WorldWide Drilling Resource

Drilling Into Money Not Boring by Mark E. Battersby Related doesn’t Work with Taxes All too often, unsuspecting drilling business owners find themselves facing penalties, fines, and sub- stantial tax bills because the ever-vigilant Internal Revenue Service (IRS) has ignored a past transaction it views as having been conducted by “related persons.” Below market rate loans, sales of property, installment sales, like-kind exchanges, intercompany transactions, etc. all may suffer from special tax treatment. Making things more difficult, there isn't just one definition of “related persons”, “related parties”, or “related taxpayers” to be found in our tax laws. That’s right, different transactions have different definitions. In fact, related persons or parties can include much more than an immediate family member such as parents and children. Ancestors and lineal descendants, a partner and a partnership, a share- holder and a corporation, etc. are all considered “related” by the IRS. Transactions between related persons can generally be defined as a business deal or arrangement between two parties who are joined by a special relationship prior to the deal. One example would be a business transaction between a major shareholder and his or her drilling business, such as a contract for the shareholder's business to perform renovations to the offices of the drilling operation. Under our tax rules, this would be deemed a transaction between related parties. Not surprisingly, the IRS requires loans be structured in a business-like manner with terms which reflect current market conditions. If the terms of a loan are too favorable in the IRS of the IRS, they can recharacterize the loan as a gift, additional compensation, or as a corporate dividend or distribution - with all the tax implications recharacterization implies. The IRS and the courts examine a number of things, such as a written instrument, repayment terms, how the parties treat the transaction on their books, etc. Most of these factors may be documented and meet the requirements, but the IRS and courts also question whether a transaction, particularly a loan, is commercially feasible. That is, would an unrelated party advance money in the same situation? Our basic tax law, the Internal Revenue Code is quite clear when it comes to transactions between “related persons”, de- manding any gain recognized be treated as ordinary income (taxable in the case of an individual at a maximum rate of 39.6%). So, it is not surprising the IRS requires loans be structured in a business-like manner with terms reflecting current market conditions. Obviously, professional guidance is necessary for any drilling operating hoping to avoid the tax laws’ related-person pitfalls. Mark Mark E. Battersby may be contacted via e-mail to michele@worldwidedrillingresource.com 44 APRIL 2016 WorldWide Drilling Resource ®