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Income Tax Return Preparation

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Income Tax Return Preparation

Income tax return preparation 6. Income tax return preparation   Insurance Table of Contents What's New Introduction Topics - This chapter discusses: Useful Items - You may want to see: Deductible PremiumsSelf-Employed Health Insurance Deduction Nondeductible Premiums Capitalized Premiums When To Deduct Premiums What's New Retiree drug subsidy. Income tax return preparation  Beginning in 2013, sponsors of certain qualified retiree prescription drug plans must account for the subsidy received by reducing the amount of qualified retiree prescription drug plans expense by the subsidy received (taking into account the taxpayer's accounting method). Income tax return preparation For more information, see the retiree drug subsidy frequently asked questions on IRS. Income tax return preparation gov. Income tax return preparation Introduction You generally can deduct the ordinary and necessary cost of insurance as a business expense if it is for your trade, business, or profession. Income tax return preparation However, you may have to capitalize certain insurance costs under the uniform capitalization rules. Income tax return preparation For more information, see Capitalized Premiums , later. Income tax return preparation Topics - This chapter discusses: Deductible premiums Nondeductible premiums Capitalized premiums When to deduct premiums Useful Items - You may want to see: Publication 15-B Employer's Tax Guide to Fringe Benefits 525 Taxable and Nontaxable Income 538 Accounting Periods and Methods 547 Casualties, Disasters, and Thefts Form (and Instructions) 1040 U. Income tax return preparation S. Income tax return preparation Individual Income Tax Return See chapter 12 for information about getting publications and forms. Income tax return preparation Deductible Premiums You generally can deduct premiums you pay for the following kinds of insurance related to your trade or business. Income tax return preparation Insurance that covers fire, storm, theft, accident, or similar losses. Income tax return preparation Credit insurance that covers losses from business bad debts. Income tax return preparation Group hospitalization and medical insurance for employees, including long-term care insurance. Income tax return preparation If a partnership pays accident and health insurance premiums for its partners, it generally can deduct them as guaranteed payments to partners. Income tax return preparation If an S corporation pays accident and health insurance premiums for its more-than-2% shareholder-employees, it generally can deduct them, but must also include them in the shareholder's wages subject to federal income tax withholding. Income tax return preparation See Publication 15-B. Income tax return preparation Liability insurance. Income tax return preparation Malpractice insurance that covers your personal liability for professional negligence resulting in injury or damage to patients or clients. Income tax return preparation Workers' compensation insurance set by state law that covers any claims for bodily injuries or job-related diseases suffered by employees in your business, regardless of fault. Income tax return preparation If a partnership pays workers' compensation premiums for its partners, it generally can deduct them as guaranteed payments to partners. Income tax return preparation If an S corporation pays workers' compensation premiums for its more-than-2% shareholder-employees, it generally can deduct them, but must also include them in the shareholder's wages. Income tax return preparation Contributions to a state unemployment insurance fund are deductible as taxes if they are considered taxes under state law. Income tax return preparation Overhead insurance that pays for business overhead expenses you have during long periods of disability caused by your injury or sickness. Income tax return preparation Car and other vehicle insurance that covers vehicles used in your business for liability, damages, and other losses. Income tax return preparation If you operate a vehicle partly for personal use, deduct only the part of the insurance premium that applies to the business use of the vehicle. Income tax return preparation If you use the standard mileage rate to figure your car expenses, you cannot deduct any car insurance premiums. Income tax return preparation Life insurance covering your officers and employees if you are not directly or indirectly a beneficiary under the contract. Income tax return preparation Business interruption insurance that pays for lost profits if your business is shut down due to a fire or other cause. Income tax return preparation Self-Employed Health Insurance Deduction You may be able to deduct premiums paid for medical and dental insurance and qualified long-term care insurance for yourself, your spouse, and your dependents. Income tax return preparation The insurance can also cover your child who was under age 27 at the end of 2013, even if the child was not your dependent. Income tax return preparation A child includes your son, daughter, stepchild, adopted child, or foster child. Income tax return preparation A foster child is any child placed with you by an authorized placement agency or by judgment, decree, or other order of any court of competent jurisdiction. Income tax return preparation One of the following statements must be true. Income tax return preparation You were self-employed and had a net profit for the year reported on Schedule C (Form 1040), Profit or Loss From Business; Schedule C-EZ (Form 1040), Net Profit From Business; or Schedule F (Form 1040), Profit or Loss From Farming. Income tax return preparation You were a partner with net earnings from self-employment for the year reported on Schedule K-1 (Form 1065), Partner's Share of Income, Deductions, Credits, etc. Income tax return preparation , box 14, code A. Income tax return preparation You used one of the optional methods to figure your net earnings from self-employment on Schedule SE. Income tax return preparation You received wages in 2013 from an S corporation in which you were a more-than-2% shareholder. Income tax return preparation Health insurance premiums paid or reimbursed by the S corporation are shown as wages on Form W-2, Wage and Tax Statement. Income tax return preparation The insurance plan must be established, or considered to be established as discussed in the following bullets, under your business. Income tax return preparation For self-employed individuals filing a Schedule C, C-EZ, or F, a policy can be either in the name of the business or in the name of the individual. Income tax return preparation For partners, a policy can be either in the name of the partnership or in the name of the partner. Income tax return preparation You can either pay the premiums yourself or your partnership can pay them and report the premium amounts on Schedule K-1 (Form 1065) as guaranteed payments to be included in your gross income. Income tax return preparation However, if the policy is in your name and you pay the premiums yourself, the partnership must reimburse you and report the premium amounts on Schedule K-1 (Form 1065) as guaranteed payments to be included in your gross income. Income tax return preparation Otherwise, the insurance plan will not be considered to be established under your business. Income tax return preparation For more-than-2% shareholders, a policy can be either in the name of the S corporation or in the name of the shareholder. Income tax return preparation You can either pay the premiums yourself or your S corporation can pay them and report the premium amounts on Form W-2 as wages to be included in your gross income. Income tax return preparation However, if the policy is in your name and you pay the premiums yourself, the S corporation must reimburse you and report the premium amounts on Form W-2 as wages to be included in your gross income. Income tax return preparation Otherwise, the insurance plan will not be considered to be established under your business. Income tax return preparation Medicare premiums you voluntarily pay to obtain insurance in your name that is similar to qualifying private health insurance can be used to figure the deduction. Income tax return preparation If you previously filed returns without using Medicare premiums to figure the deduction, you can file timely amended returns to refigure the deduction. Income tax return preparation For more information, see Form 1040X, Amended U. Income tax return preparation S. Income tax return preparation Individual Income Tax Return. Income tax return preparation Amounts paid for health insurance coverage from retirement plan distributions that were nontaxable because you are a retired public safety officer cannot be used to figure the deduction. Income tax return preparation Take the deduction on Form 1040, line 29. Income tax return preparation Qualified long-term care insurance. Income tax return preparation   You can include premiums paid on a qualified long-term care insurance contract when figuring your deduction. Income tax return preparation But, for each person covered, you can include only the smaller of the following amounts. Income tax return preparation The amount paid for that person. Income tax return preparation The amount shown below. Income tax return preparation Use the person's age at the end of the tax year. Income tax return preparation Age 40 or younger–$360 Age 41 to 50–$680 Age 51 to 60–$1,360 Age 61 to 70–$3,640 Age 71 or older–$4,550 Qualified long-term care insurance contract. Income tax return preparation   A qualified long-term care insurance contract is an insurance contract that only provides coverage of qualified long-term care