The oil depletion allowance in American (US) tax law is a tax break claimable by anyone with an economic interest in a mineral deposit or standing timber. The principle is that the asset is a capital investment that is a wasting asset, and therefore

depreciation In accountancy, depreciation refers to two aspects of the same concept: first, an actual reduction in the fair value of an asset, such as the decrease in value of factory equipment each year as it is used and wears, and second, the allocation i ...

can reasonably be offset (effectively as a capital loss) against income. The allowance encouraged people who were taxed at a high marginal rate to invest in, perhaps risky, oil ventures. If the venture failed, then the costs would effectively reduce income, so the effective loss at a 90% marginal rate would only be 10% of the actual investment. Conversely if the venture was successful, an amount up to initial investment (under cost depletion, see below) would be tax free. Under the percentage depletion method the amount could potentially be even greater. The oil depletion allowance has been subject of interest because one method (percentage depletion) of claiming the allowance makes it possible to write off more than the whole capital cost of the asset.

Depletion calculation

Two methods of depletion calculations are available, detailed regulations determine which can be used, but in some circumstances the asset owner can choose.IRS publication 535
Chapter 9.

Cost depletion

With this method the original investment is effectively amortized over the productive life of the asset, starting with the original capital investment, the annual percentage being the percentage of the reserves at the beginning of the year that are sold in the course of the year. The amortized amount is deducted from the

net income In business and Accountancy, accounting, net income (also total comprehensive income, net earnings, net profit, bottom line, sales profit, or credit sales) is an entity's income minus cost of goods sold, expenses, depreciation and Amortization (a ...

before calculating taxes. The total amount deducted by this method cannot exceed the original value of the capital invested.Depletion Allowance
at Mineral Web

Percentage depletion

With this method, a fixed percentage of the

gross income For households and individuals, gross income is the sum of all wages, salaries, profits, interest payments, rents, and other forms of earnings, before any deductions or taxes. It is opposed to net income, defined as the gross income minus taxes ...

is treated as deductible. The percentage is dependent on the nature of the resource being extracted. It is possible under this scheme for the total deductibles (or indeed the annual deductible) to exceed the original capital investment.

Table of percentages

The following percentages are prescribed by the

Internal Revenue Code The Internal Revenue Code of 1986 (IRC), is the domestic portion of federal statutory tax law in the United States. It is codified in statute as Title 26 of the United States Code. The IRC is organized topically into subtitles and sections, co ...

, section 613(b). For geothermal assets the rate is 15%

Limits

For independent producers or royalty owners of oil and gas, the deduction for percentage depletion is limited to the smaller of: * The taxable mineral income from the property figured without the deduction for depletion and the deduction for domestic production activities under section 199 of the Internal Revenue Code. * 65% of the taxpayer's gross taxable income from all sources. Amounts not deductible due to the 65% limit can be carried forward.

Impact

Over the nine decades of its existence since 1916, the oil depletion allowance has benefitted

oil companies The following is a list of notable companies in the petroleum industry that are engaged in petroleum exploration and production. The list is in alphabetical order by continent and then by country. This list does not include companies only involved ...

and the

petrochemical industry file:Jampilen Petrochemical Co. 02.jpg, 300px, Jampilen Petrochemical co., Asaluyeh, Iran The petrochemical industry is concerned with the production and trade of petrochemicals. A major part is constituted by the plastics industry, plastics (poly ...

by more than $470 billion as of 2014, everything else being equal.Mother Jones, 14 April 201
"A Brief History of Big Tax Breaks for Oil Companies: There Will Be Subsidies: Nine Decades Later, “Perhaps The Most Glaring Loophole” in The Tax Code Is Still Going Strong"
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Proposals for repeal, and reduction in size and applicability

Several attempts have been advanced to repeal the allowance tax loophole. U.S. Secretary of the Treasury Henry Morgenthau in 1937 declared the depletion allowance “perhaps the most glaring loophole” in the tax code. US President

Franklin D. Roosevelt Franklin Delano Roosevelt (January 30, 1882April 12, 1945), also known as FDR, was the 32nd president of the United States, serving from 1933 until his death in 1945. He is the longest-serving U.S. president, and the only one to have served ...

decried it and other tax-avoidance stratagems by business as “so widespread and so amazing, both in their boldness and their ingenuity, that further action without delay seems imperative.” The

US Congress The United States Congress is the legislature, legislative branch of the federal government of the United States. It is a Bicameralism, bicameral legislature, including a Lower house, lower body, the United States House of Representatives, ...

refused to abolish the allowance. Similarly, President

Harry S. Truman Harry S. Truman (May 8, 1884December 26, 1972) was the 33rd president of the United States, serving from 1945 to 1953. As the 34th vice president in 1945, he assumed the presidency upon the death of Franklin D. Roosevelt that year. Subsequen ...

unsuccessfully proposed repealing the allowance. In Congress in 1969 there was a cut in the depletion allowance from 27.5% to 23%, despite objections from Gulf Oil's president. It was later reduced to 15%. In 1975

Gerald Ford Gerald Rudolph Ford Jr. (born Leslie Lynch King Jr.; July 14, 1913December 26, 2006) was the 38th president of the United States, serving from 1974 to 1977. A member of the Republican Party (United States), Republican Party, Ford assumed the p ...

signed a tax bill that repealed the allowance for large companies. In 2005

George W. Bush George Walker Bush (born July 6, 1946) is an American politician and businessman who was the 43rd president of the United States from 2001 to 2009. A member of the Bush family and the Republican Party (United States), Republican Party, he i ...

signed the

Energy Policy Act of 2005 The Energy Policy Act of 2005 () is a federal law signed by President George W. Bush on August 8, 2005, at Sandia National Laboratories in Albuquerque, New Mexico. The act, described by proponents as an attempt to combat growing energy problems ...

, expanding the allowance to more drillers.

Sources

This article uses text from ''Internal Revenue Code, Section 613(b)'', and ''Publication 535 (2013), Business Expenses '' which are in the

Public Domain The public domain (PD) consists of all the creative work to which no Exclusive exclusive intellectual property rights apply. Those rights may have expired, been forfeited, expressly Waiver, waived, or may be inapplicable. Because no one holds ...

as works of the US Federal Government

References

{{Authority control American legal terminology Petroleum economics United States tax law Oil and gas law