WorldWide Drilling Resource

Drilling Into Money Not Boring by Mark E. Battersby Taxing Pass-Through Income ~ or Most of It Pass-through business entities, drilling businesses which don’t pay taxes, but instead, pass income (and losses) onto the personal income tax returns of their owners, have long been extremely popular. In fact, S Corporations are currently the most-used entity with limited liability companies (LLCs), the most frequently chosen. However, thanks to the recently enacted “reforms” under the Tax Cuts and Jobs Act (TCJA), pass-through owners might face higher tax bills, prompting many to consider the basic ‘C’ Corporation for their operations. S Corporations, LLCs, partnerships, and sole proprietorships, even those paying no wages, can now deduct 20% of their income below $315,000 (half this amount for single taxpayers). For income above this level, the 20% deduction remains - but only for “business profits,” creating a top effective tax rate of 29.6%. To apply the wage and capital limitations, the new law imposes on pass-through owners earning more than the threshold amount, it is first necessary to calculate 20% of the qualified net business income - for each separate business activity. The next step requires selecting the higher of one of two factors. Factor one equals 50% of the wages paid and deducted by the drilling business. Factor two consists of the sum of 25% of business wages and 2.5% of qualified unadjusted property. Once the greater of these two factors has been determined, a drilling professional uses the lesser of the wage and capital limitation, or the percentage of business income factor as their deduction. Qualified property is defined by our lawmakers as tangible property subject to depreciation which is held by, available for use in, the qualified trade or business at the close of the taxable year. Wages paid by the drilling operation or business refers to all wages, including wages paid to employees of the business. Clear as mud? After all, with rules which disallowed fringe benefits and demand reasonable compensation for pass-through drilling businesses, why would anyone want to operate under those rules when they could easily pay tax at the new 21% cor- porate tax rate and deduct fringe benefits. Because S Corporations attempting to convert to regular ‘C’ Corporation face new rules under the TCJA, professional guidance is obviously needed, especially when attempting to decide which type of business entity is right for the drilling oper- ation - and which will produce the lowest possible tax bill under the TCJA. Mark Mark E. Battersby may be contacted via e-mail to michele@worldwidedrillingresource.com 8 MARCH 2018 WorldWide Drilling Resource ®