taxable income must also be applied in determining A.M.T.I. but with the A.M.T. adjustments taken into account, except as otherwise specifically provided". In the Form 6251 instructions (Alternative Minimum Tax for Individuals) for at least one tax year, the IRS has stated that "your depletion deduction must be refigured for the A.M.T." Such language may allow the taxpayer to figure the 65% limit based upon the A.M.T.I. amount, which is beneficial when the A.M.T.I. exceeds the regular taxable income.

If you have significant statutory depletion, either from the current year or carried over from a prior year in which the depletion deduction had been limited, consider taking advantage of this tax position. It may allow you to deduct a greater amount of your available statutory depletion.

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