WorldWide Drilling Resource

Drilling Into Money Not Boring by Mark E. Battersby Tax Penalties for not Working Enough Although losses are a part of every drilling business, the Internal Revenue Service (IRS) appears to be denying tax benefits to an increasing number of owners of money-losing small business- es. While it may appear the owner is “materially participating” in the drilling operation and, thus allowed to deduct losses, the IRS seems increasingly eager to jump in wherever they feel a taxpayer is not as involved as the IRS thinks he or she should be. There might be multiple businesses with the owner not too active in one or more of them. Or, it may be a semiretired business owner whose child is running the drilling operation. Most sole proprietors can claim ma- terial participation because they typically spend substantial amounts of time run- ning their business. Someone with a business operating as an S Corporation or other pass-through entity, even sole proprietors, clearly runs the show - or do they? Unfortunately, merely having a finan- cial interest in a business (even if it is significant), is not enough to meet the material participation criteria - unless the taxpayer also handles the day-to-day management of the business - more than simply reviewing financial statements, monitoring operations, or providing busi- ness advice. According to the IRS, an individual materially participates in business activi- ties if he or she participates on a "reg- ular, continuous, and substantial basis." If an individual's participation is not ma- terial, he/she cannot deduct losses to the same extent as a business owner who does materially participate in the business. Investors are not treated as ma- terially participating unless they are in- volved in routine operations of the drilling business. Participation in an activity in- cludes the time of a spouse, even if the spouse doesn’t own any part of the busi- ness or when a joint tax return is not filed. The drilling business owner, share- holder, or principal has the burden of proving he or she materially participated. According to the IRS, this generally means a taxpayer will be treated as materially participating in an activity only if he or she is involved in the operation of the activity on a basis which is: 1. Regular, 2. Continuous, and 3. Substantial. Obviously, every drilling business owner will need professional assistance to ensure they meet the IRS’s criteria for materially participating in any money- losing activity or business - at least if they hope to reap the maximum benefit of their operation’s losses. Mark Mark E. Battersby may be contacted via e-mail at admin@ worldwidedrillingresource.com 57 WorldWide Drilling Resource ® JUNE 2014 " ; # 511-,(2 0) 20'5&43 %9 4+(3( ,/( $/5)$&452(23 ; 08 029'0/ # ! : : $8 $,- 3$-(3 *,6(/3,/4(2/$4,0/$- &0. "(% ,4( 777 *,6(/3,/4(2/$4,0/$- &0.