American Jobs Act of 2011 - Oil Subsidies or Wounded Warriors ? Republicans Get to Choose

Originally Published on forbes.com on September 4th,2011

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The revenue raising pieces of the American Job Acts of 2011 are drawn from the populist grab bag (They start on page 134 of the 155 page documents.  I wonder whether  they always have dessert first at White House dinners.)   They are:

1. 28% Limitation of Certain Deductions and Exclusions

2.Tax Carried Interest in Investment Partnerships as Ordinary Income

3. Close Loophole for Corporate Jet Depreciation

4.Repeal Oil Subsidies

5. Dual Capacity Taxpayers

6. Increase Target and Trigger for Joint Select Committee on Deficit Reduction

Number 6 is an admission that there is just not enough money in the populist grab bag to pay for all the good stuff in the bill.  The balance will get picked up by making the Joint Select Committee just work a little bit harder.  I don’t have much to say on 3 and 5.  Number 1 is still giving me a headache.  I’d actually like to hear what The Wandering Tax Pro has to say on it.  I can tell it would be easier to walk through, if I still did returns by hand like The Pro does. (I understand it conceptually but the details of how to do the computations are a little challenging). Number 2 is close to my heart.  Proposed Code Section 710 is different in this incarnation than in the one that I have been grousing about.  I’ve reached out to the experts and hope to hear back from them soon.  That leaves number 4 for this post – Repeal Oil Subsidies.

Here is my question on that. Why do we have to go from favoring oil  to picking on it ? The bill proposes that we get rid of expensing of intangible drilling costs and the oil and gas working interest exception to the passive activity loss rules.  I’m with you there.  Those are special breaks to the oil  industry.  There are a few more things being repealed like the marginal well production credit, that I think you have to live in the oil patch to understand, but I can take on faith that they are subsidies to the industry.  What is with percentage depletion and Section 199, though ?  The proposal is not to end percentage depletion and Section 199.  The proposal is to just end them for oil.  I should probably explain what they are.
Percentage Depletion – The Deduction that Keeps on Deducting

The income tax is not a tax on gross receipts.  When you sell something you get to reduce income by your basis in that thing. Generally your basis in something is what you paid for it, but of course it can be more complicated than that.  If you buy a lot of stuff, all at once, that you sell off over time, apportioning that basis to particular sales can be a little complicated.  One thing is clear though, once you sell all the stuff you will have been allowed to deduct its entire cost and no more than that. 

If what you bought was a bunch of gold that is buried in the ground, what you could do is have somebody estimate how much gold there is in that thar hill.  Divide that amount by how much you paid for the gold mine.  Say it comes to $300 per ounce.  Then as you sell the gold you can deduct $300 per ounce.  You might change the estimate as time goes on adjusting the per ounce cost of the remaining gold.  Ultimately though you will get to deduct the whole cost.  If there is still some gold left, because your estimate was off, you don’t have anything left to deduct.  That is the way it works if you are using cost depletion.

Percentage depletion is different.  In the case of a gold mine, you just deduct 15% of the gross income as a depletion deduction and reduce your cost basis in the mine.  That doesn’t seem like such a huge benefit.  You could look at it as a simplified way of recovering your basis.  What is special about percentage depletion is that once your basis has been recovered you get to keep on taking depletion deductions.  That can confuse accountants.  Before your basis is recovered you debit depletion expense and credit basis in gold mine.  Afterwards you debit depletion expense and …..  There is nothing to credit.  Very disturbing to some accountants, but the people benefiting from the deduction don’t seem to mind.  As a matter of fact percentage depletion is one of the reasons why owning a gold mine is like owning a gold mine.

You don’t just get percentage depletion on gold mines.  It is also iron and silver and copper and uranium.  The list goes on and on.  Oddly enough oil and gas percentage depletion deductions are already subject to special limitations that don’t apply to other depletable assets like brucite, coal, lignite, perlite, sodium chloride, and wollastonite.  I wonder what wollastonite is.

My question then is how can we call percentage depletion an oil subsidy when it applies to so many other things?  Furthermore why isn’t there outrage about the wollastonite subsidies ? I just had to look it up.  Wollastonite is used primarily in ceramics, friction products (brakes and clutches), metalmaking, paint filler, and plastics.  So pertoleum makes cars go and wollastonite makes them stop.  Seem like we need them both. I don’t understand why they should be taxed differently.

Section 199 – The Entry the starts out unbalanced.

Section 199 terrifies me.  It applies to a lot of industries.  Manufacturing, construction, natural resources.  The deduction is 9% of income attributable to domestic production activiites.  There are limitations including one related to W-2 wages, which I discussed in a previous post.  The deduction terrifies me because it is a totally unbalanced entry, so I am always worried that I am going to forget about it when I am reviewing a return.  The deduction doesn’t apply to service income so I suppose I should be with the President on this one.  If you are not going to give the break to public accounting, why should oil  be getting it?  On the other hand why aren’t they going after the wollastonite miners or the manufacuturers who make the stupid tchotchkes you see in gift shops (I guess not many of them are domestic, but that’s not the point.)  Why just oil ?

Is the whole thing a set up ?

The President has cherry picked the revenue raisers with the most populist appeal – logic and sound tax policy be damned. They don’t raise enough money for the good things in the bill, but he has the Joint Select Committee to do the actual work of finding revenue raisers that might not be popular or spending cuts to pay for the bill.  If the bill does not pass, it will make a great campaign narrative.  The Republicans chose the hedge fund managers and the oil  industry over the Returning Heroes and Wounded Warriors Work Opporunity Tax Credit.  Oh well.  It is what it is.  Deal with it.