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Why oil and gas companies cannot file amended returns for missed 263(c) elections

What are 263(c) elections and how do they work?

263(c) elections allow the taxpayer the option to expense intangible drilling and development costs (IDC expenses), which are the costs associated with developing oil and gas wells for elements that are not part of a final operating well. However, the code states that the taxpayer must exercise the election on the first taxable year in which the taxpayer pays or incurs such costs. No formal statement is necessary, but if the taxpayer fails to deduct the IDC, the taxpayer is deemed to have elected to recover such costs through depletion, to the extent that physical property does not represent the cost and through depreciation to the extent the cost represent physical property. If the taxpayer does not make the election, the default accounting method is capitalization.

You missed the election – can you file an amended return?

In the event a taxpayer did not capitalize or expense IDC on a timely-filed original return, it would appear that no election to expense or capitalize was made, and the taxpayer could simply file an amended return and chose the deduction method. However, the IRS takes the position that if the expense was not taken on the original return, the taxpayer is deemed to have elected to capitalize, whether an amount was omitted or not. This means that an amended return is not permitted; an amended return would only be filed to correct the capitalized amount, in such a case it would be from zero to the correct capitalized amount.      

So, where is the relief for the taxpayer?

The only avenue available to taxpayers to receive relief is under section 301.9100-3. The taxpayer would need to provide evidence to establish, to the satisfaction of the Commissioner, that the taxpayer acted reasonably and in good faith and the grant of relief will not prejudice the interests of the government. This would require the taxpayer to file a private letter ruling (PLR) requesting an extension to file the election on an amended return. The PLR requires an explanation of the facts and reasons why there was a failure to make the election. Reasons such as inexperience of the tax preparer in the oil and gas industry and lack of knowledge on the operations of the investment could be sufficient. The PLR would also require a fee of $10,900, which is paid to the IRS. This relief is valuable to taxpayers who are unaware of the option to elect to expense IDCs in the initial filing of the tax return.

For more information on this topic or to learn how Baker Tilly specialists can help, contact our team.

The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.

Wesley Middleton
Managing Partner
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