Did You Receive a Schedule K-1 with Upstream Oil Income? Here’s What to Do

Partners and shareholders of pass-through entities that invest in oil and gas properties are often unfamiliar with how oil and gas activity should be reported on their tax returns. In order to ensure that they include all of the tax benefits associated with oil and gas, investors must understand the importance of depletion allowances and other deductions specific to the industry.

After receiving a Schedule K-1 that includes oil and gas activity, investors should check and/or confirm following five key points to ensure that their tax return reports that activity accurately.

The IDC Deduction

Oil and gas investors should ensure that they include in their tax return their deduction for intangible drilling costs (IDCs), which is reported as “other deductions” on Line 13J of Schedule K-1. The IDC is usually the largest deduction that upstream oil and gas companies incur, and not taking the correct deduction can significantly affect taxable income. Partners and shareholders should note that the IDC deduction might be in the footnotes instead of on the face of the form, depending on the amount of activity on the Schedule K-1.

The Depletion Deduction

Investors should make sure that they include the depletion deduction reported on line 20T of Schedule K-1. The depletion deduction comprises both percentage and cost depletion. Depending on the holdings of the company, this could include both royalty depletion, which is reported on Schedule E part I, and working interest depletion, which is reported on Schedule E part II.

Lines 17D and 17E on Schedule K-1

Investors will need to remember to fill in the return lines 17D and 17E on Schedule K-1, which includes the gross income, the IDC deduction from Line 13J and the depletion from Line 20T. They should also check that they enter their excess IDC on the return. These items allow investors to calculate how much, if any, of their IDC they need to capitalize to avoid paying the Alternative Minimum Tax (AMT).

Section 199A Income

Investors should also double check that the amount of their IRC Section 199A income includes their current IDC and depletion deductions and the IDC amount amortized under IRC Section 59(e).

Asset Sale During the Current Tax Year

Lastly, oil and gas investors should confirm whether there were any asset sales during the current tax year. If there were, they may need to adjust the amount reported on the Schedule K-1 to include elections made at the individual level. Such adjustment could include capitalizing rather than deducting IDC, which could change the amount of recapture and overall gain recognized. In helping them make any adjustments, the Schedule K-1 will include a note on what assumptions the partnership made in the amount reported on the Schedule K-1.

Contact Weaver today for help in reporting oil and gas activity on your tax return.

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