What is the Marginal Well Credit?

By Amanda Halverson, CPA

Section 45I of the Internal Revenue Code (IRC) allows domestic producers of crude oil and natural gas a nonrefundable federal income tax credit (Marginal Well Credit) during times of low prices. The credit targets production from marginal wells (generally wells with low profitability).

Each year, the IRS determines the credit amount based on the relationship between the commodity’s calendar year reference price and an inflation-adjusted price limit. There is a credit in years that the reference price is less than the adjusted price limit. Producers must then determine if they qualify for the credit based on annual production.

In May 2022, the IRS announced the 2021 reference price and credit (see Internal Revenue Bulletin: 2022-18), providing a 2021 credit for producers of qualified natural gas at $0.67 per thousand cubic feet (Mcf) , which is a one-cent increase from 2020. High oil prices in 2021 phased out of the 2021 credit for qualified crude oil producers.

What are the qualifications for the Marginal Well Credit?

The credit is available on the gross production of the first 1,095 barrels of oil equivalent (BOE) per property, which is approximately 6,570 Mcf of gas. In 2021, the maximum credit amount for qualified natural gas producers is $4,402 per property or well. Producers with an operating interest in more than one well that is on one tract or parcel of land generally must combine interests under IRC Section 614(b)(2).

Each combined property is eligible for the credit. However, if the producer filed a separate property election, each well is eligible for the credit. The separate property election must be filed in the first tax year the producer has development or operational expenditures after acquiring the property interest.

There is no limit to the number of properties (or wells with a valid separate property election) a producer can use to calculate the credit. In many cases, the credit is maximized by calculating production on each well separately.

How is the credit for natural gas production calculated?

IRC Section 45I(c)(3) defines a “qualified marginal well” with two different production measurements:

• A stripper well property with gross production of 15 barrels of oil (90 Mcf of gas) or less on average per day or

• A property with gross production of more than 15 barrels of oil on average per day (90 Mcf of gas) if:

1. Average daily production is not more than 25 barrels of oil (150 Mcf gas); and
2. It produces water at a rate of not less than 95% of total well effluent.

If a property qualifies, then gross production (limited to the first 1,095 BOE) is multiplied by the annual credit amount per barrel (Mcf).

Additional considerations when calculating the credit include:

• In 2021, the maximum credit is $4,402 per property used to offset federal income tax, not Alternative Minimum Tax.
• The credit is a nonrefundable General Business Credit.
• The credit has a 5-year carryback and 20-year carryforward.
• The credit is available for tax years 2019 through 2021. Producers may amend returns for unclaimed Marginal Well Credits but can’t amend returns for the separate property election under IRC Section 614(b)(2).
• If a producer owns less than a 100% operating interest in qualifying property, the credit is calculated based on the property’s gross production (limited to the first 1,095 BOE), then allocated based on each producer’s operating interest.
• If a producer is eligible for both the marginal well credit under IRC Section 45I and nonconventional sources credit under IRC Section 45K, producers must elect out of the nonconventional sources credit to claim the marginal well credit.

What are the next steps?

To determine eligibility, producers may calculate qualified natural gas production from their marginal wells and complete Form 8904, Credit for Oil and Gas Production from Marginal Wells. The Marginal Well Credit for natural gas has been available since 2019 because of low prices.

However, in June 2022, natural gas prices reached a 10-year high of over $9.00. If the natural gas reference price is greater than the inflation adjust price, there will be no marginal well credit in 2022.

Amanda Halverson, CPA, is a senior tax manager at Eide Bailly LLP in Oklahoma City. She has worked in public accounting since 2012 and graduated from Dickinson State University in 2014. Halverson was nominated for the 2018 Oklahoma City Young Professionals Horizon Award, received the 2019 OSCPA Trailblazer Award and was named the 2019 Eide Bailly Rising Star for the Oklahoma City-Norman office.