|IRS Office of Chief Counsel Issues Guidance on the IDC Tax Preference for AMT Purposes
The IRS Office of Chief Counsel has just released Chief Counsel Advice Memorandum 201235010 (the “Memorandum”), in which it provides its view on how an independent oil and gas company should compute the limitation on the exclusion of the intangible drilling and development costs (“IDC”) tax preference in a tax year in which the company has a loss as computed for alternative minimum tax (“AMT”) purposes.
The AMT for corporations was enacted more than thirty years ago to provide an alternative tax system for companies that reported net operating losses for the tax year and therefore paid no regular federal income tax. The AMT starts with the computation of taxable income or loss for regular tax purposes and then makes certain adjustments to items such as the deduction for depreciation and adds back certain items of tax preference, with an objective that the company pay some minimum amount of income tax even when it incurs a net operating loss for regular tax purposes. With these adjustments and items of tax preference, many companies that report a net operating loss under the regular tax system report alternative minimum taxable income upon which a tax of twenty percent is imposed.
For oil and gas companies, two of the most important items of tax preference are the preference for depletion and the preference for IDC. Congress recognized the importance of the IDC deduction for independent oil and gas companies, however, and limited the impact of the IDC preference on those companies for taxable years beginning after December 31, 1992. Section 57(a)(2)(E)(i) of the Internal Revenue Code (“Code”) now provides that the IDC preference does not apply to independent oil and gas companies, but Section 57(a)(2)(E)(ii) limits the benefit of this exception to forty percent of the alternative minimum taxable income of the company determined by first taking into account the IDC preference and by not taking into account the alternative tax net operating loss deduction.
Despite taking AMT adjustments and items of tax preference into account, many independent oil and gas companies may not report positive alternative minimum taxable income in some years, reporting instead an AMT net operating loss that may be carried back or forward for use in other AMT tax years. The Memorandum addresses the computation for such a company, providing in its facts that for the tax year in question, the company had negative 100X of alternative minimum taxable income before the IDC preference and negative 20X of alternative minimum taxable income after adding back an 80X IDC preference. The company reported the negative 100X amount of alternative minimum taxable income as an AMT net operating loss on its tax return, taking the position first that as an independent oil and gas company, the IDC preference did not apply by reason of section 57(a)(2)(E)(i) and second that the section 57(a)(2)(E)(ii) limitation on the exception did not apply because the limitation only applies when the taxpayer has alternative minimum taxable income (and not when the taxpayer has an AMT net operating loss). The IRS on audit questioned this position, thinking instead that the amount that should have been reported was negative 20X. The company's IRS examination team contacted Chief Counsel’s Office for its views.
The Chief Counsel’s Office agreed with the IRS examination team, concluding that since the company would have negative alternative minimum taxable income before and after adding in the IDC preference, the company’s situation was not one for which the relief from AMT provided for in section 57(a)(2)(E) was appropriate. But the Memorandum failed to address the company’s statutory argument that the limitation cannot apply if the taxpayer does not have alternative minimum taxable income. A plain reading of the section 57(a)(2)(E)(ii) limitation to the exception for independent oil and gas companies supports the company’s position, that is, if the taxpayer has no alternative minimum taxable income, then the 40 percent limitation in the reduction of alternative minimum taxable income provided for in the section simply cannot apply, leaving the taxpayer to report a larger AMT net operating loss that excludes the IDC preference.
Independent oil companies facing this situation should consult their tax advisors to determine their tax reporting positions.
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