services. Income tax return preparation The contract must meet all the following requirements. Income tax return preparation It must be guaranteed renewable. Income tax return preparation It must provide that refunds, other than refunds on the death of the insured or complete surrender or cancellation of the contract, and dividends under the contract may be used only to reduce future premiums or increase future benefits. Income tax return preparation It must not provide for a cash surrender value or other money that can be paid, assigned, pledged, or borrowed. Income tax return preparation It generally must not pay or reimburse expenses incurred for services or items that would be reimbursed under Medicare, except where Medicare is a secondary payer or the contract makes per diem or other periodic payments without regard to expenses. Income tax return preparation Qualified long-term care services. Income tax return preparation   Qualified long-term care services are: Necessary diagnostic, preventive, therapeutic, curing, treating, mitigating, and rehabilitative services, and Maintenance or personal care services. Income tax return preparation The services must be required by a chronically ill individual and prescribed by a licensed health care practitioner. Income tax return preparation Worksheet 6-A. Income tax return preparation Self-Employed Health Insurance Deduction Worksheet Note. Income tax return preparation Use a separate worksheet for each trade or business under which an insurance plan is established. Income tax return preparation 1. Income tax return preparation Enter the total amount paid in 2013 for health insurance coverage established under your business for 2013 for you, your spouse, and your dependents. Income tax return preparation Your insurance can also cover your child who was under age 27 at the end of 2013, even if the child was not your dependent. Income tax return preparation But do not include the following. Income tax return preparation   Amounts for any month you were eligible to participate in a health plan subsidized by your or your spouse's employer or the employer of either your dependent or your child who was under the age of 27 at the end of 2013. Income tax return preparation Any amounts paid from retirement plan distributions that were nontaxable because you are a retired public safety officer. Income tax return preparation Any amounts you included on Form 8885, line 4. Income tax return preparation Any qualified health insurance premiums you paid to “U. Income tax return preparation S. Income tax return preparation Treasury-HCTC. Income tax return preparation ” Any health coverage tax credit advance payments shown in box 1 of Form 1099-H. Income tax return preparation Any payments for qualified long-term care insurance (see line 2) 1. Income tax return preparation   2. Income tax return preparation For coverage under a qualified long-term care insurance contract, enter for each person covered the smaller of the following amounts. Income tax return preparation       a) Total payments made for that person during the year. Income tax return preparation       b) The amount shown below. Income tax return preparation Use the person's age at the end of the tax year. Income tax return preparation         $360— if that person is age 40 or younger          $680— if age 41 to 50         $1,360— if age 51 to 60         $3,640— if age 61 to 70         $4,550— if age 71 or older         Do not include payments for any month you were eligible to participate in a long-term care insurance plan subsidized by your or your spouse’s employer or the employer of either your dependent or your child who was under the age of 27 at the end of 2013. Income tax return preparation If more than one person is covered, figure separately the amount to enter for each person. Income tax return preparation Then enter the total of those amounts 2. Income tax return preparation   3. Income tax return preparation Add lines 1 and 2 3. Income tax return preparation   4. Income tax return preparation Enter your net profit* and any other earned income** from the trade or business under which the insurance plan is established. Income tax return preparation Do not include Conservation Reserve Program payments exempt from self-employment tax. Income tax return preparation If the business is an S corporation, skip to line 11 4. Income tax return preparation   5. Income tax return preparation Enter the total of all net profits* from: Schedule C (Form 1040), line 31; Schedule C-EZ (Form 1040), line 3; Schedule F (Form 1040), line 34; or Schedule K-1 (Form 1065), box 14, code A; plus any other income allocable to the profitable businesses. Income tax return preparation Do not include Conservation Reserve Program payments exempt from self-employment tax. Income tax return preparation See the Instructions for Schedule SE (Form 1040). Income tax return preparation Do not include any net losses shown on these schedules. Income tax return preparation 5. Income tax return preparation   6. Income tax return preparation Divide line 4 by line 5 6. Income tax return preparation   7. Income tax return preparation Multiply Form 1040, line 27, by the percentage on line 6 7. Income tax return preparation   8. Income tax return preparation Subtract line 7 from line 4 8. Income tax return preparation   9. Income tax return preparation Enter the amount, if any, from Form 1040, line 28, attributable to the same trade or business in which the insurance plan is established 9. Income tax return preparation   10. Income tax return preparation Subtract line 9 from line 8 10. Income tax return preparation   11. Income tax return preparation Enter your Medicare wages (Form W-2, box 5) from an S corporation in which you are a more-than-2% shareholder and in which the insurance plan is established 11. Income tax return preparation   12. Income tax return preparation Enter any amount from Form 2555, line 45, attributable to the amount entered on line 4 or 11 above, or any amount from Form 2555-EZ, line 18, attributable to the amount entered on line 11 above 12. Income tax return preparation   13. Income tax return preparation Subtract line 12 from line 10 or 11, whichever applies 13. Income tax return preparation   14. Income tax return preparation Enter the smaller of line 3 or line 13 here and on Form 1040, line 29. Income tax return preparation Do not include this amount when figuring any medical expense deduction on Schedule A (Form 1040). Income tax return preparation 14. Income tax return preparation   * If you used either optional method to figure your net earnings from self-employment from any business, do not enter your net profit from the business. Income tax return preparation Instead, enter the amount attributable to that business from Schedule SE (Form 1040), Section B, line 4b. Income tax return preparation * *Earned income includes net earnings and gains from the sale, transfer, or licensing of property you created. Income tax return preparation However, it does not include capital gain income. Income tax return preparation Chronically ill individual. Income tax return preparation   A chronically ill individual is a person who has been certified as one of the following. Income tax return preparation An individual who has been unable, due to loss of functional capacity for at least 90 days, to perform at least two activities of daily living without substantial assistance from another individual. Income tax return preparation Activities of daily living are eating, toileting, transferring (general mobility), bathing, dressing, and continence. Income tax return preparation An individual who requires substantial supervision to be protected from threats to health and safety due to severe cognitive impairment. Income tax return preparation The certification must have been made by a licensed health care practitioner within the previous 12 months. Income tax return preparation Benefits received. Income tax return preparation   For information on excluding benefits you receive from a long-term care contract from gross income, see Publication 525. Income tax return preparation Other coverage. Income tax return preparation   You cannot take the deduction for any month you were eligible to participate in any employer (including your spouse's) subsidized health plan at any time during that month, even if you did not actually participate. Income tax return preparation In addition, if you were eligible for any month or part of a month to participate in any subsidized health plan maintained by the employer of either your dependent or your child who was under age 27 at the end of 2013, do not use amounts paid for coverage for that month to figure the deduction. Income tax return preparation   These rules are applied separately to plans that provide long-term care insurance and plans that do not provide long-term care insurance. Income tax return preparation However, any medical insurance payments not deductible on Form 1040, line 29, can be included as medical expenses on Schedule A (Form 1040), Itemized Deductions, if you itemize deductions. Income tax return preparation Effect on itemized deductions. Income tax return preparation   Subtract the health insurance deduction from your medical insurance when figuring medical expenses on Schedule A (Form 1040) if you itemize deductions. Income tax return preparation Effect on self-employment tax. Income tax return preparation   For tax years beginning before or after 2010, you cannot subtract the self-employed health insurance deduction when figuring net earnings for your self-employment tax from the business under which the insurance plan is established, or considered to be established as discussed earlier. Income tax return preparation For more information, see Schedule SE (Form 1040). Income tax return preparation How to figure