What is Severance Tax on Oil and Gas?
Thanks to mother nature, there are many resource-rich locations in the US, including Alaska, North Dakota, and Wyoming. Local governments in these states and many others collect severance tax on oil and gas.
Unlike most countries, the US government gives property owners the right to the minerals beneath their land.
If you have absolute fee simple ownership of your property, you own the surface structures and the minerals in the subsurface. You can either extract these resources or lease your rights to an oil and gas company to earn royalties.
However, before you think about leasing or renting your mineral rights, you should know about severance tax and how it works. This discourse will provide further details.
What Is Severance Tax Oil and Gas?
A severance tax is a payable amount mandated by the government upon extracting non-renewable consumer resources. Oil and gas companies must pay taxes on the volume and value of the resources they extract from the ground.
Similarly, if you’re a mineral rights owner who earns royalty interest on oil and gas extraction, you will have to pay a small fraction of your payments in severance tax. Although the taxation rate and system vary from state to state, you might want to get legal help to assess the tax deductions from your royalty payments.
Mainly, the natural resources upon which you have to pay severance tax include,
- Natural Gas
- Crude Oil
- Coalbed Methane
- Carbon Dioxide
The tax is imposed on resource extractors, producers, and royalty owners according to the value and volume of the material extracted, according to the respective state’s laws.
Why The Term ‘Severance’?
The term ‘severance’ is used because the taxation amount covers the loss or ‘severance’ of the resources from the ground. As mentioned, in the US, the natural resources in the subsurface belong to the owners rather than the government itself.
However, as the resources lie in the state’s vicinity, and extracting it uses up an extent of the state’s resources, this tax is imposed on oil and gas companies. Moreover, the tax is only imposed on non-renewable resources as they are permanently ‘severed’ from the subsurface without further compensation to the state.
Furthermore, the tax is not imposed on every drilling well intended to extract natural resources. Instead, each well is assessed for its potential to produce the resources, and the tax amount is mandated accordingly. Meaning wells that do not meet the minimum amount of resource production are exempted from the severance tax.
Why Are Severance Tax Oil and Gas Mandated?
Attributing to the rapid advancements in industrial technology, today, it is easier to discover and extract natural resources such as oil and gas from the subsurface. More people can extract and earn revenue on the resources found underneath their property, making states ponder upon the chances to generate revenue from the same.
By mandating severance tax on oil and gas, US states make sure that the rich resources in their vicinity also benefit the state and its various communities along with the owners.
Similarly, while oil and gas production does increase the economic influx in the country, it also inflicts damages on the communities existing within the nation. For example, infrastructure intended for developing and extracting these resources may cause communities and societies to relocate.
Thus, severance tax collected by the government helps them reimburse these communities for the impact they face in their everyday lives due to oil and gas extraction. Besides that, as oil and gas are non-renewable resources, the tax also works as a fine and compensation for permanently severed resources from the ground.
How Many States Charge Severance Taxes?
If you’re a mineral rights owner concerned about deductions from your royalty payments, you shouldn’t worry immediately. Not all US states have mandated severance taxes on natural resources just yet.
Around thirty-four states producing oil, natural gas, and other non-renewable resources have mandated severance taxes or levy fees for extraction, production, and sale. Apart from oil and gas, these taxes are imposed upon various other materials severed from the ground. The list of materials included under the severance law, along with their taxable value and volume, varies from state to state.
A total of thirty-four states in the US produce natural resources. Among these states, five stand out as the highest-producing states. These include Louisiana, Oklahoma, Pennsylvania, Texas, and Wyoming.
Pennsylvania is the country’s highest natural resources producer, which still does not charge a severance tax from its citizens. Although, oil and gas extraction companies do have to pay a particular levy upon each well they drill as an impact fee to compensate for its impact on the environment.
Moreover, thirty-one states are producing crude oil where severance tax is mandated on extraction companies. The highest-producing states from this list include Texas, North Dakota, New Mexico, Alaska, and Oklahoma.
If you’re not aware of the specifications in your state and want to know how much tax you’ll have to pay on your royalty interest, you should get legal help immediately.
How Is Severance Tax Oil and Gas Calculated?
In some cases, severance tax is calculated based on the value and volume of the resources extracted or a combination of both. While some states allow extraction companies to pay tax on their gross revenue, others narrow down the chances for companies to reduce deductions.
The company can deduct marketing, transportation, and other logistic costs from its taxable revenue in most states. Similarly, certain exemptions are put in place to attract companies to areas where extraction can be tricky and costly in most cases.
While each state has a different set of laws and specifications, there are two main ways of calculating severance tax.
Gross Value Method
The gross value method imposes a tax upon the extraction company based on the exact value of the oil or gas extracted. This way, the tax is mandated as soon as the product is produced, without any issues regarding exemptions or deductions.
However, this method is subject to market fluctuation, so the state cannot specify the revenue it will earn through severance tax.
Volume Value Method
Apart from the physical value method, the volume value method is also used in some states. In this case, the tax is mandated according to the volume of oil or gas produced, such as per barrel or cubic foot. In this process, the material’s pricing or value is not considered.
Severance tax on oil and gas extraction, production, and sales is imposed in almost every natural-resource producing state in the US. However, the taxation amount deducted from your revenue depends entirely on the severance tax laws in your state.
Apart from legal variations and taxation methods, many states allow companies to buy credits and avail exemptions to continue working in economically non-viable locations. If you’re a mineral rights owner earning royalty, these aspects will impact the amount deducted from your yearly paycheck.