Percentage Depletion
Percentage depletion is a tax deduction for depreciation allowable for businesses involved in extracting fossil fuels, minerals, and other nonrenewable resources from the earth. Percentage depletion assigns a set percentage of depletion to the gross income derived from extracting these nonrenewable resources. Since the percentage depletion deduction is a flat rate, the resulting tax break often exceeds the cost depletion deduction, thus acting as a sizable subsidy to qualifying energy companies. The allowable statutory percentage depletion deduction is the lesser of net income or 15% of gross income. If net income is less than 15% of gross income, the deduction is limited to 100% of net income.
What Is Percentage Depletion?
Percentage depletion is a tax deduction for depreciation allowable for businesses involved in extracting fossil fuels, minerals, and other nonrenewable resources from the earth.
Percentage depletion assigns a set percentage of depletion to the gross income derived from extracting these nonrenewable resources. The deduction is intended as an incentive for drillers and investors to develop domestic mineral and energy production.
How Percentage Depletion Works
The rules of oil and gas accounting require that the costs incurred to find, develop, and obtain minerals and oil- and gas-producing properties must be capitalized.
Percentage depletion allows for an income tax deduction for these capitalized costs, reflecting the declining production of reserves over time. The percentage depletion is a measure of the amount of depletion associated with the extraction of nonrenewable resources. It is an allowance that independent producers and royalty owners can apply to the taxable gross income of a productive well’s property.
The Benefit to Investors
Oil and gas investments at the wellhead have become one of the most tax-advantaged investments available in the U.S. today due to the depletion allowance. Approximately 15% of gross income from oil and gas is tax-free for small investors and independent oil and gas producers.
There is no dollar limit to the total amount of depletion that can be deducted from income from qualified nonrenewable resources. However, percentage depletion can only be taken from a property that has net income (or profits).
If a property recognizes a net loss for any given tax year, percentage depletion cannot be deducted.
Percentage depletion is limited to 50% of net income, less exploration costs.
There is no dollar limit to the deduction from income from qualified nonrenewable resources.
The allowable statutory percentage depletion deduction is the lesser of net income or 15% of gross income. If net income is less than 15% of gross income, the deduction is limited to 100% of net income.
Depreciation Rates Vary
Percentage depletion is a capital cost recovery method that is allowed for nearly all natural resources except timber.
The IRS sets different depletion rates for different resources. Some of the rates are as follows:
The percentage depletion formula requires that gross income be multiplied by the appropriate percentage.
Alternate Method
The IRS provides another method of determining depletion: cost depletion. Cost depletion is easier to calculate and involves producers writing off the real cost of their investments based on the fraction of resources extracted.
Since the percentage depletion deduction is a flat rate, the resulting tax break often exceeds the cost depletion deduction, thus acting as a sizable subsidy to qualifying energy companies.
Related terms:
Capital Recovery
Capital recovery refers to the earning back of the initial funds put into an investment that a company must accrue before it can earn a profit on its investment. read more
Capitalize
To capitalize is to record a cost/expense on the balance sheet for the purposes of delaying full recognition of the expense. In general, capitalizing expenses is beneficial as companies acquiring new assets with long-term lifespans can amortize the costs. read more
Cost Depletion
Cost depletion is one of two accounting methods used to allocate the costs of extracting natural resources, such as timber, minerals, and oil, and to record those costs as operating expenses to reduce pretax income. read more
Depletion
Depletion is an accrual accounting method used to allocate the cost of extracting natural resources such as timber, minerals, and oil from the earth. read more
Depreciation, Depletion, and Amortization (DD&A)
Depreciation, depletion, and amortization (DD&A) is an accounting technique associated with new oil and natural gas reserves. read more
Gross Income : Formula & Examples
Gross income represents the total income from all sources, including returns, discounts, and allowances, before deducting any expenses or taxes. read more
Net Income (NI)
Net income, also called net earnings, is sales minus cost of goods sold, general expenses, taxes, and interest. read more
Nonrenewable Resources
A nonrenewable resource is a natural substance that is not replenished with the speed at which it is consumed. Its supply is finite. read more
Renewable Resource
A renewable resource is a substance of economic value that can be replaced or replenished in less time than it takes to draw the supply down. read more