Percentage Depletion

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When accounting students study income tax accounting, the first concept they learn is financial accounting and income tax accounting will produce different amounts of revenue and expenses. The net income reported on financial statements will differ from the net income reported to the Internal Revenue Service. The difference is created by temporary and/or permanent tax differences.
Temporary tax differences are caused by timing; these differences will eventually reverse themselves. Permanent tax differences, as the name suggests, will not be reversed. An example that most students are familiar with would be interest income earned on municipal bonds. However, many students are not familiar with the permanent tax
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Marginal wells, also referred to as stripper wells, produce less than 15 BO per day. These wells contribute 20% of domestic oil production and 12% of domestic gas production (U.S. Energy Information Administration). The IPAA also reminded Congress that marginal wells are expensive to operate and revenue barely covers operating costs. Percentage depletion allows the operator to retain more of the marginal well’s revenue.
Obviously the goal for the oil and gas producer is to make more money and using percentage depletion will help the producer reach that goal. The goal of permanent tax differences is to encourage desirable behavior or discourage undesirable behavior. For example, buy municipal bonds and the government will not tax your interest income because the government encourages this behavior. Fines and penalties paid for infractions of regulations are not allowed as expense deductions. Government will not reward bad behavior. Percentage depletion was meant to encourage drilling and to keep marginal wells producing. The statistical data provided by the US Energy Information Administration support the conclusion that this tax policy is working.
While the benefit of this permanent tax difference is apparent, costs associated with percentage depletion are harder to
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