Anticipated marginal well credit on 2024 tax returns

What happened?

The IRS in July 2024 released Notice 2024-52 announcing the reference price for natural gas and the associated credit to be applied to the 2024 tax year. The IRS releases these annual notices announcing the reference price for natural gas and associated tax credit per 1,000 cubic feet (mcf) of natural gas. These amounts apply for taxpayers wishing to claim the marginal well credit (MWC) on their tax returns. The MWC is a nonrefundable general business credit that may be carried forward if not used in the current period.

The annual notice also provides the inflation adjustment factor (IAF) to be used to calculate the phaseout limit when determining the MWC. Over the past few years, the MWC has been available only for natural gas producing properties since the credit currently is phased out and not available for oil.

Why is it relevant?

Section 45I and Notice 2024-52 outline the steps for determining the estimated reference price and MWC for the 2024 tax year. Due to the natural gas price decline in 2023, the MWC is available at a maximum credit of $0.77 per mcf for 2024 tax returns.

Note: Taxpayers were not eligible to claim the MWC on their tax returns for the 2023 calendar year since the reference price published in Notice 2023-58 stated that the credit was fully phased out at an estimated $0 per mcf.

Action to consider

Although the IRS has used similar and consistent methodology to calculate the reference price for the prior seven years, taxpayers should apply caution when using estimates for other calendar year reference prices and anticipated MWC. The IRS could adjust their methodology to calculate the credit; however, this has not been the case for the past seven years.

Overview

The MWC was enacted as part of the American Jobs Creation Act of 2004 as a production-based tax credit intended to assist taxpayers with exploration and production activities as a price support when oil and gas prices are low. Governed by Section 45I, the MWC has been unavailable for most of its existence due to historical oil and natural gas prices in the United States.

Below is a high-level overview of the credit and key factors to consider when seeking to calculate the MWC.

Marginal well

Section 45I(c)(3) provides that a marginal well is a well with (1) average daily production of not more than 15 barrels of oil equivalents per day or (2) average daily production of not more than 25 barrels of oil equivalents per day and water production of 95% or more of waste output. If a well produces both oil and gas, the production of both, as based on oil equivalents, must be considered when determining whether the well qualifies as a marginal well.

Tax credit amount

The maximum natural gas MWC allowed for qualified marginal wells is $0.50 per mcf of natural gas based on when the credit was enacted in 2004. Although Section 45I provides that the maximum credit allowed is $0.50 cents per mcf, the credit is adjusted for inflation and is reduced to the extent that the applicable reference price exceeds $1.67 (adjusted for inflation). More specifically, Section 45I(b)(2)(A) provides that the tentative credit amount is reduced by an amount that bears the same ratio to such amount as the excess (if any) of the applicable reference price over $1.67 (adjusted for inflation), bears to $0.33 (adjusted for inflation). As a result, the MWC is not available if the applicable reference price for qualified natural gas production exceeds $2 (adjusted for inflation) or more.

Observation: As discussed above, no oil credit is expected to be available for 2024 because no oil MCW has been available in prior years due to crude oil prices being lower than expected for the national average (see Notice 2024-52 in which it has been determined that the annual average domestic crude oil price for 2023 was $76.10, which applies to calendar year 2024 determination of credits). However, the 2024 estimated credit for natural gas for 2024 tax returns is a maximum of $0.77 per mcf.

Reference price

Section 45I(b)(2)(C) defines “reference price” as the Treasury's estimate of the annual average wellhead price with respect to any calendar year. The reference price is used to compute the MWC. Section 45K(d)(2)(C) establishes the reference price for crude oil as determined by the Secretary from energy prices from the Energy Information Administration. No such data is collected for natural gas. Thus, the Secretary’s determination is based on inflation data. 

Reference prices are determined on a one-year lookback basis. The applicable reference price for a tax year is the reference price for the calendar year prior to the calendar year in which the tax year begins as shown on the tax return. For example, the 2021 reference price is used to calculate the MWC on the 2022 calendar year-end tax return. Likewise, the 2022 reference price is used to calculate the MWC on the 2023 calendar year-end tax return. A fiscal year-end taxpayer whose tax year begins in 2024 would use the 2023 reference price.

The MWC begins to phase out as the reference price increases above $2.58 for gas (adjusted for inflation). The MWC is completely phased out once the reference price reaches $3.09 (adjusted for inflation) for natural gas.

Inflation adjustment factor

Section 45I(b)(2)(B) states that the reference prices and phaseout ranges provided in Section 45I should be adjusted for inflation. Notice 2024-52 provides that the IAF of 1.5447 should be used to calculate tax credits for 2024 tax returns. As discussed above, no oil credit is expected to be available for 2024 because no oil MCW has been available in prior years with crude oil prices higher than expected for the national average and the credit out ranges.

Production limitations

Section 45I(c)(2) limits the amount of production by well that can qualify for the MWC. Only the first 1,095 barrels of oil (or 6,570 mcf of gas) per well are considered “qualified” and can be used to claim the credit. For example, if a taxpayer’s well produced 8,000 mcf of gas in a calendar year, only the first 6,570 mcf would be eligible for the MWC credit. The number of wells for which a taxpayer can claim the MWC is unlimited.

Other items

Other important components of and qualifications to the MWC should be considered and accounted for properly when calculating the credit.

• Only domestic wells qualify for the MWC.
• Taxpayers must have an operating interest in the well to claim the MWC.
• Taxpayers already claiming the Section 45K nonconventional credit cannot claim the MWC.
• The credit limitations are applied on a pro-rated basis for short tax years.
• Form 8904, Credit for Oil and Gas Production From Marginal Wells, is used to report the MWC for years beginning in 2016 and onward. Note that this form has not been updated since December 2018 and requires adjustment for the rates applicable to the filing period.
• The credit has a five-year carryback period and a 25-year carryforward period.

Future reference prices

Observation: Notice 2017-51 indicated that the method used to calculate the 2015 reference price likely will be similar for future years. This method has been consistent since the notice was released for all subsequent years; however, caution should be used when estimating other calendar-year reference prices until the IRS provides more guidance.