the deduction. Income tax return preparation   Generally, you can use the worksheet in the Form 1040 instructions to figure your deduction. Income tax return preparation However, if any of the following apply, you must use Worksheet 6-A in this chapter. Income tax return preparation You had more than one source of income subject to self-employment tax. Income tax return preparation You file Form 2555, Foreign Earned Income, or Form 2555-EZ, Foreign Earned Income Exclusion. Income tax return preparation You are using amounts paid for qualified long-term care insurance to figure the deduction. Income tax return preparation If you are claiming the health coverage tax credit, complete Form 8885, Health Coverage Tax Credit, before you figure this deduction. Income tax return preparation Health coverage tax credit. Income tax return preparation   You may be able to take this credit only if you were an eligible trade adjustment assistance (TAA) recipient, alternative TAA (ATAA) recipient, reemployment trade adjustment assistance (RTAA) recipient, or Pension Benefit Guaranty Corporation (PBGC) pension recipient. Income tax return preparation Use Form 8885 to figure the amount, if any, of this credit. Income tax return preparation   When figuring the amount to enter on line 1 of Worksheet 6-A, do not include the following. Income tax return preparation Any amounts you included on Form 8885, line 4. Income tax return preparation Any qualified health insurance premiums you paid to “U. Income tax return preparation S. Income tax return preparation Treasury-HCTC. Income tax return preparation ” Any health coverage tax credit advance payments shown in box 1 of Form 1099-H, Health Coverage Tax Credit (HCTC) Advance Payments. Income tax return preparation More than one health plan and business. Income tax return preparation   If you have more than one health plan during the year and each plan is established under a different business, you must use separate worksheets (Worksheet 6-A) to figure each plan's net earnings limit. Income tax return preparation Include the premium you paid under each plan on line 1 or line 2 of that separate worksheet and your net profit (or wages) from that business on line 4 (or line 11). Income tax return preparation For a plan that provides long-term care insurance, the total of the amounts entered for each person on line 2 of all worksheets cannot be more than the appropriate limit shown on line 2 for that person. Income tax return preparation Nondeductible Premiums You cannot deduct premiums on the following kinds of insurance. Income tax return preparation Self-insurance reserve funds. Income tax return preparation You cannot deduct amounts credited to a reserve set up for self-insurance. Income tax return preparation This applies even if you cannot get business insurance coverage for certain business risks. Income tax return preparation However, your actual losses may be deductible. Income tax return preparation See Publication 547. Income tax return preparation Loss of earnings. Income tax return preparation You cannot deduct premiums for a policy that pays for lost earnings due to sickness or disability. Income tax return preparation However, see the discussion on overhead insurance, item (8), under Deductible Premiums , earlier. Income tax return preparation Certain life insurance and annuities. Income tax return preparation For contracts issued before June 9, 1997, you cannot deduct the premiums on a life insurance policy covering you, an employee, or any person with a financial interest in your business if you are directly or indirectly a beneficiary of the policy. Income tax return preparation You are included among possible beneficiaries of the policy if the policy owner is obligated to repay a loan from you using the proceeds of the policy. Income tax return preparation A person has a financial interest in your business if the person is an owner or part owner of the business or has lent money to the business. Income tax return preparation For contracts issued after June 8, 1997, you generally cannot deduct the premiums on any life insurance policy, endowment contract, or annuity contract if you are directly or indirectly a beneficiary. Income tax return preparation The disallowance applies without regard to whom the policy covers. Income tax return preparation Partners. Income tax return preparation If, as a partner in a partnership, you take out an insurance policy on your own life and name your partners as beneficiaries to induce them to retain their investments in the partnership, you are considered a beneficiary. Income tax return preparation You cannot deduct the insurance premiums. Income tax return preparation Insurance to secure a loan. Income tax return preparation If you take out a policy on your life or on the life of another person with a financial interest in your business to get or protect a business loan, you cannot deduct the premiums as a business expense. Income tax return preparation Nor can you deduct the premiums as interest on business loans or as an expense of financing loans. Income tax return preparation In the event of death, the proceeds of the policy are generally not taxed as income even if they are used to liquidate the debt. Income tax return preparation Capitalized Premiums Under the uniform capitalization rules, you must capitalize the direct costs and part of the indirect costs for certain production or resale activities. Income tax return preparation Include these costs in the basis of property you produce or acquire for resale, rather than claiming them as a current deduction. Income tax return preparation You recover the costs through depreciation, amortization, or cost of goods sold when you use, sell, or otherwise dispose of the property. Income tax return preparation Indirect costs include premiums for insurance on your plant or facility, machinery, equipment, materials, property produced, or property acquired for resale. Income tax return preparation Uniform capitalization rules. Income tax return preparation   You may be subject to the uniform capitalization rules if you do any of the following, unless the property is produced for your use other than in a business or an activity carried on for profit. Income tax return preparation Produce real property or tangible personal property. Income tax return preparation For this purpose, tangible personal property includes a film, sound recording, video tape, book, or similar property. Income tax return preparation Acquire property for resale. Income tax return preparation However, these rules do not apply to the following property. Income tax return preparation Personal property you acquire for resale if your average annual gross receipts are $10 million or less for the 3 prior tax years. Income tax return preparation Property you produce if you meet either of the following conditions. Income tax return preparation Your indirect costs of producing the property are $200,000 or less. Income tax return preparation You use the cash method of accounting and do not account for inventories. Income tax return preparation More information. Income tax return preparation   For more information on these rules, see Uniform Capitalization Rules in Publication 538 and the regulations under Internal Revenue Code section 263A. Income tax return preparation When To Deduct Premiums You can usually deduct insurance premiums in the tax year to which they apply. Income tax return preparation Cash method. Income tax return preparation   If you use the cash method of accounting, you generally deduct insurance premiums in the tax year you actually paid them, even if you incurred them in an earlier year. Income tax return preparation However, see Prepayment , later. Income tax return preparation Accrual method. Income tax return preparation   If you use an accrual method of accounting, you cannot deduct insurance premiums before the tax year in which you incur a liability for them. Income tax return preparation In addition, you cannot deduct insurance premiums before the tax year in which you actually pay them (unless the exception for recurring items applies). Income tax return preparation For more information about the accrual method of accounting, see chapter 1. Income tax return preparation For information about the exception for recurring items, see Publication 538. Income tax return preparation Prepayment. Income tax return preparation   You cannot deduct expenses in advance, even if you pay them in advance. Income tax return preparation This rule applies to any expense paid far enough in advance to, in effect, create an asset with a useful life extending substantially beyond the end of the current tax year. Income tax return preparation   Expenses such as insurance are generally allocable to a period of time. Income tax return preparation You can deduct insurance expenses for the year to which they are allocable. Income tax return preparation Example. Income tax return preparation In 2013, you signed a 3-year insurance contract. Income tax return preparation Even though you paid the premiums for 2013, 2014, and 2015 when you signed the contract, you can only deduct the premium for 2013 on your 2013 tax return. Income tax return preparation You can deduct in 2014 and 2015 the premium allocable to those years. Income tax return preparation Dividends received. Income tax return preparation   If you receive dividends from business insurance and you deducted the premiums in prior years, at least part of the dividends generally are income. Income tax return preparation For more information, see Recovery of amount deducted (tax benefit rule) in chapter 1 under How Much Can I Deduct. Income tax return preparation Prev  Up  Next   Home   More Online Publications
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Understanding your CP21I Notice

