A different approach to reducing your taxable income liability this year
October 25th, 2018
By Marcus Ashworth, CFP®
As a financial planner with twenty plus years practicing, serving hundreds of families across the Southeast, it’s a common question to arise during my year end reviews. How can I save on taxes? Certainly, for small business owners there are some distinct advantages like contributing to SEPs, 401ks or Simple IRAs.
However, because those accounts also obligate the owner to also contribute to employees accounts up to a certain amount, it can become an expensive method for the owner just to achieve tax reduction. Individuals are also afforded some of these tax deferred investment accounts like the Traditional IRAs but are limited to relatively small contribution amounts (2018 cannot be more than $5,500 or $6,500 if over the age of 50).
Other retirement benefit plans like deferred compensation plans can be effective but are also complex and costly to set up. So, what’s left?
One of the most under-utilized tax advantaged opportunities for accredited investors are called a Tax Advantaged Drilling Partnership. ‘In order to encourage investment in domestic energy production and reduce our dependence on foreign imports, the federal government granted direct investments into oil & natural gas production very special tax considerations’ (source: MDS energy program). Here’s an overview of how it works.
• Companies that invest directly into the drilling of new natural gas wells are allowed to expense a large portion of that investment in the current tax year.
• Partnerships are designed to allow retail investors to take advantage of these tax benefits investing alongside a company, thus allowing SUBSTANTIAL current year tax deductions called the Intangible Drilling cost deduction and the depreciation deduction to be taken against income on their personal tax returns and can be used to offset income from other sources like RMDs’ from IRA accounts or converting Traditional IRAs to a Roth (an income event).
• In the year the client makes an investment into Tax Advantage Drilling Partnership it can take typically between 77-83% of the investment as a current year tax deduction.
• After the wells are drilled, the income starts flowing to the investors typically on a monthly basis to the partners which is also tax advantaged. These distributions can last up to 20 years.
Why Natural Gas?
• Enormous amounts of clean burning natural gas have been unlocked from shale formations in the U.S. The U.S. is now the world’s larger natural gas producer and a net Exporter of natural gas.
• ‘Amble domestic natural gas is luring companies (and jobs) away from cheap foreign labor, bringing jobs back to the U.S. It has also drastically reduced our dependence on mid-east energy. In addition, it’s helped cut our CO2 emissions to levels not seen since the early 1990s’ (source: MDS energy).
For more information about the unique tax advantages of a natural gas drilling program click on this short video provided by MDS Shale Development, LP (must type in password: mds2018 for access to content). https://vimeo.com/285342435
General Risk Factors could Include:
• Potential Loss of Principal and Illiquidity
• Because some wells may not return their drilling and completion costs, it may take many years to return your investment in cash, if ever.
• Partnership distributions may be reduced if oil and gas prices decrease during peak production, or if there is a decrease in the price of oil and natural gas.
• Prices for oil and natural gas will depend on factors largely beyond the control of the Partnerships and prices may fluctuate widely in response to factors including but not limited to: changes in the supply of and demand for oil or natural gas, market and geopolitical uncertainty; and fluctuations in world currency markets.
• Possible Leasehold Defects.
• Transfer of the working interest will not be made until well is completed.
• Participation with third parties in drilling wells may require a partnership to pay additional costs.
Please give us a call to discuss the risks associated with this type of investment and whether or not it is a suitable tax reduction strategy for your particular situation.