Existing Oil Tax Credit Available for First Time in a Decade

Overview

Since 2006, the enhanced oil recovery credit (“EORC”) has been unavailable to taxpayers who operate in the energy sector. However, recent reductions in the realized prices of oil have once again made the EORC relevant for tax year 2016. Taxpayers who qualify for the EORC may be entitled to a 2016 general business tax credit equal to 15% of their qualified costs and expenses associated with their oil extraction activities during 2016. This blog post provides a summary of the EORC and its requirements.

The EORC’s Applicability in 2016

As discussed above, the EORC provides a general business tax credit to certain taxpayers in tax years where the price of oil is low. To accomplish this result, I.R.C. § 43 generally provides that the tax credit begins to phase out for any given tax year if the previous year’s “reference price” of crude oil exceeds $28 (adjusted for inflation). On July 18, 2016, the IRS released both the reference price of crude oil in 2015 and the inflation index factor for 2016. See Notices 2016-43 and 2016-44. Because the reference price of crude oil in 2015 was $44.39, which amount was less than the threshold price of $46.10 ($28 times the inflation index factor of 1.6464), the EORC may be claimed by taxpayers who meet the requirements for that tax credit in 2016.

Some of the requirements a taxpayer must meet to claim the EORC include:

    • The taxpayer must be an owner of an “operating mineral interest”—i.e., the tax credit is
       unavailable to those taxpayers who have only a royalty interest;

    • The taxpayer must have paid or incurred costs related to a qualified enhanced oil recovery.
       By way of illustration, these costs may include those costs associated with certain tangible
       property, intangible drilling and development costs, and certain injectant costs;

    • The costs must be borne in a qualified enhanced oil recovery project, which, among
       other things, means that the project involves certain tertiary extraction methods.
       Notably, horizontal drilling is not a qualified enhanced oil recovery project. In addition,
       to be a qualified project, the first injection of liquid or gas must have occurred on
       or after January 1, 1991, and the project must be certified as meeting these
       and other requirements by a petroleum manager.

Conclusion

Although oil prices have taken a dramatic downward turn in recent years, taxpayers in the energy sector may be able to take advantage of the EORC with respect to certain oil extraction projects in 2016. Taxpayers in the energy sector who are interested in claiming the EORC should discuss the credit and its applicability to their particular situation with their tax professional.