In 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48), which establishes accounting and disclosure requirements for uncertain tax positions.  FIN 48 applies to all entities that issue GAAP financial statements, including pass-through entities like partnerships and LLCs.  Since its issuance, a number of questions have been raised about how to apply the provisions of the interpretation.  So far, there aren’t many answers.

As a result, the FASB has deferred the effective date of FIN 48 to annual financial statements for fiscal years beginning after December 15, 2008.  The deferral applies to most nonpublic entities with certain exceptions.

If an entity elects to defer adoption of the Interpretation, the entity must disclose its election, as well as its accounting policy for evaluating uncertain tax positions for each set of financial statements were the deferral applies.

 A windfall profits tax is an idea floated by many that would tax an industry based on income in a single year that is much higher than its previous years.  The idea became very popular in late 2008 when the price of a barrel of oil approached $150.  President Obama made a campaign promise to enact such a tax.  Many people continue to push the idea of a Windfall Profits Tax even though oil has since dropped below $40 a barrel as a method to stimulate the economy.  Lloyd Chapman makes this argument in his Huffington Post article.

 There are some new changes to the 2008 Partnership Tax Return (Form 1065) that could make taxpayers have to do some more digging and have us, preparers, asking a lot more questions.

Schedule B (Other Information) was previously a half-page, list of 12 “yes or no” questions whose repsonses could easily be carried forward from the prior year. The new Schedule B (still labeled Other Information) now spans a page and a half! This makes the Form 1065 five pages instead of four.

New reporting requirements ask that you state any corporation, partnership, or trust that “directly or indirectly owns more than 50% of the profit, loss or capital of the partnership”. A separate section asks about individuals or estates that “directly or indirectly owns more than 50% of the profit, loss or capital of the partnership”. The key word that I think definitely has to be focused on is INDIRECTLY; that word alone will require a taxpayer to do some mapping of ownership amongst its partners.

Another question in Schedule B asks about the partnerships ownership of other entities. It requires you list any corporation or partnership directly with at least 20% or own “directly or indirectly 50% or more of the voting power”. Again, the term “indirectly” pops out to makes us think a little harder beyond just the entity filing the return and its partners.

So, as information is beginning to be gathered and you prepare to file your return or have it filed by your trusted tax professional, do yourself (and them) a favor and get this new information together as well. If you want to review all the new questions and required information, check out the IRS website to view a copy of the form.

One of the common issues encountered in the setup of a drilling company is the handling of the economic deal of the partners in the drafting of the partnership agreement.

Many deals, especially those financed by investment funds, have a tiered or waterfall structure for allocating income and distributions.  It is normal for the partners who are putting the deal together and who will run the day-to-day operations to have a relatively small ownership percentage on the front end since most of the capital will come from an investment fund.

Over time, based on the entity’s performance and the increase in value of the enterprise, these “operations partners” may increase their ownership percentage in the income and profits of the partnership.  This will usually occur once certain return hurdles are met for the “investment partners.”  Unless provided for in the partnership agreement, this switch in sharing percentages will result in the “investment partners” being allocated more income and therefore more distributions over time that the parties intend.

Although there are several options, the best way to make sure all partners end up being allocated the income and distributions everyone intends each party to receive over time, is to handle income allocation and distribution provisions independently in the partnership agreement.

Like-kind Exchanges, or 1031 Exchanges, allow for the deferral of gain on trade or business or investment property when it is exchanged for similar property. Like-kind exchanges are often used by businesses to exchange cars or pieces of real estate. Similarly, you can use a 1031 Exchange for oil and gas properties as well.

Working interests and royalty interests are considered interests in real estate. As a result, not only can you exchange a working interest for another working interest and take advantage of deferring tax on the gain, you can exchange oil and gas interests with other types of real estate as well.

To qualify for Like-kind Exchange treatment, there are some limitations:

1. The property relinquished and the replacement property must be trade or business property or be property held for investment.
2. Upon the sale of the relinquished property, you have 45 days to specifically identify the replacement property. There are additional limitations if you identify more than three replacement properties.
3. You must close on the purchase of the replacement property within 180 days of the sale of the relinquished property.
4. The exchange must take place using a qualified intermediary.

For additional information on using 1031 Exchanges for oil and gas properties, see this article from 1031 Corporation.