Audits In the Oil and Gas Industry
In August 2020, the WESTLAW Energy and Environment Daily Briefing posted the following update:
- A Pennsylvania man has been sentenced to prison and ordered to pay more than $10.2 million in restitution to multiple federal agencies for fraudulently obtaining renewable fuel credits for his businesses.
This was the ruling from United States v. Dunham, et al. U.S. District Judge Jeffrey L. Schmehl for the Eastern District of Pennsylvania sentenced David M. Dunham Jr. on Aug. 6, saying his prison stint will be followed by three years of supervised release.
Dunham, owner of Smarter Fuel LLC and co-owner of Greenworks Holdings LLC, was convicted in April 2019 on charges of wire fraud, obstruction of justice, filing false tax documents, and associated conspiracy counts.
The criminal case stemmed from Dunham’s scheme to deceive the U.S. Environmental Protection Agency, other federal agencies, and his customers by obtaining renewable fuel credits for his biofuel business, the DOJ said. “David Dunham is a thief, dressed up in ‘green energy’ clothing,” U.S. Attorney William M. McSwain said in a statement from the Department of Justice.
This article will tell you how you may be able to save yourself from becoming a similar headline. The oil and gas industry is one of the most regulated in the world, so it should come as no surprise to you that it is frequently a target of tax audits by the IRS and California taxing authorities. In order to ensure that your or your enterprise, or Oil and Gas Investment does not fall on the wrong side of the law, it is crucial that you are aware of all of the intricate issues involved in audits of the oil and gas industry.
Oil and Gas Industry Overview
Huge sums of money are needed to discover, develop, and produce crude oil and natural gas. Companies will occasionally collaborate and pool their resources to fund oil exploration. Partnerships are frequently created to allow outside investors to fund drilling projects. The investors can be unfamiliar with the oil and gas sector. They are prepared to put money into risky drilling projects since there are potential tax advantages and significant economic gains. Institutional investors make substantial investments to achieve returns without taking on excessive risk by purchasing royalty interests in producing oil and gas properties.
The IRS and California Taxing Authorities, such as the California Franchise Tax Board (FTB), Employment Development Department (EDD), and California Department of Tax and Fee Administration (CDTFA are aware that the unique aspects of the oil and gas industry present opportunities to evade taxes in numerous ways. The IRS audits oil and gas companies so frequently that it has even developed an Oil and Gas Audit Technique Guide strictly for examinations within this industry. You should know that the IRS is extremely meticulous in its approach and has a deep understanding of all of the vulnerable areas. For example, in light of the fact that the oil and gas industry has expanded its activities into financial products, the agents are now trained to be on the lookout for vehicles that are being used to “hedge” and claim an ordinary loss versus a capital loss.
Mr. Klasing is a dually licensed Tax Attorney and CPA who has decades of experience as a former auditor himself from working for various public accounting firms. As such, he can often anticipate the approach auditors will take and can craft a strategy to meet these challenges.
Why Was I Audited?
Why were you chosen? Well, the IRS selects returns to audit not “at random” but (often) according to a well-defined scoring system. Every tax return is “scored” using the IRS’s “Discriminant Function System” or DIF. There are an array of reasons why oil and gas entities get audited. Some of the most common issues that get audited include the following: the total amount of gross income reported; the trade or business deductions taken; bad debts; net operating losses; capital loss carryforwards; depreciation; and capital expenditures.
You may have improperly included estimates that are overstated, nondeductible costs, or allowances for contingencies in the total estimated costs figure that reduced the percentage of completion. This may have resulted in the understatement of the corresponding income to be reported on the contract.
Or youmay have improperly allocated costs from contracts that are still in progress to completed contracts that accelerated the expense recognition. An unusually low gross profit on a job could have indicated to the IRS existence ofan improper job allocation.
Common Oil and Gas Industry Audit Issues
Please be aware that examiners will ascertain your overhead allocation during the initial interview. They will try to establish whether you had an economic interest in the property. Your properties will be inspected to check whether overhead is distributed between producing and nonproducing properties. Additionally, the properties will be closely examined to check whether all business activities, such as investing, manufacturing, refining, etc., are receiving their fair amount of overhead. Interest payments made on operating capital borrowings are an overhead expense that is recognized as an increasing production cost under the guidelines of IRC. Before allocating, you are advised to net interest expenses to the extent of interest income.
The compliance requirements are undoubtedly complex and burdensome. In order to ensure all legal requirements are being met, The best course of action in such a situation would be to consult the Tax Law Office of David Warren Klasing.
