How would following Generally Accepted Accounting Principles (GAAP) for depletion be any ethically different than following GAAP for depreciation or amortization?
What does GAAP have to do with tax deductions?
To restate this, it appears that under percentage depletion, it doesn’t matter how much you spent to develop and obtain the resource, you get to reduce taxable income 15% for oil and gas resources. Under cost depletion, you capitalize your expenses directly then depreciate them based on the percentage of the resource used.
But what do we know about business and taxes?
This can’t possibly be legal, can it?
GAAP dictates how a company states expenses on their income statement. Depletion is an expense, just like depreciation is an expense.
Taxes are based on net income, i.e., revenue minus expenses.
That’s not how it works. Taxes are based on taxable income, which has only a loose relationship with GAAP income.
And Net Income is AFTER taxes. But accounting tax expense and taxes actually paid are quite different.
Why do I feel like I’m teaching an Accounting 101 class?
I feel like I’m in a Thunderdome type situation run by actuaries.
“As it is written in the Holy Form W3-J 'Two men (or adult indivuals of any gender) enter. One man (or adult individual of any gender) leaves. This will be a fight to the death, said death being certified by qualified medical personnel. Before we witness the grand spectacle of combat, a toast from the waters of Camp Lejeune!”
Because you are.
So that means that the taxable income may start with the GAAP income, then you apply the various and sundry discounts such as depletion.
Makes sense to me. Depreciation is an actual lowering of the worth of your physical assets; Depletion is the reduction of … future raw materials? meaning future cessation of earnings?
Yeah, this is a specific tax break for the oil industry. Are depletion breaks allowed for coal mining? What about gold/silver/etc.? What about water wells? At this point, the aquafer is a depletable resource!
Hey! Let’s get things straight here! This is all tax and accounting. Actuaries have nothing to do with it.
Watch it, or I’ll report you for denigrating the fine, upstanding Actuarial profession! 
(can you tell what I did for 20 years?)
I didn’t go into Actuarial Science because the opening line in my interview with the department head was “What we are concerned with in Actuarial Science is Morbidity and Mortality” in an absolutely incredible monotone.
Decision Sciences seemed like a positive hoot after that.
But I’m teaching it to people who want to school me.
And, actually, that’s exactly the type of calculation used in determining depletion. Actuaries (or, at least Actuarial Science) can be used in manufacturing sites to estimate costs due to future equipment failure.
Actuaries! Not just for breakfast any more!
Fraud is actually hard to prove. You have to prove not only that they underpaid their taxes but that they knew they underpaid their taxes and were doing it on purpose. Then you have to prove it beyond a reasonable doubt. With a big corporation, where everyone is responsible for only a small part of its operations, it’s not that easy to prove. It’s much easier to prove in a civil case that it’s more likely than not that the corporation underpaid its taxes. The government collects the back taxes, interest, and penalties. There is no need to prove intent.
With big corporations, there can also be very large collateral consequences to a criminal conviction. For example, a criminal conviction against an investment bank might mean that it can’t remain registered as a broker-dealer and must go out of business. I think there are also ramifications for companies that have federal government contracts. These potential consequences give the corporation limitless motivation to fight a criminal charge.
There are several angles here. The kids’ allowance becomes a deductible business expense. The kids can contribute the income to a tax deductible IRA, so they don’t pay income taxes on it. Subsequent growth in the IRA is tax deferred (or, if they are using a Roth IRA, tax free). It removes cash from the estate without using up the unified credit, so it can save on estate taxes and preserve estate tax planning flexibility. There might be other benefits I’m forgetting at the moment.
As an example, one weird loophole I remember reading about years ago. There was a tax credit credit intended to promote using renewable fuels. Paper mills for years had been using renewable fuels forever because they use part of the pulp waste to heat vats of something or other while making paper. But the tax credit was only for blending renewable fuels into fossil fuels. It was intended for things like adding corn-based fuel to gasoline or bio-diesel to regular diesel. To get the tax credit, the paper mills started burning barrels of oil with their pulp waste, thereby reducing their taxes and harming the environment in one fell swoop.
