Drilling For Tax Credits

Many activities within the oil and gas industry qualify for the R&D tax credit, and this significant tax incentive is often overlooked within the industry. The R&D tax credit was originally enacted as part of the Economic Recovery Tax Act of 1981. For a company to qualify for the credit, a company needed to discover something new to its industry or its particular field of science or engineering.

However, in December 2003, the IRS replaced the “Discovery Test” with a “Four-Part Test” to qualify for the credit. This change opened up the types of activities that are eligible for the credit and greatly enhanced this opportunity for the oil and gas industry.

the four part test
The Four Part Test

The Four-Part Test

For a company to qualify for the R&D tax credit, it now needs to perform activities within the United States that meet the following “Four-Part Test” criteria.

First, the company needs to be trying to (these do not need to be successful endeavors) develop a new or improved “business component.” As defined in IRS regulations, the business components include a product, process, technique, invention, formula or software.

Second, the activity needs to be technological; in other words, it needs to involve the hard sciences, like engineering, physics, biology, computer science or chemistry.

Third, there needs to be some uncertainty at the onset when the company is trying to develop a new or improved business component. However, there only needs to be uncertainty regarding one of three things: can they do it, how would they do it, or the ultimate or appropriate design of what they are trying to develop.

And, finally, the company needs to be evaluating different alternatives when it is trying to develop the new or improved business component. Examples of this include systematic trial and error, modeling and simulation.

Qualifying Activities for Oil and Gas Industries

Several activities within the oil and gas industry involve the development of new or improved products, processes or techniques that would qualify for the R&D tax credit. These include:

  • Improvements made to a drilling process and its design
  • Developing fracking techniques
  • Improving methods to refine or transport oil and gas more efficiently
  • Developing plug and abandonment solutions
  • Offshore structure design
  • Design of a plant, including considerations made to pollution control and safety
  • Wastewater solution design
  • Improvements made to wells and other field equipment

Costs That Qualify For The Credit

R&D expenditures used to calculate the R&D tax credit include the wages paid to employees for engaging in qualifying R&D activity within the US, including direct supervision and direct support of such activities. Also, up to 65% of outside contractor costs associated with qualifying R&D activities can count towards the credit calculation as well, as long as the contractors are based in the US.
0 %
Outside Contractors

Very Meaningful Federal And State Tax Credit

The federal R&D tax credit typically comes out to about 5% to 7% of the above R&D spend. Most states have an R&D tax credit as well. Texas, for example, has a state R&D tax credit that comes out to about 2/3 of the federal credit and can be used to offset up to 50% of the Texas franchise taxes paid by a company each year.

The Benefit To Oil and Gas Companies

These dollar-for-dollar federal and state tax credits can significantly reduce the tax burden for oil and gas companies. In this very competitive industry, these tax savings can be used for further investments in technological advancements and also to finance additional projects and to hire more employees.

Recent Posts

ENERGY STAR vs. ZERH: Tax Implications

Building a new home is an exciting endeavor, but it can also be a significant financial investment. Fortunately, the federal government offers a tax credit program incentivizing builders and developers to construct energy-efficient homes. This not only benefits the environment, but it can also put more money back in your pocket. This article will guide

Read More »
energy tax incentives

When Should You Consider Energy Tax Incentives?

If you’re exploring energy tax incentives for your next development, you’re already ahead of the game. Surprisingly, many developers overlook significant tax breaks like the 179D deduction—or they miss their chance to claim maximum benefits by not acting early enough. You may think of energy tax incentives such as 179D as a potential bonus to

Read More »
estate planning

Estate Planning for Investors: Unlock Tax Savings with Cost Segregation

Estate planning is essential for a smooth transfer of assets, and it becomes especially complex for real estate investors. To minimize tax burdens and maximize the value of your estate, it’s crucial to understand strategies like cost segregation. This tax-saving tool allows you to reclassify specific property components for faster depreciation deductions, which translates into

Read More »

Contact Us