Depending on your perspective, wealth management can either be a burdensome chore or a satisfying challenge. However, if you are a high-net-worth individual and interested in oil and gas investments, odds are that you fall into the later camp of “money managers” who find joy in growing their net worth. Of course, even for such enthusiastic individuals, the end of the calendar year can be a challenging time as the days get shorter and so to the window of opportunity to lower your tax burden.
There are dozens of year-end tax reduction strategies that high-income earners and high-net-worth individuals like yourself can take advantage of. Although you may have already spoken to your financial advisor about your year-end tax strategy, you may wish to brush up on some of the most common tax tips in case anything was overlooked. Even with a great advisor and a fair bit of money know-how, changing tax laws and increasing complexity can make it hard for anyone to stay on top of the latest tax reduction strategies.
In this article, we’ll explore some of these basic tips, tools, and strategies for lowering your tax liability. This is not an exhaustive list, however, and individuals may have different needs based on their financial goals; speak to your financial advisor if you have questions and want to craft the best year-end tax strategy for your individual situation.
A Refresh on Tax Deductions
The year’s end usually brings with it a flurry of tax-reducing activities, but not all deductions are created equal–and not all deductions will help in the same way come filing season. The most common income tax deductions can be classified into two categories: above-the-line and below-the-line. In either case, the “line” represents your calculated adjusted gross income (AGI), the threshold to calculate tax deductions.
Above-the-line, or top-line, deductions are taken before you arrive at your final AGI, and usually appear as income subtractions, though they may also be taken as explicit deductions; below-the-line, or bottom-line, deductions are taken after you have determined your AGI and are used to reduce your taxable income further. Depending on your situation, top-line deductions may generally be more beneficial than bottom-line deductions as they lower the AGI by which other subsequent computations may have an even greater effect.
Two of the most common top-line tax deductions for high-net-worth individuals you may consider for your year-end tax strategy are IRA contributions and charitable distributions.
- IRA Contributions: these are deductible based on your modified adjusted gross income (MAGI) and whether or not you have access to a group retirement plan. If you and your spouse do not have access to such a plan, either your employer doesn’t offer one or you are both self-employed, there is no income limit for deducting traditional IRA deductions. For married couples with just one spouse having access to a group retirement plan, the MAGI limit to deduct contributions is between $204,000 and $214,000; if both spouses have access to a group plan, then the MAGI limit for the deduction is between $109,000 and $129,000.
- Qualified Charitable Distributions: these are distinct from normal charitable contributions as they are made from an IRA owned by an individual over the age of 70 (and six months, to be exact) that is paid directly to a qualified charity. A qualified charitable distribution (QCD) can be used instead of taking the required minimum distribution (RMD), which may help you avoid being pushed into a higher income tax bracket and/or prevent phaseouts of other tax deductions. QCDs are not right for every situation, but if you meet the requirements, it may be a savvy way to keep your AGI (and subsequent tax liability) as low as possible.
Adjust Your Portfolio to Maximize Year-End Tax Savings
Another way to change the way your income is taxed is to adjust the assets in your portfolio. This is a very popular strategy for high-income earners who are looking for last-minute ways to reduce their tax liability. As with any other tax-saving strategy, speak to your financial advisor to determine which strategy, or combination of strategies, will work best for you. Some of your options include: Another way to change how your income is taxed is by adjusting the assets in your portfolio. This is a very popular strategy for high-income earners looking for last-minute ways to reduce their tax liability. As with any other tax-saving strategy, speak to your financial advisor to determine which strategy, or combination of strategies, will work best for you. Some of your options include:
- Roth Conversions – After age 59-½, Roth distributions are generally tax-free. Converting your traditional, SEP, or SIMPLE IRA to a Roth IRA can be a powerful tool to reduce your tax liability on future income, but you’ll need to carefully analyze your tax bracket to assure this is the best strategy for you.
- Business Entity Restructuring: Most high-income earners, especially those high-net-worth individuals who may be considering oil and gas investments, have some kind of business entity. If you currently have an S-corp or sole proprietorship under your name, incorporating may grant a lower top tax rate. Additionally, earnings from a pass-through entity may also qualify for additional deductions of business income.
- Unrealized Loss Harvesting – Also known as tax-loss harvesting, selling investments in taxable accounts that have losses may be one of the best strategies to reduce your current-year tax liabilities. Currently, the IRS allows taxpayers to deduct up to $3,000 in losses against regular income, allowing you to offset losses with current and future year capital gains. Also worth noting is that losses not used in the current year can be carried forward to subsequent years.
