Tucked inside a massive tax bill that won the support of Pennsylvania legislators Monday is a nod to oil and gas investors who've been battling with the state Department of Revenue for half a dozen years.
Individual investors and company owners who report their oil and gas proceeds as personal income have been trying to get Pennsylvania to allow the same tax deduction on drilling costs as they get from the federal government. That is, a 100 percent deduction of intangible drilling costs in the same year the money is spent.
"Oil and gas is risky," said Charles Potter, a voting shareholder and attorney at Downtown-based law firm Buchanan Ingersoll & Rooney who is litigating at least 10 cases against the Pennsylvania Department of Revenue. "Ever since the federal tax code was invented in 1913, they always put [in] incentives because they want to encourage people to explore for oil and gas."
Intangible drilling costs cover everything that goes into putting a well into production, except the cost of the equipment. They include, for example, land surveying expenses, fracking, labor, fuel and drilling mud.
The federal government offers the option of immediate deduction or capitalization over five years, while Pennsylvania allows such expenses to be amortized only over the life of a well. That's the way it's always been in the state, said Department of Revenue spokeswoman Elizabeth Brassell.
But some in the oil and gas industry noticed a change about the time that development of the Marcellus Shale resources got going in Pennsylvania. They say investors and independent producers continued to claim the deduction as before, but the state started inspecting their tax returns and not allowing it.
"Until three or four years ago, they paid almost no attention to it," Mr. Potter said. "We didn't have anybody assessed until 2006."
Both Mr. Potter and the Marcellus Shale Coalition, an industry group that represents operators in the region, say this issue is one for the small guys -- the individual investors, or small pass-through companies. Those smaller operators are not the driving force behind the development of the Marcellus Shale, whose wells run, on average, $5 million a pop.
But it's the Marcellus Shale Coalition that pushed this effort in the Legislature. Jeff Wlahofsky, a CPA at Strip District-based accounting firm Schneider Downs & Co Inc., led the coalition's effort to bring Pennsylvania in line with the federal government.
He wrote a white paper on the subject for legislators and was asked to draft the language for the bill, asking for a 100 percent deduction in the first year. Lawmakers modified it to a 33 percent immediate deduction with the rest amortized over 10 years.
The accelerated deduction could be a win for a rising class of Marcellus backers -- private equity investors. As the industry has consolidated over the past few years, some of its seasoned executives took the money they made on those consolidation deals and started new oil and gas firms with private equity money.
Still unclear is how much the newly permitted deduction would impact state tax revenue.
Both the House and Senate appropriation committees concluded the state would lose $1.1 million next year. The Senate committee further projected another $3.3 million during the 2013-2014 fiscal year, and $4.2 million the year after that.
"Where those numbers come from, I have no idea. They don't make any sense to me," Mr. Wlahofsky said, suspecting the impact might be higher.
The Department of Revenue declined to provide a fiscal analysis, Ms. Brassell said.
The bill has been approved by both the House and Senate.
It won't be a full victory for the industry -- not an immediate write-off like the federal government offers. "I think it's a start," Mr. Wlahofsky said. "At least we have some guidance of how to handle these costs going forward."
"It's better than nothing," Mr. Potter said.
Anya Litvak: email@example.com or 412-263-1455