Tax Planning Considerations for Oil and Gas Investment Owners

By Kaisee Littlejohn

During 2021, oil and natural gas prices made a fast-paced comeback compared to the beginning of the pandemic, with the price of crude oil rising from averaging $42/barrel in 2020 to $71/barrel in 2021 and the prices in natural gas rising from averaging around $2/MMBtu in 2020 to $4/MMBtu in 2021. Industry observers point to a sustained increase in demand from the pandemic lows as well as a renewed discipline from oil companies to temper supply increases in a rising price environment. The U.S Energy Information Administration projects that oil consumption will increase by 4% in 2022 in comparison to 2021 and further increasing an additional 2% from 2022 to 2023.

How do these price and demand fluctuations affect oil and gas investment owners?

With prices comparably higher than in 2020, many mineral interest owners are likely to see an increase in the revenue and net income from the properties they own. The consistent price increases could result in oil and gas income pushing owners into higher tax brackets than in previous years.

Another tax implication for oil and gas investment owners to be aware of is the net investment income (NII) tax. This 3.8% tax applies to investment income such as capital gains, dividends, interest, annuities, royalties, and rents. It also applies to business income earned by passive investors. Mineral interest owners and other passive oil and gas investors will generally be subject to the net investment income tax.

An exception to the net investment income tax being levied on oil and gas income applies to those who own a working interest and materially participate in the activity of the working interest. A working interest owner bears the economic risk of the operating and development costs of the property. Working interest owners, who materially participate, are instead subject to the self-employment tax, which includes a base 2.9% Medicare tax and an additional 0.9% Medicare tax for those above certain threshold amounts.

The Importance of Tax Planning

Consulting tax advisors who understand both the structure and character of your oil and gas income is crucial because of the differences between royalty and working interests, as well as potential state income tax implications related to these interests. As the next tax deadline approaches, it is beneficial to get a head-start on planning considerations to take advantage of any tax saving opportunities and avoid unexpected tax liabilities and penalties.