We made changes to your tax return for the tax year specified on the notice for Individual
Retirement Arrangement (IRA) taxes. You owe money on your taxes as a result
of these changes.

Tax publications you may find useful

How to get help

Calling the toll free number listed on the top right corner of your notice is the fastest way to get your questions answered.

You can also authorize someone (such as an accountant) to contact the IRS on your behalf using this Power of Attorney and Declaration of Representative (Form 2848).

Or you may qualify for help from a Low Income Taxpayer Clinic.
 


What you need to do

  • Read your notice carefully ― it will explain why you owe money on your taxes.
  • Pay the amount owed by the date on the notice's payment coupon.
  • Make payment arrangements if you can't pay the full amount you owe.
  • Contact us if you disagree with the change(s) we made.
  • Correct the copy of your tax return that you kept for your records.

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Answers to Common Questions

What should I do if I disagree with the changes you made?
If you disagree, contact us at the toll-free number listed on the top right corner of your notice.

What happens if I can't pay the full amount I owe?
You can arrange to make a payment plan with us if you can't pay the full amount you owe.

Am I charged interest on the money I owe?
If you don't full pay the amount you owe by the date on the payment coupon, interest will accrue on the unpaid balance after that date.

Will I receive a penalty if I can't pay the full amount?
Yes, you'll receive a late payment penalty. You can contact us at the number listed on your notice if you’re unable to pay the full amount shown in your specific notice because of circumstances beyond your control. Contact us by the due date of your payment and, depending on your situation, we may be able to remove the penalty.

Can I set up a payment plan?
Yes. Call the toll-free number listed on the top right corner of your notice to discuss payment options or check out more information on payment options and how to make a payment arrangement.

There are other options, such as paying by credit card. Note: There may be a fee to pay by credit card.

What if I need to make another correction to my account?
You'll need to file Form 1040X, Amended U.S. Individual Income Tax Return.

What if I have tried to get answers and after contacting IRS several times have not been successful?
Call Taxpayer Advocate at 1-877-777-4778 or for TTY/TDD 1-800-829-4059.


Tips for next year

Consider filing your taxes electronically. Filing online can help you avoid mistakes and find credits and deductions that you may qualify for. In many cases you can file for free. Learn more about e-file.

