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OIL AND GAS TAX A LOOK AT THIS YEAR’S HOT CONCEPTS. August 20-21, 2009 Brian Dethrow Jackson Walker, L.L.P. 901 Main Street, Suite 6000 Dallas, Texas 75202 [email protected] 214-953-5794. Change is coming . . . or “proposals floated for sinking you”. Hodge podge of new tax plans mentioned

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oil and gas tax a look at this year s hot concepts


August 20-21, 2009

Brian Dethrow

Jackson Walker, L.L.P.901 Main Street, Suite 6000Dallas, Texas 75202

[email protected]


change is coming or proposals floated for sinking you
Change is coming . . . or “proposals floated for sinking you”

Hodge podge of new tax plans mentioned

No percentage depletion, only “cost” remains

No current expensing of IDC, really big as IDCs account for up to 80%

No “working interest exception” from the passive activity loss rules

applies to investors looking for current tax deductions (but the deductions . . . and maybe the investors . . . are gone anyway)

Carried interest rules for "investment services partnership interest" -- aimed at hedge funds and private equity funds

regardless of underlying character of net partnership income (e.g., capital gain), service provider will book ordinary income

subject to self-employment tax

applies to a person who provides a substantial quantity of services (picking, managing, arranging financing)

applies to real estate and commodities (oil and gas is traded)

may hit oil and gas deals


consulting geologist gets a working interest in a prospect (if no opt-out from Subchapter K)

consulting geologist is granted a partnership profits interest in investment partnership

"promoter" brings in outside investors on similar basis

Higher tax rates--both capital and ordinary rates; really serious for oil patch given loss of depletion/IDC

crystal ball conclusions
Crystal ball conclusions

Accelerate income - if you can stand it (low present values, low present tax rate)

Be thoughtful making the election to "opt-in" to Subchapter K in your JOAs

Explore overseas…..but check-a-box is under attack, too

Drill now to get your IDC (drill baby, drill)

net operating losses section 382
Net operating losses -- Section 382

Corporate and individual

Huge now, especially with the potential loss of current oil and gas tax write-offs

It could be your only "appreciating" asset, with tax rates rising

Generate some gains before NOLs expire or get suspended

use taxable exchanges (do NOT elect 1031 for like-kind exchanges)

generate depletable basis

BUT run pro formas on AMT and Texas margin tax (no free lunch)

Corporate NOLs

get help to retain

lose on 50% change in ownership over 3-year period

new investors can essentially kill NOLs

Individual NOLs

don't die

closed deals second thoughts
Closed deals -- second thoughts!

Things looked good; closed deal; going to pay tax; now not so hot (consideration now not too valuable)

Key date for valuation: closing--not today

Times were great; now a crash in values

Same issue with taxable equity grants to executives (stock or partnership interest)

Ideas to consider:

Un-wind transaction

Rescind -- if SAME TAX YEAR; not otherwise

By December '09, be looking at "closed" deals to see if un-wind is feasible

Squeeze into installment sale reporting (Section 453)

But what if a demand note? No 453

Bad basis recovery may be a toll charge

See if closing actually occurred

European deal requiring "notorial seal" -- none obtained

Taxable roll-up with IPO planned (you know the rest of the story)…..

Maybe it was a partnership interest

Income partner stake not taxable upon receipt

Perfect "partnership agreement" not required but clean facts and industry documents


Taxable stock deal



Discount consideration received

Discount consideration received

Discount consideration received

Amend return

Won't work on promissory notes

On equity, hire valuation firm

Lock-up creates discount

Thin (or no) trading creates discount

When all else fails

Generate losses to offset gains

Use NOLs

bad investor partnership deals hotel california
Bad Investor Partnership Deals - Hotel California

IRRs from hell

Looked good at the time

Now deeply underwater

Never going to see daylight?

Never going to see daylight?

Go-forward changes in partnership allocations/distributions not a tax problem

Tough negotiations!


Corporations -- make the S election to be a pass-through entity

C corp double tax is expensive

C corp double tax avoided on FUTURE growth in value

10-year hold (7-year if made S election ’02 or ’03)

Low value for double tax on current built-in gain

each shareholder gets to handle his own depletion (like partnerships), choose cost/percentage

Make lemonade: use today's low values to . . .

incentivize the heck out of management at low values
Incentivize the heck out of management at low values --

huge future upside; less cash cost today

low current tax cost, but low current deduction to company, too

income partner interests -- IRS certainty in safe harbor under section 83(b)

liquidate today, management gets nothing

must be held for two years (make protective 83(b) election - just in case)

re-allocate income at liquidation to make proportionate (to extent possible)

capital interest

current taxation to executive but nominal amount?

facts and circumstances test

minority and marketability discounts

risky--no safe harbor; return preparer issues?

make family gifts
Make family gifts

outright gift of (current) low value property

outright gift of deep strata in Haynesville (retain shallow producing piece for current income and to diminish gift value)

keep the current value -- gift the upside

acronym techniques -- GRAT, IDGT

Appalachian oil family with

younger generation E&P company

community property agreement for old marriage

community property basis step-up on death of first spouse

8-10 years of virtually tax-free income

Get solid valuations – of industry interest and entity interest

gift early, gift often

housekeeping issues
Housekeeping Issues

Opt into tax partnership in your Joint Operating Agreements

give money partner full tax write-offs for money invested (IDCs--on money invested)

avoid Rev. Rul. 7.176 for multiple operating interests in exchange for drilling services (unrelated property taxation)

specially allocate tax items

separately make depletion decisions (percentage vs cost)

bring in workers using profits interests – see above

BUT partnership tax returns annually, maintain capital accounts, etc. and potentially carried interest rules may apply

Be mindful of Texas margin tax -- 1% of gross receipts less COGs

depletion may NOT be allowable as a COGs deduction

passive entities are non-taxable entities

LPs, GPs, trusts…..but NOT LLCs

at least 90% of federal gross income must be passive sourced; this is "passive":

net capital gain from sale of real property (working interests)

royalties, bonuses and delay rental income

income from non-operating mineral interests (even working interests, if not the operator, including affiliates)

if GP owns more than 50% of a partnership (including post-flip) and GP/affiliate is operator, partnership NOT passive

Brian Dethrow focuses his practice on tax and business planning for complex corporate, family, and inter-generational transactions.

Mr. Dethrow has broad experience with innovative tax and corporate planning, including in the oil and gas arena. He has worked extensively with large business owners on business succession, asset protection, and gift and estate tax reduction strategies


Mr. Dethrow is admitted to practice in Texas.


Mr. Dethrow received his B.A. degree, with high honors, from the University of Texas, where he was a member of Phi Beta Kappa. He received his J.D. degree from Harvard Law School.

Brian DethrowPartner – Tax, International

Brian Dethrow

Jackson Walker L.L.P.901 Main Street, Suite 6000Dallas, Texas [email protected]