It is important to determine if the taxpayer has a preference item for alternative minimum tax if they are claiming percentage depletion. Pursuant to IRC section 57(a)(1), a tax preference item is defined as the excess of percentage depletion over the adjusted basis of the depletable interest at the end of the tax year with respect to each property. Without considering the depletion deduction for the tax year, the property’s adjusted basis is calculated, and the amended basis of the depletable property at the start of the year must be supported by documentation from the taxpayer. The majority of taxpayers incorporate the property’s modified basis in their depletion schedule. All percentage depletion will be regarded as a tax preference item if the taxpayer is unable to produce this substantiation. Therefore, it is crucial to be as meticulous as possible and to seek professional assistance.
The property concept is the basis for the use of the property unit as the tax entity for purposes of depletion, abandonment losses, recapture rules, etc. The property definitionemphasizes separateness, specifically, the separateness of different types of interests, geographic locations (surface), and oil and gas deposits (subsurface). The taxing authorities are aware that the taxpayer might manipulate the definition of property to attempt to take larger deductions for depletion, take a premature deduction for an abandonment, or reduce its recapture potential. They know that many taxpayers will account for their income and expenses on a well-by-well basis for their accounting records; others might segregate their income and expenses by prospect. Since records are set up this way, many taxpayers may not want to go through the inconvenience and cost of converting the records to reflect the property concept for tax purposes.
Initial Information Documents Request
Several records are required to start investigating oil and gas activity. You can expect to be served with the first Information Document Request (IDR) and Form 4564. Additionally, you may be invited to attend the audit from the very beginning. The list below covers oil and gas-related items, which will be requested on the initial IDR. The basic records that might be required of you are as follows:
- Charts of cost centers, lease names, and numbers.
- Detailed depletion schedules related to the tax return.
- Records show the lease’s expiration or release for leaseholds abandoned during this tax year.
In order to establish which elements apply specifically to you, it is imperative to seek assistance from a qualified tax attorney to help in the identification of legal regulations and requirements.
Requesting Assistance from Specialists
It is common practice for examiners of an oil and gas company to seek assistance from subject matter experts (“SMEs”) or a specialist in the field. Doing this helps them identify planning and development issues. An examiner may sometimes require support from more than one specialty examiner (specialist). Specialists can include IRS engineers, computer and audit specialists, CBA representatives, financial products specialists, etc.
State Regulation of Oil and Gas Production
State agencies closely monitor and regulate oil and gas development and production. Each state’s authorities to carry out law enforcement differ. A variety of state permits must be secured before any form of drilling, exploration, deepening, plugging, abandoning, or examiners can use another activity to summarize the various acts taken on oil and gas assets. Different useful dates of notices of intention to drill a well, the type of well, the legal description of the property, the estimated total depth, etc., are included in the applications for the various permits and reports of work submitted to state agencies.
“Upstream” and “Downstream” are typically considered to be the only two fundamental parts of the oil and gas business. Companies in the upstream segment explore oil and gas fields and drill wells to produce crude oil and natural gas, along with harvesting those raw materials in the general area of its wells. Companies in the downstreamsegment execute the tasks such as gathering, processing, transportation, refining, marketing, distribution, and retailing. Although more than one person carries out some functions, the downstream segment has several recognized sectors. The conversion of these raw materials into completed ones must typically be carried out differently due to the physical and chemical differences between crude oil and natural gas.
This type of interest entitles its owner to a portion of the mineral deposit’s production, free of development and maintenance charges, and extends undiminished for the duration of the property’s productive life.
Entitles its owner to a share in the production. However, the owner is still responsible for paying a share of the development and operation costs. Owners of working and royalties interests may sell or otherwise dispose of all or a portion of their respective interests in the total production, subject to certain limitations. The overall production is then further divided into overriding royalties, oil and gas production payments, net profits interest, carried interest, and other income categories.
Overhead Costs of Oil Company Departments
The cost of acquiring oil and gas leasehold properties must be deducted from certain departmental overhead expenses.
Leveraged Oil & Gas Drilling Partnerships
Investors in specific drilling operations use partnerships to make claims for loss and current deduction for IDC in amounts that the Services claims exceed the partnerships’ real IDC and the investors’ economic expenditure. Even while not all oil and gas drilling partnerships participate in these unethical practices, agents looking into these partnerships are very conscious of this issue.
Taxpayer Audit Steps
The key steps that examiners follow in oil and gas audits are:
- Identifying the operator of all drilling prospects associated with the partnership.
- Determining if the partnership has a working interest.