Page Last Reviewed or Updated: 26-Feb-2014

The Income Tax Return Preparation

Income tax return preparation 9. Income tax return preparation   Depletion Table of Contents Introduction Topics - This chapter discusses: Who Can Claim Depletion? Mineral PropertyCost Depletion Percentage Depletion Oil and Gas Wells Mines and Geothermal Deposits Lessor's Gross Income TimberTimber units. Income tax return preparation Depletion unit. Income tax return preparation Introduction Depletion is the using up of natural resources by mining, drilling, quarrying stone, or cutting timber. Income tax return preparation The depletion deduction allows an owner or operator to account for the reduction of a product's reserves. Income tax return preparation There are two ways of figuring depletion: cost depletion and percentage depletion. Income tax return preparation For mineral property, you generally must use the method that gives you the larger deduction. Income tax return preparation For standing timber, you must use cost depletion. Income tax return preparation Topics - This chapter discusses: Who can claim depletion Mineral property Timber Who Can Claim Depletion? If you have an economic interest in mineral property or standing timber, you can take a deduction for depletion. Income tax return preparation More than one person can have an economic interest in the same mineral deposit or timber. Income tax return preparation In the case of leased property, the depletion deduction is divided between the lessor and the lessee. Income tax return preparation You have an economic interest if both the following apply. Income tax return preparation You have acquired by investment any interest in mineral deposits or standing timber. Income tax return preparation You have a legal right to income from the extraction of the mineral or cutting of the timber to which you must look for a return of your capital investment. Income tax return preparation A contractual relationship that allows you an economic or monetary advantage from products of the mineral deposit or standing timber is not, in itself, an economic interest. Income tax return preparation A production payment carved out of, or retained on the sale of, mineral property is not an economic interest. Income tax return preparation Individuals, corporations, estates, and trusts who claim depletion deductions may be liable for alternative minimum tax. Income tax return preparation Basis adjustment for depletion. Income tax return preparation   You must reduce the basis of your property by the depletion allowed or allowable, whichever is greater. Income tax return preparation Mineral Property Mineral property includes oil and gas wells, mines, and other natural deposits (including geothermal deposits). Income tax return preparation For this purpose, the term “property” means each separate interest you own in each mineral deposit in each separate tract or parcel of land. Income tax return preparation You can treat two or more separate interests as one property or as separate properties. Income tax return preparation See section 614 of the Internal Revenue Code and the related regulations for rules on how to treat separate mineral interests. Income tax return preparation There are two ways of figuring depletion on mineral property. Income tax return preparation Cost depletion. Income tax return preparation Percentage depletion. Income tax return preparation Generally, you must use the method that gives you the larger deduction. Income tax return preparation However, unless you are an independent producer or royalty owner, you generally cannot use percentage depletion for oil and gas wells. Income tax return preparation See Oil and Gas Wells , later. Income tax return preparation Cost Depletion To figure cost depletion you must first determine the following. Income tax return preparation The property's basis for depletion. Income tax return preparation The total recoverable units of mineral in the property's natural deposit. Income tax return preparation The number of units of mineral sold during the tax year. Income tax return preparation Basis for depletion. Income tax return preparation   To figure the property's basis for depletion, subtract all the following from the property's adjusted basis. Income tax return preparation Amounts recoverable through: Depreciation deductions, Deferred expenses (including deferred exploration and development costs), and Deductions other than depletion. Income tax return preparation The residual value of land and improvements at the end of operations. Income tax return preparation The cost or value of land acquired for purposes other than mineral production. Income tax return preparation Adjusted basis. Income tax return preparation   The adjusted basis of your property is your original cost or other basis, plus certain additions and improvements, and minus certain deductions such as depletion allowed or allowable and casualty losses. Income tax return preparation Your adjusted basis can never be less than zero. Income tax return preparation See Publication 551, Basis of Assets, for more information on adjusted basis. Income tax return preparation Total recoverable units. Income tax return preparation   The total recoverable units is the sum of the following. Income tax return preparation The number of units of mineral remaining at the end of the year (including units recovered but not sold). Income tax return preparation The number of units of mineral sold during the tax year (determined under your method of accounting, as explained next). Income tax return preparation   You must estimate or determine recoverable units (tons, pounds, ounces, barrels, thousands of cubic feet, or other measure) of mineral products using the current industry method and the most accurate and reliable information you can obtain. Income tax return preparation You must include ores and minerals that are developed, in sight, blocked out, or assured. Income tax return preparation You must also include probable or prospective ores or minerals that are believed to exist based on good evidence. Income tax return preparation But see Elective safe harbor for owners of oil and gas property , later. Income tax return preparation Number of units sold. Income tax return preparation   You determine the number of units sold during the tax year based on your method of accounting. Income tax return preparation Use the following table to make this determination. Income tax return preparation    IF you  use . Income tax return preparation . Income tax return preparation . Income tax return preparation THEN the units sold during the year are . Income tax return preparation . Income tax return preparation . Income tax return preparation The cash method of accounting The units sold for which you receive payment during the tax year (regardless of the year of sale). Income tax return preparation An accrual method of accounting The units sold based on your inventories and method of accounting for inventory. Income tax return preparation   The number of units sold during the tax year does not include any for which depletion deductions were allowed or allowable in earlier years. Income tax return preparation Figuring the cost depletion deduction. Income tax return preparation   Once you have figured your property's basis for depletion, the total recoverable units, and the number of units sold during the tax year, you can figure your cost depletion deduction by taking the following steps. Income tax return preparation Step Action Result 1 Divide your property's basis for depletion by total recoverable units. Income tax return preparation Rate per unit. Income tax return preparation 2 Multiply the rate per unit by units sold during the tax year. Income tax return preparation Cost depletion deduction. Income tax return preparation You must keep accounts for the depletion of each property and adjust these accounts each year for units sold and depletion claimed. Income tax return preparation Elective safe harbor for owners of oil and gas property. Income tax return preparation   Instead of using the method described earlier to determine the total recoverable units, you can use an elective safe harbor. Income tax return preparation If you choose the elective safe harbor, the total recoverable units equal 105% of a property's proven reserves (both developed and undeveloped). Income tax return preparation For details, see Revenue Procedure 2004-19 on page 563 of Internal Revenue Bulletin 2004-10, available at www. Income tax return preparation irs. Income tax return preparation gov/pub/irs-irbs/irb04-10. Income tax return preparation pdf. Income tax return preparation   To make the election, attach a statement to your timely filed (including extensions) original return for the first tax year for which the safe harbor is elected. Income tax return preparation The statement must indicate that you are electing the safe harbor provided by Revenue Procedure 2004-19. Income tax return preparation The election, if made, is effective for the tax year in which it is made and all later years. Income tax return preparation It cannot be revoked for the tax year in which it is elected, but may be revoked in a later year. Income tax return preparation Once revoked, it cannot be re-elected for the next 5 years. Income tax return preparation Percentage Depletion To figure percentage depletion, you multiply a certain percentage, specified for each mineral, by your gross income from the property during the tax year. Income tax return preparation The rates to be used and other rules for oil and gas wells are discussed later under Independent Producers and Royalty Owners and under Natural Gas Wells . Income tax return preparation Rates and other rules for percentage depletion of other specific minerals are found later in Mines and Geothermal Deposits . Income tax return preparation Gross income. Income tax return preparation   When figuring percentage depletion, subtract from your gross income from the property the following amounts. Income tax return preparation Any rents or royalties you paid or incurred for the property. Income tax return preparation The part of any bonus you paid for a lease on the property allocable to the product sold (or that otherwise gives rise to gross income) for the tax year. Income tax return preparation A bonus payment includes amounts you paid as a lessee to satisfy a production payment retained by the lessor. Income tax return preparation   Use the following fraction to figure the part of the bonus you must subtract. Income tax return preparation No. Income tax return preparation of units sold in the tax year Recoverable units from the property × Bonus Payments For oil and gas wells and geothermal deposits, more information about the definition of gross income from the property is under Oil and Gas Wells , later. Income tax return preparation For other property, more information about the definition of gross income from the property is under Mines and Geothermal Deposits , later. Income tax return preparation Taxable income limit. Income tax return preparation   The percentage depletion deduction generally cannot be more than 50% (100% for oil and gas property) of your taxable income from the property figured without the depletion deduction and the domestic production activities deduction. Income tax return preparation   Taxable income from the property means gross income from the property minus all allowable deductions (except any deduction for depletion or domestic production activities) attributable to mining processes, including mining transportation. Income tax return preparation These deductible items include, but are not limited to, the following. Income tax return preparation Operating expenses. Income tax return preparation Certain selling expenses. Income tax return preparation Administrative and financial overhead. Income tax return preparation Depreciation. Income tax return preparation Intangible drilling and development costs. Income tax return preparation Exploration and development expenditures. Income tax return preparation Deductible taxes (see chapter 5), but not taxes that you capitalize or take as a credit. Income tax return preparation Losses sustained. Income tax return preparation   The following rules apply when figuring your taxable income from the property for purposes of the taxable income limit. Income tax return preparation Do not deduct any net operating loss deduction from the gross income from the property. Income tax return preparation Corporations do not deduct charitable contributions from the gross income from the property. Income tax return preparation If, during the year, you dispose