- Charitable Gifting – Another way to adjust your portfolio is through charitable gifting, specifically using a donor-advised fund (DAF). DAFs allow you the opportunity to deposit assets into an account and receive a tax deduction in the year of the contribution (while the funds themselves can be spread out as distributions to preferred charities over years to come). Because assets put into a DAF can be deducted at their current market value, these funds are not subject to estate taxes and can also help you lower or avoid capital gains completely.
- Qualified Opportunity Zones – Qualified opportunity funds (QOFs) were created to boost investment to distressed communities that are part of qualified opportunity zones (QOZs). If you have capital gains from an investment, or series of investments, you can roll these gains over into a qualified QOF and defer or reduce your capital gains tax liability. There are additional rules to follow when using QOFs, so speak to your financial advisor, but this is an excellent opportunity for high-net-worth individuals to further diversify their portfolio while reducing their tax liability.
- Education Expenses – Section 529 plans are tax-advantaged savings plans designed to help pay for education. Originally limited to college expenses, 529 plans have since been expanded to cover K-12 education and apprenticeship programs. Shifting money out of your estate may shield the growth of substantial amounts from taxation if used for a family member’s education expenses. You may gift up to five times your annual gift exclusion limit into a Section 529 account in what is known as “superfunding”.
Plan for Even More Tax Savings Next Year by Investing in Oil and Gas
So far we’ve talked about some things you can do in the short term to reduce your tax liability, but in the long-term one of the best strategies to grow your wealth and effectively manage your taxes is oil and gas commodities. In fact, one of the top reasons why qualified investors choose to take advantage of joint venture oil and gas exploration opportunities is for the compelling tax benefits that go with them, especially when structured as a joint venture.
We may be biased, but there’s no denying that oil and gas commodities are in a league of their own when it comes to tax-advantaged investments. The tax incentives of energy exploration and production investments, taken separately or together, can help you build wealth, protect your portfolio, and reduce your overall tax liabilities, making them the ideal instruments for savvy, high-net-worth individuals.
Notably, oil and gas investors enjoy several major tax benefits that are found nowhere else in the tax code. Some of the tax breaks and financial advantages you can look forward to including:
- Active Income from Net Losses – The tax code specifies that a working interest in an oil and gas well is not a “passive activity,” which means that all net losses incurred in conjunction with well-head production are classified as “active income” and can be offset against other forms of income, including interest and capital gains.
- Drilling Cost Deductions – Joint venture oil and gas partners may also deduct 100% of intangible drilling costs in the year incurred, regardless of whether the well actually produces or not. These intangible costs include everything but the actual drilling equipment, such as labor, chemicals, grease, and other miscellaneous items. Tangible drilling costs, on the other hand, refer to the actual direct costs of drilling. These are also 100% deductible but must be depreciated over seven years.
- Depletion Allowance – Joint ventures may also take advantage of a provision in the 1990 Tax Act which allows certain entities to exempt 15% of their gross income from federal taxes to help support direct investors. This depletion allowance allows for the drop in oil and gas reserves in a well without incurring additional production revenue tax liabilities as a result. The small producer tax exemption, as it is known, extends only to entities that own, produce, or refine less than 50,000 barrels per day.
- Pass-Through Tax Benefits – Oil and gas partnerships, such as a joint venture agreement, provide tax benefits on a pass-through basis, which means the venture’s revenues and expenses “pass through” to the partners’ tax returns. Partners in a joint venture oil and gas well receive a Form K-1 each year, detailing their share of the revenue and expenses for easy tax-filing purposes.
How Can You Invest in Oil and Gas Exploration?
The first step to being part of an oil and gas industry joint venture is to contact Legacy Exploration. As an industry-leading upstream oil and gas company, Legacy Exploration is focused on identifying and developing energy projects that combine low risk with high return potential.
Each of our wells is its own joint venture, providing investors the opportunity for direct participation in all aspects of ownership revenue generated from oil and gas production. With over 50 years of combined industry experience backed by extensive due diligence, experienced engineers and landmen, and actual, proven oil- and natural gas-producing fields in our portfolio, Legacy Exploration is one of the leading providers of joint venture oil and gas investment opportunities.
Request your free investor kit today and take the first step toward direct ownership of oil and gas resources in the United States – in addition to all the tax benefits that come with it. If you have specific questions or would like to talk to us about getting started or would like to learn more about the tax strategies involved in oil and gas investments, contact us online today!
For more information on ownership interests, working interest, and other factors in oil and gas investment, contact Legacy Exploration, LLC today.
*Individuals may have different needs based on their financial goals; speak to your financial advisor if you have questions and want to craft the best year-end tax strategy for your individual situation.