- Identifying if there are any wells or activities outside of the United States.
- Comparing wells actually drilled to wells only listed in the document that transfers working interests, often identified as a prospect agreement, but not actually drilled.
- Determining when the wells were actually drilled and whether any related invoices are dated prior to the stated or actual formation of the partnership.
- Reviewing the dates of the invoices for the wells and noting any unusual lengths of time after the well was spudded.
- Determining whether documents from third parties indicate whether the promoter, a promoter-controlled entity or its contractor, was the primary or sole contact with the actual well operators.
- Determining whether the division order or joint interest billing statements were sent to the promoter, or a promoter-controlled entity, as the named working interest partner for payment.
- Determining whether the promoter, promoter-controlled entity, or the partnership, signed the election letters for well operations.
- For each associated partnership, requesting executed copies of agreements between the Turnkey Driller and any well-servicing companies for activities, i.e., logging, cementing, casing, perforating, fracturing, and maintenance.
Why do You Need Us? If any actions with your filing could be viewed as fraudulent!!!
While representing you, our objectives in dealing with the examining agent are:
- to attempt to limit the scope of the inquiry;
- to limit the information provided to avoid both waiver of the Fifth Amendment and incrimination;
- to avoid tying you to an explanation you cannot support;
- to prevent the presentation of false or misleading information that could lead to the allegation that you are engaged in a scheme to cover up the fraud; and
- to avoid claiming the Fifth Amendment or otherwise alerting the revenue agent to the fraudulent aspects of the returns.
There is a world of difference between an ordinary audit and a tax fraud investigation. The objective of most civil audits is to present as much evidence as possible to convince the agent or conferee that an adjustment is not appropriate. However, our goal in a tax fraud investigation is to limit the scope of the investigation to purely civil matters where possible.
You should also know that although federal authorities file most criminal tax charges, California also has laws prohibiting both individual and corporate tax evasion and tax fraud. Criminal Tax Law Defense is a specialized area of practice. It is important for the practitioner to be familiar both with the applicable tax laws and the criminal statutes applicable for failure to follow those laws and effective defense strategies.
Our Role as Criminal Tax Defense Attorneys
If a revenue agent suspects tax fraud, the agent is directed to notify his manager and a Fraud Enforcement Advisor (FEA) may be associated into the case. The role of an FEA is to serve as a resource and liaison to tax compliance employees (e.g., revenue agents) and assist in fraud investigations and offer advice on matters concerning tax fraud. Thereafter, the goal of the revenue agent and the FEA working on the case will be to establish sufficient affirmative acts to confirm a finding of tax fraud. In all likelihood, the revenue agent will seek to gather as much information as possible before making a referral to the IRSCriminal Investigation Division because once such a referral is made, IRS policy generally mandates that the civil audit cease. The revenue agent will not ordinarily volunteer the fact that he is working with an FEA to build a case for criminal tax referral.
Our role will include becoming involved in the criminal tax investigation, eggshell audit or reverse eggshell audit at the earliest possible time. Initially, we will strive to protect you by not furnishing incriminating information to the special agents or at least limiting the amount of information that must be voluntarily given to the Service. This is because we would need time to discern the nature of every client representation and to review relevant records (evidence).
Our job as dually licensed criminal tax defense attorney & CPAs also includes weaving a defense from the sources of available information. Special agents are much more likely to accept a defense premised on the third party’s written and oral information. This will require me to interview third parties during the investigation. There is no need to wait for the special agents to interview a particular witness first. Any key witness, such as the preparer or accountant, should be interviewed as soon as possible and copies of any documents held by these persons obtained. Oftentimes, witnesses give their original documents to the special agents, thus foreclosing their later availability to the taxpayer’s attorney. Correspondingly, this would foreclose an attorney from determining what knowledge or belief is in the mind of the special agent.
We truly understand how the IRS and California Tax authorities function and run their civil audits and criminal tax investigations. We are well conversant with the background information that IRS, CDTFA, FTB, and EDD have on the oil and gas industry and how it familiarizes and trains its examiners with the issues they need to understand when auditing or criminally investigating/prosecuting you.To schedule a confidential, reduced-rate initial consultation, call our Irvine or Los Angeles law firm at 800-681-1295 or schedule online today HERE.
Warning signs an IRS tax audit has gone criminal
What Is An Eggshell Tax Audit
What are effective Tax Defense Counsels Goals in an Egg Shell Audit?
So you cheated on your taxes and you are under a tax audit
Why should I hire a tax attorney to represent me in a tax audit?