of an item of section 1245 property that was used in connection with mineral property, reduce any allowable deduction for mining expenses by the part of any gain you must report as ordinary income that is allocable to the mineral property. Income tax return preparation See section 1. Income tax return preparation 613-5(b)(1) of the regulations for information on how to figure the ordinary gain allocable to the property. Income tax return preparation Oil and Gas Wells You cannot claim percentage depletion for an oil or gas well unless at least one of the following applies. Income tax return preparation You are either an independent producer or a royalty owner. Income tax return preparation The well produces natural gas that is either sold under a fixed contract or produced from geopressured brine. Income tax return preparation If you are an independent producer or royalty owner, see Independent Producers and Royalty Owners , next. Income tax return preparation For information on the depletion deduction for wells that produce natural gas that is either sold under a fixed contract or produced from geopressured brine, see Natural Gas Wells , later. Income tax return preparation Independent Producers and Royalty Owners If you are an independent producer or royalty owner, you figure percentage depletion using a rate of 15% of the gross income from the property based on your average daily production of domestic crude oil or domestic natural gas up to your depletable oil or natural gas quantity. Income tax return preparation However, certain refiners, as explained next, and certain retailers and transferees of proven oil and gas properties, as explained next, cannot claim percentage depletion. Income tax return preparation For information on figuring the deduction, see Figuring percentage depletion , later. Income tax return preparation Refiners who cannot claim percentage depletion. Income tax return preparation   You cannot claim percentage depletion if you or a related person refine crude oil and you and the related person refined more than 75,000 barrels on any day during the tax year based on average (rather than actual) daily refinery runs for the tax year. Income tax return preparation The average daily refinery run is computed by dividing total refinery runs for the tax year by the total number of days in the tax year. Income tax return preparation Related person. Income tax return preparation   You and another person are related persons if either of you holds a significant ownership interest in the other person or if a third person holds a significant ownership interest in both of you. Income tax return preparation For example, a corporation, partnership, estate, or trust and anyone who holds a significant ownership interest in it are related persons. Income tax return preparation A partnership and a trust are related persons if one person holds a significant ownership interest in each of them. Income tax return preparation For purposes of the related person rules, significant ownership interest means direct or indirect ownership of 5% or more in any one of the following. Income tax return preparation The value of the outstanding stock of a corporation. Income tax return preparation The interest in the profits or capital of a partnership. Income tax return preparation The beneficial interests in an estate or trust. Income tax return preparation Any interest owned by or for a corporation, partnership, trust, or estate is considered to be owned directly both by itself and proportionately by its shareholders, partners, or beneficiaries. Income tax return preparation Retailers who cannot claim percentage depletion. Income tax return preparation   You cannot claim percentage depletion if both the following apply. Income tax return preparation You sell oil or natural gas or their by-products directly or through a related person in any of the following situations. Income tax return preparation Through a retail outlet operated by you or a related person. Income tax return preparation To any person who is required under an agreement with you or a related person to use a trademark, trade name, or service mark or name owned by you or a related person in marketing or distributing oil, natural gas, or their by-products. Income tax return preparation To any person given authority under an agreement with you or a related person to occupy any retail outlet owned, leased, or controlled by you or a related person. Income tax return preparation The combined gross receipts from sales (not counting resales) of oil, natural gas, or their by-products by all retail outlets taken into account in (1) are more than $5 million for the tax year. Income tax return preparation   For the purpose of determining if this rule applies, do not count the following. Income tax return preparation Bulk sales (sales in very large quantities) of oil or natural gas to commercial or industrial users. Income tax return preparation Bulk sales of aviation fuels to the Department of Defense. Income tax return preparation Sales of oil or natural gas or their by-products outside the United States if none of your domestic production or that of a related person is exported during the tax year or the prior tax year. Income tax return preparation Related person. Income tax return preparation   To determine if you and another person are related persons, see Related person under Refiners who cannot claim percentage depletion, earlier. Income tax return preparation Sales through a related person. Income tax return preparation   You are considered to be selling through a related person if any sale by the related person produces gross income from which you may benefit because of your direct or indirect ownership interest in the person. Income tax return preparation   You are not considered to be selling through a related person who is a retailer if all the following apply. Income tax return preparation You do not have a significant ownership interest in the retailer. Income tax return preparation You sell your production to persons who are not related to either you or the retailer. Income tax return preparation The retailer does not buy oil or natural gas from your customers or persons related to your customers. Income tax return preparation There are no arrangements for the retailer to acquire oil or natural gas you produced for resale or made available for purchase by the retailer. Income tax return preparation Neither you nor the retailer knows of or controls the final disposition of the oil or natural gas you sold or the original source of the petroleum products the retailer acquired for resale. Income tax return preparation Transferees who cannot claim percentage depletion. Income tax return preparation   You cannot claim percentage depletion if you received your interest in a proven oil or gas property by transfer after 1974 and before October 12, 1990. Income tax return preparation For a definition of the term “transfer,” see section 1. Income tax return preparation 613A-7(n) of the regulations. Income tax return preparation For a definition of the term “interest in proven oil or gas property,” see section 1. Income tax return preparation 613A-7(p) of the regulations. Income tax return preparation Figuring percentage depletion. Income tax return preparation   Generally, as an independent producer or royalty owner, you figure your percentage depletion by computing your average daily production of domestic oil or gas and comparing it to your depletable oil or gas quantity. Income tax return preparation If your average daily production does not exceed your depletable oil or gas quantity, you figure your percentage depletion by multiplying the gross income from the oil or gas property (defined later) by 15%. Income tax return preparation If your average daily production of domestic oil or gas exceeds your depletable oil or gas quantity, you must make an allocation as explained later under Average daily production. Income tax return preparation   In addition, there is a limit on the percentage depletion deduction. Income tax return preparation See Taxable income limit , later. Income tax return preparation Average daily production. Income tax return preparation   Figure your average daily production by dividing your total domestic production of oil or gas for the tax year by the number of days in your tax year. Income tax return preparation Partial interest. Income tax return preparation   If you have a partial interest in the production from a property, figure your share of the production by multiplying total production from the property by your percentage of interest in the revenues from the property. Income tax return preparation   You have a partial interest in the production from a property if you have a net profits interest in the property. Income tax return preparation To figure the share of production for your net profits interest, you must first determine your percentage participation (as measured by the net profits) in the gross revenue from the property. Income tax return preparation To figure this percentage, you divide the income you receive for your net profits interest by the gross revenue from the property. Income tax return preparation Then multiply the total production from the property by your percentage participation to figure your share of the production. Income tax return preparation Example. Income tax return preparation Javier Robles owns oil property in which Pablo Olmos owns a 20% net profits interest. Income tax return preparation During the year, the property produced 10,000 barrels of oil, which Javier sold for $200,000. Income tax return preparation Javier had expenses of $90,000 attributable to the property. Income tax return preparation The property generated a net profit of $110,000 ($200,000 − $90,000). Income tax return preparation Pablo received income of $22,000 ($110,000 × . Income tax return preparation 20) for his net profits interest. Income tax return preparation Pablo determined his percentage participation to be 11% by dividing $22,000 (the income he received) by $200,000 (the gross revenue from the property). Income tax return preparation Pablo determined his share of the oil production to be 1,100 barrels (10,000 barrels × 11%). Income tax return preparation Depletable oil or natural gas quantity. Income tax return preparation   Generally, your depletable oil quantity is 1,000 barrels. Income tax return preparation Your depletable natural gas quantity is 6,000 cubic feet multiplied by the number of barrels of your depletable oil quantity that you choose to apply. Income tax return preparation If you claim depletion on both oil and natural gas, you must reduce your depletable oil quantity (1,000 barrels) by the number of barrels you use to figure your depletable natural gas quantity. Income tax return preparation Example. Income tax return preparation You have both oil and natural gas production. Income tax return preparation To figure your depletable natural gas quantity, you choose to apply 360 barrels of your 1000-barrel depletable oil quantity. Income tax return preparation Your depletable natural gas quantity is 2. Income tax return preparation 16 million cubic feet of gas (360 × 6000). Income tax return preparation You must reduce your depletable oil quantity to 640 barrels (1000 − 360). Income tax return preparation If you have production from marginal wells, see section 613A(c)(6) of the Internal Revenue Code to figure your depletable oil or natural gas quantity. Income tax return preparation Also, see Notice 2012-50, available at www. Income tax return preparation irs. Income tax return preparation gov/irb/2012–31_IRB/index. Income tax return preparation html. Income tax return preparation Business entities and family members. Income tax return preparation   You must allocate the depletable oil or gas quantity among the following related persons in proportion to each entity's or family member's production of domestic oil or gas for the year. Income tax return preparation Corporations, trusts, and estates if 50% or more of the beneficial interest is owned by the same or related persons (considering only persons that own at least 5% of the beneficial interest). Income tax return preparation You and your spouse and minor children. Income tax return preparation A related person is anyone mentioned in the related persons discussion under Nondeductible loss in chapter 2 of Publication 544, except that for purposes of this allocation, item (1) in that discussion includes only an individual, his or her spouse, and minor children. Income tax return preparation Controlled group of corporations. Income tax return preparation   Members of the