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Understanding What Severance Tax Is All About

Understanding What Severance Tax Is All About

What is the severance tax?

The severance tax is a state tax imposed on the extraction of non-energy natural resources for consumption in other states. These natural resources include condensate and natural gas, crude oil, methane coal, wood, uranium, and carbon dioxide.

Understanding what severance tax is all about

The severance tax is levied on resource producers or any person with commercial interests or royalties in the oil, gas, or mineral operations of the state. The tax is calculated based on the value or volume of production, although states sometimes use a combination of the two. The severance tax is imposed to compensate States for the loss or "Severance" of the non-renewable source and to cover the costs associated with the extraction of these resources. However, it is only required when a wellbore can produce above a certain level of natural resources, determined by the government of each state.

Things to note:

    •    A severance tax is a state tax imposed on the extraction of non-energy natural resources for consumption by other states.

    •    The severance tax aims to compensate States for the loss of non-renewable resources.

Various tax incentives in the form of loans or lower rates are often allowed in situations where the rate can be expensive enough for the extractors to lock into the wells. Therefore, these tax exemptions should encourage the production and expansion of oil and gas activities.

Taxpayers must pay their proportional share of the oil severance taxes. This deduction is recorded in the monthly income account of the royalty holder. For these owners, severance costs may be levied, even if they do not get a net benefit from their investment. However, state taxes on severance are deductible from corporate tax obligations. It is important to note that the severance tax is different from income tax and that royalty owners and producers must pay all federal and state taxes on oil and gas revenues, in addition to the severance tax.

Individual wells may be exempt from severance tax, depending on the quantity produced. Different states have different rules. For example, in Colorado, an oil well that produces less than an average of 15 barrels per day of production or a gas well that produces less than an average of 90,000 cubic meters per day of production is exempt from this set. This rule took effect in 2017.

In 2017, the Pennsylvania Senate approved a budget that included, for the first time, a severance tax on natural gas produced in the state. The state remains the only major gas producer in the country, not to have taxed production. Instead, it imposes an impact tax on the well, imposing an annual tax on all unconventional wells. 

Gas companies pay the impact tax for each well, which is different from the severance tax that gas companies pay based on the amount of gas produced.

Claims fees represent a tiny percentage of government revenue, except for resource-rich states such as North Dakota and Wyoming, and some others.

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