More Commonly Asked Tax Audit Questions
- How should Tax Audits be Handled by Criminal Tax Counsel?
- How to survive audit when I cheated on return being audited
- What is an eggshell audit?
- What is a reverse egg shell audit?
- Why is a reverse egg shell audit dangerous for a taxpayer?
- Warning signs of a criminal referral from an IRS audit
- Effective tax defense counsels goals in an egg shell audit?
- How are the 4 goals and outcomes 1 and 2 best obtained?
- What are the possible outcomes of an egg shell audit?
- Is it my right to know why I was selected for examination?
- What can I do to prepare for an audit?
- What is an IRS civil examination?
- How IRS decides which tax returns are audited
- What are my appeal options if I disagree with IRS?
- What are my basic taxpayer rights if the IRS audits me?
- Options if I am unable to pay at the conclusion of audit
- What a 30 or 90-Day Letter from the IRS means
- What is involved with appealing disagreements?
- Rights to disagree with IRStaxauditor’sss findings
- Can I stop the IRS from repeatedly auditing me?
- Can I have the examination transferred to another area?
- Can I record my IRS interview and is it a good idea?
- How many years of returns are at risk during an audit?
- Common reasons for the IRS to conduct a tax audit
- How to avoid negative consequences from an IRS interview
- Have to agree to interview by taxing authority directly?
- Are all audits the same?
- What should I do if the IRS is investigating me?
- What ifIdon’ttt respond to a taxing authority audit notice
- Your rights during an IRS tax audit
- Risks of attending an IRS audit without a tax lawyer
- Most common audit technique used by taxing authorities
- Don't go into an IRS audit without representation
- Why hire an attorney to represent me in an audit?
- Why hire David W. Klasing to represent me in an audit
California Sales Tax Questions and Answers
- Common issues encountered during sales tax audit
- What is a sales tax audit?
- Disagreeing with business audit conclusions
- Timeline to file Petition for Redetermination?
- What should Petition for Redetermination contain?
- Is the appeals conference formal or informal?
- Appeals Division’s Decision and Recommendation
- Are a mark-up percentage and a profit margin the same?
- Problems with the mark up audit
- Can State Board of Equalization ignore my business records
- What is a sales tax deficiency determination?
- Business being audited for sales tax. Should I be worried?
- Audit determined fraud to avoid sales and use tax
- Definition of “sale” for California Sales Tax
- What do California sellers need to know about sales tax?
- How do I apply for a sellers permit?
- What are my obligations as a permit holder?
- What is sales tax?
- What is tangible personal property?
- What is a sale?
- What are total gross receipts?
- What is use tax?
- Who is responsible for paying the use tax?
- Who is a retailer engaged in business in California?
- Who is a qualified purchaser?
- Do I need a Certificate of Registration Use tax?
- Do I need a Use Tax Direct Payment Permit?
- What types of sales are exempt from sales tax?
- How are Internet Transactions Taxed?
- How is California sales or use tax determined?
- What is the statewide sales and use tax rate?
- Are there other local and district sales and use taxes?
- Total sales and use tax rate calculation
- How to protect against successor liability in California
- Recourse when issued California sales tax liability notice
- CA Sales Tax liability extend to purchasers/successors?
- Waiting Until Audited to Take Action on Tax Matters
- Sales tax records needed in California
- What are California’s sales and use taxes?
- Why does the State of California audit businesses to ensure compliance with sales and use taxes? How does the State determine whether to audit my business?
- The BOE reviews the purchase invoices of my business
Questions and Answers for Criminal Tax Representation
- When tax defense counsel parallels tax crime investigation
- Guilty of tax obstruction by backdating documents?
- To be found guilty of tax obstruction must a person actually be successful in impeding the IRS’s functions?
- Help! The Document I Gave the IRS Had False Information
- Tax crime aiding or assisting false return IRC §7206(2)
- What is the crime known as tax obstruction § 7212?
- What is the difference between tax perjury and tax evasion?
- What is the tax crime commonly known as tax perjury?
- What is a Klein Conspiracy?
- Increased possibility of civil action in IRS investigation
- Am I Guilty of Tax Evasion if the Law is Vague?
- What happens if the IRS thinks I committed tax crimes?
- What are ways to defend against a tax evasion charge?
- Difference between criminal tax evasion and civil tax fraud
- What accounting method does the IRS use for tax fraud
- Can I Change Accounting Method to the Accrual Method
- What is the willfulness requirement for tax evasion?
- I didn’t know I committed tax fraud. Can I get off?