same controlled group of corporations are treated as one taxpayer when figuring the depletable oil or natural gas quantity. Income tax return preparation They share the depletable quantity. Income tax return preparation A controlled group of corporations is defined in section 1563(a) of the Internal Revenue Code, except that, for this purpose, the stock ownership requirement in that definition is “more than 50%” rather than “at least 80%. Income tax return preparation ” Gross income from the property. Income tax return preparation   For purposes of percentage depletion, gross income from the property (in the case of oil and gas wells) is the amount you receive from the sale of the oil or gas in the immediate vicinity of the well. Income tax return preparation If you do not sell the oil or gas on the property, but manufacture or convert it into a refined product before sale or transport it before sale, the gross income from the property is the representative market or field price (RMFP) of the oil or gas, before conversion or transportation. Income tax return preparation   If you sold gas after you removed it from the premises for a price that is lower than the RMFP, determine gross income from the property for percentage depletion purposes without regard to the RMFP. Income tax return preparation   Gross income from the property does not include lease bonuses, advance royalties, or other amounts payable without regard to production from the property. Income tax return preparation Average daily production exceeds depletable quantities. Income tax return preparation   If your average daily production for the year is more than your depletable oil or natural gas quantity, figure your allowance for depletion for each domestic oil or natural gas property as follows. Income tax return preparation Figure your average daily production of oil or natural gas for the year. Income tax return preparation Figure your depletable oil or natural gas quantity for the year. Income tax return preparation Figure depletion for all oil or natural gas produced from the property using a percentage depletion rate of 15%. Income tax return preparation Multiply the result figured in (3) by a fraction, the numerator of which is the result figured in (2) and the denominator of which is the result figured in (1). Income tax return preparation This is your depletion allowance for that property for the year. Income tax return preparation Taxable income limit. Income tax return preparation   If you are an independent producer or royalty owner of oil and gas, your deduction for percentage depletion is limited to the smaller of the following. Income tax return preparation 100% of your taxable income from the property figured without the deduction for depletion and the deduction for domestic production activities under section 199 of the Internal Revenue Code. Income tax return preparation For a definition of taxable income from the property, see Taxable income limit , earlier, under Mineral Property. Income tax return preparation 65% of your taxable income from all sources, figured without the depletion allowance, the deduction for domestic production activities, any net operating loss carryback, and any capital loss carryback. Income tax return preparation You can carry over to the following year any amount you cannot deduct because of the 65%-of-taxable-income limit. Income tax return preparation Add it to your depletion allowance (before applying any limits) for the following year. Income tax return preparation Partnerships and S Corporations Generally, each partner or S corporation shareholder, and not the partnership or S corporation, figures the depletion allowance separately. Income tax return preparation (However, see Electing large partnerships must figure depletion allowance , later. Income tax return preparation ) Each partner or shareholder must decide whether to use cost or percentage depletion. Income tax return preparation If a partner or shareholder uses percentage depletion, he or she must apply the 65%-of-taxable-income limit using his or her taxable income from all sources. Income tax return preparation Partner's or shareholder's adjusted basis. Income tax return preparation   The partnership or S corporation must allocate to each partner or shareholder his or her share of the adjusted basis of each oil or gas property held by the partnership or S corporation. Income tax return preparation The partnership or S corporation makes the allocation as of the date it acquires the oil or gas property. Income tax return preparation   Each partner's share of the adjusted basis of the oil or gas property generally is figured according to that partner's interest in partnership capital. Income tax return preparation However, in some cases, it is figured according to the partner's interest in partnership income. Income tax return preparation   The partnership or S corporation adjusts the partner's or shareholder's share of the adjusted basis of the oil and gas property for any capital expenditures made for the property and for any change in partnership or S corporation interests. Income tax return preparation Recordkeeping. Income tax return preparation Each partner or shareholder must separately keep records of his or her share of the adjusted basis in each oil and gas property of the partnership or S corporation. Income tax return preparation The partner or shareholder must reduce his or her adjusted basis by the depletion allowed or allowable on the property each year. Income tax return preparation The partner or shareholder must use that reduced adjusted basis to figure cost depletion or his or her gain or loss if the partnership or S corporation disposes of the property. Income tax return preparation Reporting the deduction. Income tax return preparation   Information that you, as a partner or shareholder, use to figure your depletion deduction on oil and gas properties is reported by the partnership or S corporation on Schedule K-1 (Form 1065) or on Schedule K-1 (Form 1120S). Income tax return preparation Deduct oil and gas depletion for your partnership or S corporation interest on Schedule E (Form 1040). Income tax return preparation The depletion deducted on Schedule E is included in figuring income or loss from rental real estate or royalty properties. Income tax return preparation The instructions for Schedule E explain where to report this income or loss and whether you need to file either of the following forms. Income tax return preparation Form 6198, At-Risk Limitations. Income tax return preparation Form 8582, Passive Activity Loss Limitations. Income tax return preparation Electing large partnerships must figure depletion allowance. Income tax return preparation   An electing large partnership, rather than each partner, generally must figure the depletion allowance. Income tax return preparation The partnership figures the depletion allowance without taking into account the 65-percent-of-taxable-income limit and the depletable oil or natural gas quantity. Income tax return preparation Also, the adjusted basis of a partner's interest in the partnership is not affected by the depletion allowance. Income tax return preparation   An electing large partnership is one that meets both the following requirements. Income tax return preparation The partnership had 100 or more partners in the preceding year. Income tax return preparation The partnership chooses to be an electing large partnership. Income tax return preparation Disqualified persons. Income tax return preparation   An electing large partnership does not figure the depletion allowance of its partners that are disqualified persons. Income tax return preparation Disqualified persons must figure it themselves, as explained earlier. Income tax return preparation   All the following are disqualified persons. Income tax return preparation Refiners who cannot claim percentage depletion (discussed under Independent Producers and Royalty Owners , earlier). Income tax return preparation Retailers who cannot claim percentage depletion (discussed under Independent Producers and Royalty Owners , earlier). Income tax return preparation Any partner whose average daily production of domestic crude oil and natural gas is more than 500 barrels during the tax year in which the partnership tax year ends. Income tax return preparation Average daily production is discussed earlier. Income tax return preparation Natural Gas Wells You can use percentage depletion for a well that produces natural gas that is either Sold under a fixed contract, or Produced from geopressured brine. Income tax return preparation Natural gas sold under a fixed contract. Income tax return preparation   Natural gas sold under a fixed contract qualifies for a percentage depletion rate of 22%. Income tax return preparation This is domestic natural gas sold by the producer under a contract that does not provide for a price increase to reflect any increase in the seller's tax liability because of the repeal of percentage depletion for gas. Income tax return preparation The contract must have been in effect from February 1, 1975, until the date of sale of the gas. Income tax return preparation Price increases after February 1, 1975, are presumed to take the increase in tax liability into account unless demonstrated otherwise by clear and convincing evidence. Income tax return preparation Natural gas from geopressured brine. Income tax return preparation   Qualified natural gas from geopressured brine is eligible for a percentage depletion rate of 10%. Income tax return preparation This is natural gas that is both the following. Income tax return preparation Produced from a well you began to drill after September 1978 and before 1984. Income tax return preparation Determined in accordance with section 503 of the Natural Gas Policy Act of 1978 to be produced from geopressured brine. Income tax return preparation Mines and Geothermal Deposits Certain mines, wells, and other natural deposits, including geothermal deposits, qualify for percentage depletion. Income tax return preparation Mines and other natural deposits. Income tax return preparation   For a natural deposit, the percentage of your gross income from the property that you can deduct as depletion depends on the type of deposit. Income tax return preparation   The following is a list of the percentage depletion rates for the more common minerals. Income tax return preparation DEPOSITS RATE Sulphur, uranium, and, if from deposits in the United States, asbestos, lead ore, zinc ore, nickel ore, and mica 22% Gold, silver, copper, iron ore, and certain oil shale, if from deposits in the United States 15% Borax, granite, limestone, marble, mollusk shells, potash, slate, soapstone, and carbon dioxide produced from a well 14% Coal, lignite, and sodium chloride 10% Clay and shale used or sold for use in making sewer pipe or bricks or used or sold for use as sintered or burned lightweight aggregates 7½% Clay used or sold for use in making drainage and roofing tile, flower pots, and kindred products, and gravel, sand, and stone (other than stone used or sold for use by a mine owner or operator as dimension or ornamental stone) 5%   You can find a complete list of minerals and their percentage depletion rates in section 613(b) of the Internal Revenue Code. Income tax return preparation Corporate deduction for iron ore and coal. Income tax return preparation   The percentage depletion deduction of a corporation for iron ore and coal (including lignite) is reduced by 20% of: The percentage depletion deduction for the tax year (figured without this reduction), minus The adjusted basis of the property at the close of the tax year (figured without the depletion deduction for the tax year). Income tax return preparation Gross income from the property. Income tax return preparation   For property other than a geothermal deposit or an oil or gas well, gross income from the property means the gross income from mining. Income tax return preparation Mining includes all the following. Income tax return preparation Extracting ores or minerals from the ground. Income tax return preparation Applying certain treatment processes described later. Income tax return preparation Transporting ores or minerals (generally, not more than 50 miles) from the point of extraction to the plants or mills in which the treatment processes are applied. Income tax return preparation Excise tax. Income tax return preparation   Gross income from mining includes the separately stated excise tax received by a mine operator from the sale of coal to compensate the operator for the excise tax the mine operator must pay to finance black lung