Intangible Drilling Costs (IDC): Overview, Example

What Are Intangible Drilling Costs (IDC)?

Intangible drilling costs (IDC) are expenses related to developing an oil or gas well that are not a part of the final operating well. They include costs that are necessary in the drilling and preparation of wells for the production of oil and gas, such as survey work, ground clearing, drainage, wages, fuel, repairs, and supplies.

Broadly speaking, expenditures are classified as intangible drilling costs if they have no salvage value. Since intangible drilling costs include all real and actual expenses except for the drilling equipment, the word intangible is something of a misnomer.

Intangible drilling costs are tax-deductible.

Understanding Intangible Drilling Costs (IDC)

The U.S. has offered a tax deduction for intangible drilling costs since 1913 in order to attract investment capital to the high-risk business of oil and gas exploration. The deduction is allowed only for wells within or offshore the U.S.

According to the Committee for a Responsible Federal Budget, this makes 60% to 80% of total drilling costs tax-deductible.

The group indicates that this is one of the largest tax breaks available to the oil industry. Repealing the deduction would save U.S. taxpayers an estimated $14 billion between 2014 and 2023.

It also reports that it is a rare case of a tax deduction that can be taken in its entirety in the year the costs are incurred. Most similar corporate tax breaks are spread out over five years.

The Industry View

The industry is, of course, a strong supporter of the tax break. The expense deductions "have allowed producers to invest literally hundreds of billions of dollars in finding and delivering new energy that might not have been available without them," according to the Independent Petroleum Institute of America, an industry group.

The institute notes that the tax deduction encourages investment and reinvestment in new oil and gas exploration in spite of the fact that many drilling operations turn out to be unsuccessful. It also points out that many other industries, from agriculture to technology, have comparable deductions for research and development costs.

A taxpayer who elects to deduct expenses for intangible drilling costs must declare the costs for the taxable year in which the expenses were paid or incurred.

Example of Intangible Drilling Costs

Say Company OIL is proceeding with a plan to develop a new oil well.

Many costly steps are required before the oil pump starts up. They involve hiring people to conduct surveys, clear the ground area so that the well can be built, and build adequate drainage. People have to be hired to do all this.

Since none of these are costs for the actual drilling equipment, and they have no salvage value after the well is no longer functioning, they are labeled as intangible drilling costs."