Wednesday, July 6, 2016

Distributions to Working Interest Holder in Oil & Gas Venture Held Subject to Self-Employment Tax

Distributions to Working Interest Holder in Oil & Gas Venture Held
Subject to Self-Employment Tax

            Recently, the 10th Circuit Court of Appeals affirmed a determination that the holder of  working interests in an oil and gas ventures was a partner in a partnership and in consequence the distributions from the venture were subject to self-employment tax.  Methvin v. Commissioner, No. 15-9005, ___ Fed. App’x ___, 2016 WL 3457623 (10th Cir. June 24, 2016).

            Methvin owned various 2-3% working interests in certain oil and gas ventures.  In 2011, he received certain distributions on which he paid income tax, but no self-employment tax.  The IRS sought $690 in self-employment tax.  Methvin objected to that levy, asserting (it would appeal from the decision) that he was not a partner and the distributions were not subject to self-employment tax.  He lost on that argument when presented to the Tax Court (referred to in this decision once as the “district court”), and he lost again before the 10th Circuit Court of Appeals. The Tax Court’s decision is Methvin v. Commissioner, No. 28477–13, T.C. Memo. 2015-81 (April 27, 2015).

            Initially, the 10th Circuit affirmed the determination that, based upon the facts here at issue, there existed a partnership between Methvin and the operator of the wells.  While he argued he was only a passive investor, he had extensive rights under the agreements particular to these ventures including the rights to:

• inspect receipts, vouchers, insurance policies, legal opinions, drilling logs and reports, copies of drill stem tests, core analyses, electrical surveys, geological reports, and other records involving wells that had been drilled;

• audit the books and records;
• enter the property to inspect the operations;
• obtain any information reasonably requested regarding development and operation; and
• inspect the operator’s records.

Further, Methvin shared certain obligations as to expenses.  On these facts the determination that a partnership existed was affirmed.  There being a partnership, self-employment taxes were due and owing on the distributions made.

            It needs to be emphasized that the determination that a partnership existed was made on the facts and circumstances of this particular arrangement.  Methvin argued that the specifics of this arrangement were sufficiently different from those of Cokes v. Commissioner, 91 T.C. 222 (1988), wherein a partnership was also found, that no such determination should here be made.  That effort of distinguishing was not successful.  Rather:

These differences might have led the Tax Court to arrive at a different factual finding here, for “each case must rest on its own facts.” Jones v. Baker, 189 F.2d 842, 844 (10th Cir. 1951). But the Tax Court did not clearly err by characterizing Mr. Methvin’s arrangement with the operator as a partnership. In the absence of clear error, we uphold the Tax Court’s finding that the arrangement constituted a partnership.  (footnote omitted). 

            Persons holding oil and gas interests need to carefully consider whether they are in partnerships and are therefore subject to self-employment taxes on their distributions.  This is a particularly involved question of law for which attention to the details of each particular arrangement are necessary.


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