Income From Oil and Gas Interest Subject to SE Tax

Post Date: 7/20/16
Last Updated: 7/20/16


Cross References
- Methvin, T.C. Memo. 2015-81
- Methvin, 10th Circuit Court of Appeals, June 24, 2016

The taxpayer was a former executive of a computer company with no special knowledge or expertise in oil and gas drilling. He invested in working interests in several oil and gas companies that had elected out of the partnership provisions of subchapter K. He received a Form 1099-MISC for his share of the income from the operator of the oil and gas drilling venture. He reported the income on his tax return, but did not report it as subject to SE tax.

The taxpayer argued that his minority working interests were merely investments and that his activity in connection with them did not rise to the level of a trade or business. The Tax Court disagreed. The income was a distributive share of income from a partnership, subject to SE tax. Even though the taxpayer was not personally active in the management or operation of the business, self-employment tax still applied. The issue of SE tax does not hinge on lack of control, but rather, whether the taxpayer was a member of a partnership or a joint venture treated as a partnership.

Upon appeal to the 10th Circuit, the Appeals Court agreed with the Tax Court. The taxpayer had the right to inspect receipts, electrical surveys, geological reports, and other records including financial records. The taxpayer also had the right to enter the property and was responsible for his proportionate share of the monthly costs.

Author's Comment: Electing out of the partnership provisions of subchapter K does not avoid SE tax. A business venture is still taxed like a partnership after the election.

Author's Comment: SE tax does not apply when the investor is a limited partner. The taxpayer in this case was a minority investor who did not participate in management. Even so, he was still subject to partnership liabilities as a general partner.

Author's Comment: Owning a working interest in an oil and gas drilling company is not the same as receiving royalties from oil and gas. A working interest refers to an investment in an oil and gas operation where the investor bears some of the costs for exploration, drilling, and production. A royalty interest only bears the initial cost of the investment and is not liable for ongoing operation costs. Thus, in contrast to a working interest, a royalty interest is not subject to SE tax because it is an interest in a resource (the oil and gas) rather than an interest in a trade or business.
Return to Tax Industry News
© Tax Materials, Inc. 2021