Oil and Gas Investor Subject to Self-Employment Tax for Fractional Working Interest Ownership

A recent court case, Methin v. Commissioner, T.C. Memo 2015-81, ruled that an investor’s small (at times 5% or less) share of a working interest in an oil and gas well constituted self-employment income under IRC §1402.

The taxpayer’s position in the case was clear –– his ownership in these working interest programs should not be considered self-employment income based on the following:

  • The taxpayer had no knowledge of the oil and gas industry.
  • The taxpayer had an agreement with the operator of his interest whereby the operator managed the operations of the various wells, which meant the taxpayer had no control over the operations and was merely an “investing” partner.
  • The taxpayer argued he was not subject to self-employment tax imposed on general partners of a partnership by IRC §1402(a), since the entity had elected out of Subchapter K; therefore, he was not a partner.

The court agreed that the taxpayer had no knowledge of the oil and gas industry and that the taxpayer did not actively participate in the management of the oil and gas wells in which he was invested. 

However, the tax court relied on Cokes v. Commissioner, 91 T.C. 222 (1988), which concluded that a partnership still exists even when an election out of Subchapter K is made.  Since there is still a partnership (although no requirement to file a Form 1065), the taxpayer’s distributive share of income allocated would be subject to self-employment tax under §1402(a).

Had the entity been formed under state law as a limited partnership and filed a Form 1065, the results could have been different.  The taxpayer would not be subject to self-employment tax under IRC §1402 due to a special exception granted to limited partners under IRC §1402(a)(13). 

The tax laws governing oil and gas investments are complex.  If you are contemplating one of these investments, please talk to your Schneider Downs tax advisor before making the investment to determine a strategy that will provide the most tax-efficient outcome.

You’ve heard our thoughts… We’d like to hear yours

The Schneider Downs Our Thoughts On blog exists to create a dialogue on issues that are important to organizations and individuals. While we enjoy sharing our ideas and insights, we’re especially interested in what you may have to say. If you have a question or a comment about this article – or any article from the Our Thoughts On blog – we hope you’ll share it with us. After all, a dialogue is an exchange of ideas, and we’d like to hear from you. Email us at [email protected].

Material discussed is meant for informational purposes only, and it is not to be construed as investment, tax, or legal advice. Please note that individual situations can vary. Therefore, this information should be relied upon when coordinated with individual professional advice.

© 2024 Schneider Downs. All rights-reserved. All content on this site is property of Schneider Downs unless otherwise noted and should not be used without written permission.

our thoughts on
The Importance of Certified Business Valuation Professionals
Tax, Tax Impact BY Jared Sofranko
IRS Tax-Exempt and Governmental Entity New Compliance Programs
Tax BY Brianna Lundy
Employee Retention Credit: IRS’s Voluntary Disclosure Program Expiring on March 22, 2024
Pillar Two is Here; Is Your Company Ready?
Not-for-Profit, Tax BY Sarah Piot
Not-For-Profit Tax Credit Opportunities Included in the Inflation Reduction Act
Tax BY Taylor Mahan
E-Filing for Form 990-T and Form 1120-POL Temporarily Unavailable
Register to receive our weekly newsletter with our most recent columns and insights.
Have a question? Ask us!

We’d love to hear from you. Drop us a note, and we’ll respond to you as quickly as possible.

Ask us
contact us
Pittsburgh

This site uses cookies to ensure that we give you the best user experience. Cookies assist in navigation, analyzing traffic and in our marketing efforts as described in our Privacy Policy.

×