For many years, calculating the proper Intangible Drilling Costs (IDC) deduction for Pennsylvania income tax purposes has been unclear and difficult. Recently, however, Pennsylvania worked with industry members to standardize and ease the calculation of IDC deductions available to Pennsylvania taxpayers subject to the Personal Income Tax Rules through the issuance of Information Notice 2013-04.
For tax years beginning before January 1, 2014, Pennsylvania required a Schedule M addback equal to 100% of IDCs that were elected to be expensed under IRC Section 263(C) on a taxpayer’s federal tax return. For Pennsylvania Personal Income Tax purposes, the IDC deduction was then recovered over the life of the well (a timeframe sometimes hard to calculate) matching the expense recovery for book purposes under the unit of production method.
Pennsylvania Act 52 of the 2013 Amended Section 303 of the Reform Code of 1971 (72 P.S. § 7303), changed the treatment of IDCs to specifically allow a portion to be available for immediate expensing in the year incurred.
For Pennsylvania Personal Income Tax purposes, an IDC is incurred when:
“the cost is required to be recorded on the person’s books according to the person’s method of accounting. A cash method taxpayer records an IDC when he/she/it pays such cost. An accrual method taxpayer records an IDC when the cost is fixed and determined, even if not yet paid.”
Pennsylvania will now allow an immediate deduction of up to 33% of the federal IDC claimed in the current year. The remaining 67% (or more, if the full 33% was not deducted) will need to be amortized over 10 years, a timeframe standardized with this law change. The person directly incurring the IDCs makes the election to expense the 33% by taking a current deduction on their tax return. This election should be evaluated annually to determine if it is beneficial. If the election is made at the pass-through level, the lower tier taxpayers must also follow the same election and deduction treatment as determined at the top pass-through entity.
Taxpayers will not be able to retroactively change the previous method of adding back federal expense and amortizing IDCs, however, going forward the accelerated deduction has the potential to benefit many Pennsylvania taxpayers, especially the ever-growing oil & gas industry in the Pennsylvania and the size of the related IDC deductions. This ruling has no effect on the treatment of IDCs for C Corporation taxpayers.
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