I know vanishingly little about depletion rules and so perhaps what you are saying is correct but there is nothing in article that would limit the amount of percentage depletion based on the cost to acquire the resources. The article says that you multiply gross income by the appropriate percentage. So, to make numbers completely up:
Buy and develop oil well at a cost of $1,000.
First year, pump $10,000 in oil. Operating cost to pump oil is $2,000. So net of pumping costs, gross income is $8,000.
The article says you multiply that gross income by percentage depletion rate of 15%. That would give you a percentage depletion deduction of $1,200, which is more than the cost to put the well in service. And, the operator would presumably get the same deduction the next year, even though the deduction has already exceeded the cost of the well. The article notes, “Since the percentage depletion deduction is a flat rate, the resulting tax break often exceeds the cost depletion deduction, thus acting as a sizable subsidy to qualifying energy companies.”
So, while the actual rules may place other limits on the deduction, the article you are using for support does not explain those limits. Please don’t just appeal to authority. Show your work.
I’m not sure whether you are asking whether depletion expenses is allowed at all or whether you are asking whether those resources get the additional “break” of using percentage depletion. Depletion deductions are allowed for coal and precious metals mining. Omar_Little’s article notes that percentage depletion is available for gold/silver mining (but doesn’t mention coal). I’m not sure about aquifers but one would think in principle, these are extractive industries and would get a depletion deduction. Of course, in tax law, the common sense answer is not always the correct one.
And note that if the well is a bust and yields no oil you get to deduct the development cost using the Cost Depletion Method.
Heads I win, tails you lose.
Rarely is it.
I knew nothing about depletion rules, so I didn’t have much to say there, but if what you say is correct, they are entirely different from the amortization/depreciation that I save some taxes on. Making the comparison that @Omar_Little made and accusing people of hypocrisy in supporting one and not the other seems to have been entirely without merit.
I can only write off how much I spent on buildout and equipment, and the reason it is on that table is because I can’t write it off all in one year (and probably wouldn’t want to anyway).
One of the parts that makes the least sense (to me, anyway), is that if I do the work myself, I can only write off the materials, not my labor. But if I hire a contractor, I can write off based on the contract cost, which includes the contractor and his employees’ labor.
That’s what I was asking. Thanks for the answer - ignorance fought.
You could if you paid yourself to do it. But then you’d have compensation income that is taxable.
Same reason I can’t deduct the value of my work from my salary.
When I was working, my one person consulting business had lots of expenses. I deducted the cost of owning and operating my car, even though I frequently used my car for personal reasons. I would extend business trips and take a few vacation days and write off the whole trip. Whenever I bought I new laptop, I wrote that off, even though I also used them as my personal computers. ( I had to depreciate these computers over 5 years and it always felt ridiculous, because I used these computers on construction sites and I was lucky to get 18 months out of one. I usually had 4 being depreciated each year.)
But here’s the catch. My accountant had to assign a value to the personal use of my business assets, and that value ( which wasn’t small, it was a 5 figure number) was taxable income. So I got all these executive fringe benefits, like Trump employees did, but I paid taxes on the value of those benefits.
I think I was where most businesses were, I looked to legally minimize my tax burden as much as possible but I never committed fraud, and most businesses don’t. And in the universe of businesses that commit fraud and do get caught, it usually happens because someone that knows what’s going on wanted them to get caught - a disgruntled ex-employee, a suspicious short-seller or ambitious reporter.
The best way not to get caught is to make sure no one wants you to get caught. This is where Trump messed up.
This is where much of my concerns about the ubiquity of fraud stem from–the absence of government’s pro-active pursuit of business crime. NYC and NY State and the IRS look at someone like Trump (for a convenient example) doing blatantly suspicious things for decades on end–setting up ludicrously obvious frauds like Trump University and Trump charities, and–no problem. You or I go “Wow! I’ll bet a lot of money that there’s some big-time fraud going on there–I wonder if anyone learns anything in that University or if those cancer patients ever get a millisecond of treatment” but the government waits and waits and waits for someone to step forward and say “Here! I have some proof for ya!” before they think “OK maybe, just maybe, there’s illegal shit going on here” when anyone with eyes that of course there is. Most businesses get away with this fraud for decades, if not forever.