benefits. Income tax return preparation Extraction. Income tax return preparation   Extracting ores or minerals from the ground includes extraction by mine owners or operators of ores or minerals from the waste or residue of prior mining. Income tax return preparation This does not apply to extraction from waste or residue of prior mining by the purchaser of the waste or residue or the purchaser of the rights to extract ores or minerals from the waste or residue. Income tax return preparation Treatment processes. Income tax return preparation   The processes included as mining depend on the ore or mineral mined. Income tax return preparation To qualify as mining, the treatment processes must be applied by the mine owner or operator. Income tax return preparation For a listing of treatment processes considered as mining, see section 613(c)(4) of the Internal Revenue Code and the related regulations. Income tax return preparation Transportation of more than 50 miles. Income tax return preparation   If the IRS finds that the ore or mineral must be transported more than 50 miles to plants or mills to be treated because of physical and other requirements, the additional authorized transportation is considered mining and included in the computation of gross income from mining. Income tax return preparation    If you wish to include transportation of more than 50 miles in the computation of gross income from mining, request an advance ruling from the IRS. Income tax return preparation Include in the request the facts about the physical and other requirements that prevented the construction and operation of the plant within 50 miles of the point of extraction. Income tax return preparation For more information about requesting an advance ruling, see Revenue Procedure 2013-1, available at www. Income tax return preparation irs. Income tax return preparation gov/irb/2013-01_IRB/ar11. Income tax return preparation html. Income tax return preparation Disposal of coal or iron ore. Income tax return preparation   You cannot take a depletion deduction for coal (including lignite) or iron ore mined in the United States if both the following apply. Income tax return preparation You disposed of it after holding it for more than 1 year. Income tax return preparation You disposed of it under a contract under which you retain an economic interest in the coal or iron ore. Income tax return preparation Treat any gain on the disposition as a capital gain. Income tax return preparation Disposal to related person. Income tax return preparation   This rule does not apply if you dispose of the coal or iron ore to one of the following persons. Income tax return preparation A related person (as listed in chapter 2 of Publication 544). Income tax return preparation A person owned or controlled by the same interests that own or control you. Income tax return preparation Geothermal deposits. Income tax return preparation   Geothermal deposits located in the United States or its possessions qualify for a percentage depletion rate of 15%. Income tax return preparation A geothermal deposit is a geothermal reservoir of natural heat stored in rocks or in a watery liquid or vapor. Income tax return preparation For percentage depletion purposes, a geothermal deposit is not considered a gas well. Income tax return preparation   Figure gross income from the property for a geothermal steam well in the same way as for oil and gas wells. Income tax return preparation See Gross income from the property , earlier, under Oil and Gas Wells. Income tax return preparation Percentage depletion on a geothermal deposit cannot be more than 50% of your taxable income from the property. Income tax return preparation Lessor's Gross Income In the case of leased property, the depletion deduction is divided between the lessor and the lessee. Income tax return preparation A lessor's gross income from the property that qualifies for percentage depletion usually is the total of the royalties received from the lease. Income tax return preparation Bonuses and advanced royalties. Income tax return preparation   Bonuses and advanced royalties are payments a lessee makes before production to a lessor for the grant of rights in a lease or for minerals, gas, or oil to be extracted from leased property. Income tax return preparation If you are the lessor, your income from bonuses and advanced royalties received is subject to an allowance for depletion, as explained in the next two paragraphs. Income tax return preparation Figuring cost depletion. Income tax return preparation   To figure cost depletion on a bonus, multiply your adjusted basis in the property by a fraction, the numerator of which is the bonus and the denominator of which is the total bonus and royalties expected to be received. Income tax return preparation To figure cost depletion on advanced royalties, use the computation explained earlier under Cost Depletion , treating the number of units for which the advanced royalty is received as the number of units sold. Income tax return preparation Figuring percentage depletion. Income tax return preparation   In the case of mines, wells, and other natural deposits other than gas, oil, or geothermal property, you may use the percentage rates discussed earlier under Mines and Geothermal Deposits . Income tax return preparation Any bonus or advanced royalty payments are generally part of the gross income from the property to which the rates are applied in making the calculation. Income tax return preparation However, for oil, gas, or geothermal property, gross income does not include lease bonuses, advanced royalties, or other amounts payable without regard to production from the property. Income tax return preparation Ending the lease. Income tax return preparation   If you receive a bonus on a lease that ends or is abandoned before you derive any income from mineral extraction, include in income the depletion deduction you took. Income tax return preparation Do this for the year the lease ends or is abandoned. Income tax return preparation Also increase your adjusted basis in the property to restore the depletion deduction you previously subtracted. Income tax return preparation   For advanced royalties, include in income the depletion claimed on minerals for which the advanced royalties were paid if the minerals were not produced before the lease ended. Income tax return preparation Include this amount in income for the year the lease ends. Income tax return preparation Increase your adjusted basis in the property by the amount you include in income. Income tax return preparation Delay rentals. Income tax return preparation   These are payments for deferring development of the property. Income tax return preparation Since delay rentals are ordinary rent, they are ordinary income that is not subject to depletion. Income tax return preparation These rentals can be avoided by either abandoning the lease, beginning development operations, or obtaining production. Income tax return preparation Timber You can figure timber depletion only by the cost method. Income tax return preparation Percentage depletion does not apply to timber. Income tax return preparation Base your depletion on your cost or other basis in the timber. Income tax return preparation Your cost does not include the cost of land or any amounts recoverable through depreciation. Income tax return preparation Depletion takes place when you cut standing timber. Income tax return preparation You can figure your depletion deduction when the quantity of cut timber is first accurately measured in the process of exploitation. Income tax return preparation Figuring cost depletion. Income tax return preparation   To figure your cost depletion allowance, you multiply the number of timber units cut by your depletion unit. Income tax return preparation Timber units. Income tax return preparation   When you acquire timber property, you must make an estimate of the quantity of marketable timber that exists on the property. Income tax return preparation You measure the timber using board feet, log scale, cords, or other units. Income tax return preparation If you later determine that you have more or less units of timber, you must adjust the original estimate. Income tax return preparation   The term “timber property” means your economic interest in standing timber in each tract or block representing a separate timber account. Income tax return preparation Depletion unit. Income tax return preparation   You figure your depletion unit each year by taking the following steps. Income tax return preparation Determine your cost or adjusted basis of the timber on hand at the beginning of the year. Income tax return preparation Adjusted basis is defined under Cost Depletion in the discussion on Mineral Property. Income tax return preparation Add to the amount determined in (1) the cost of any timber units acquired during the year and any additions to capital. Income tax return preparation Figure the number of timber units to take into account by adding the number of timber units acquired during the year to the number of timber units on hand in the account at the beginning of the year and then adding (or subtracting) any correction to the estimate of the number of timber units remaining in the account. Income tax return preparation Divide the result of (2) by the result of (3). Income tax return preparation This is your depletion unit. Income tax return preparation Example. Income tax return preparation You bought a timber tract for $160,000 and the land was worth as much as the timber. Income tax return preparation Your basis for the timber is $80,000. Income tax return preparation Based on an estimated one million board feet (1,000 MBF) of standing timber, you figure your depletion unit to be $80 per MBF ($80,000 ÷ 1,000). Income tax return preparation If you cut 500 MBF of timber, your depletion allowance would be $40,000 (500 MBF × $80). Income tax return preparation When to claim depletion. Income tax return preparation   Claim your depletion allowance as a deduction in the year of sale or other disposition of the products cut from the timber, unless you choose to treat the cutting of timber as a sale or exchange (explained below). Income tax return preparation Include allowable depletion for timber products not sold during the tax year the timber is cut as a cost item in the closing inventory of timber products for the year. Income tax return preparation The inventory is your basis for determining gain or loss in the tax year you sell the timber products. Income tax return preparation Example. Income tax return preparation The facts are the same as in the previous example except that you sold only half of the timber products in the cutting year. Income tax return preparation You would deduct $20,000 of the $40,000 depletion that year. Income tax return preparation You would add the remaining $20,000 depletion to your closing inventory of timber products. Income tax return preparation Electing to treat the cutting of timber as a sale or exchange. Income tax return preparation   You can elect, under certain circumstances, to treat the cutting of timber held for more than 1 year as a sale or exchange. Income tax return preparation You must make the election on your income tax return for the tax year to which it applies. Income tax return preparation If you make this election, subtract the adjusted basis for depletion from the fair market value of the timber on the first day of the tax year in which you cut it to figure the gain or loss on the cutting. Income tax return preparation You generally report the gain as long-term capital gain. Income tax return preparation The fair market value then becomes your basis for figuring your ordinary gain or loss on the sale or other disposition of the products cut from the timber. Income tax return preparation For more information, see Timber in chapter 2 of Publication 544, Sales and Other Dispositions of Assets. Income tax return preparation   You may revoke an election to treat the cutting of timber as a sale or exchange without IRS's consent. Income tax return preparation The prior election (and revocation) is disregarded for purposes of making a subsequent election. Income tax return preparation See Form T (Timber), Forest Activities Schedule, for more information. Income tax return preparation Form T. Income tax return preparation   Complete and attach Form T (Timber) to your income tax return if you claim a deduction for timber depletion, choose to treat the cutting of timber as a sale or exchange, or make an outright sale of timber. Income tax return preparation Prev  Up  Next   Home   More Online Publications