- Concealed assets from IRS. Can I avoid tax evasion charges
- How government proves I willfully engaged in tax evasion
- What is the venue or court where a tax crime case is heard?
- Must the IRS prove tax crimes beyond a reasonable doubt?
- Is it a crime to make false statements to the IRS?
- Will the IRS overlook my tax evasion if it’s minor?
- Failed to tell IRS about my nominee account
- Audit risk with cash based business transactions
- How to defend a client charged with tax evasion
- Is it tax evasion if I didn’t file income tax return?
- Government says I attempted to evade my taxes. Now what?
- I forgot to pay my taxes or estimated tax. Is this a crime?
- Government proof I “willfully” failed to pay taxes
- 5 Ways to Respond to Tax Evasion Charges
- Being audited after using a tax professional
- Rules for what an IRS agent can do while investigating me
- How tax preparers, attorneys and accountants are punished
- How the IRS selects tax crime lead for investigation
- How does the IRS prosecute suspected tax crimes?
- Does IRS reward informant leads for suspected tax crimes?
- How the government proves deficiency in a tax evasion case
- Do prior tax crimes factor into new IRS tax convictions?
- Requesting conference before investigative report is done
- Requesting conference after IRS Special Agent Report
- What are my rights during an IRS criminal investigation?
- Avoid prosecution for tax crime with voluntary disclosure?
- Defense tactics that make it hard for to prove willfulness
- How a tax attorney can stop your criminal tax case?
- What can you generally tell me about tax crimes?
- Continuing filing requirement with investigation pending
- Federal criminal code crimes that apply to tax issues
- Penalty for making, subscribing, and filing a false return
- CID special agent’s report for criminal prosecution
- What is the discovery process in a criminal tax case?
- What the IRS includes in indictment for tax case
- What is the hardest element of a tax crime to prove?
- IRS methods of gathering evidence to prove tax crime
- What does a grand jury do in IRS tax crime prosecution?
- Failure to keep records or supply information
- Failure to make a return, supply information, or pay tax
- What is attempting to evade payment of taxes?
- What is income tax evasion and how is it punished?
- What is attempted income tax evasion?
- What is the crime of failure to pay tax? What is punishment
- Crime of making or subscribing false return or document
- Criminal Investigation Division investigation tactics
- Tax crimes related to employment tax forms and trust funds
- Tactics to defend or mitigate IRS criminal tax charges
- How the IRS generates leads about suspected tax crimes
- What is the crime ”evasion of assessment” of tax?
- Specific examples of “attempting” to evade tax assessment
- What is the so-called Spies evasion doctrine?
- Does overstating deductions constitute tax evasion?
- Is it tax evasion if my W-4 contains false statements?
- IRC §7201 attempt to evade vs. common-law crime of attempt
- What are the penalties for Spies tax evasion?
- How government proves a taxpayer attempted tax fraud
- What is a tax that was “due and owing.”
- What is evasion of assessment for tax liability?
- Is evasion of assessment different from evasion of payment
- Does the IRS have a dollar threshold for tax fraud?
- What is the IRS burden of proof for tax fraud convictions?
- Are Tax Laws Constitutional?
- What is the source of law that defines tax evasion?
- Does section 7201 create two distinct criminal offenses?
- Does tax evasion definition include partnership LLC
- What if I helped someone else evade taxes?
- Is it illegal to overstate deductions on my tax return?
- Is it illegal to conceal bank accounts from the IRS?
- Do later losses justify prior deductions?
- Common reasons the IRS and DOJ start investigations
- What is the Mens Rea component of tax crimes?
- What is a proffer agreement and what are the risks?
- Why to have an attorney to review a proffer agreement
- Why enter into a proffer agreement?
- Limited use immunity from proffer agreements
- Difference between civil and criminal fraud allegation
Questions about delinquent payroll taxes and trust fund recovery penalty
- What happens if an employer continues to incur new payroll tax liabilities?
- California Employment Taxes Basics
- How Does the IRS Develop an Employment Tax Fraud Case from the First Indication of Fraud to a Criminal Indictment?
- Can more than one person be considered responsible by IRS
- How unpaid employment tax payments are allocated
- When a corporate officer is considered a responsible party
- Examples of trust fund recovery penalty determinations
- Failing to pay employment taxes after notice is given
- How to determine responsible person for trust fund recovery
- Assessing trust fund recovery penalty and option to appeal
- What is the trust fund recovery penalty?
- What are the penalties for failure to pay employment taxes
- When am I considered liable for company’s employment taxes