Personal Finance Taxes
Severance Tax
Lea D. Uradu
Reviewed by Lea D. Uradu
Lea Uradu, J.D. is graduate of the University of Maryland School of Law, a Maryland State Registered Tax Preparer, State Certified Notary Public, Certified VITA Tax Preparer, IRS Annual Filing Season Program Participant, Tax Writer, and Founder of L.A.W. Tax Resolution Services. Lea has worked with hundreds of federal individual and expat tax clients.
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Federal Income Tax Guide
Tax Deductions / Credits
Tax Laws & Regulations
What Is Severance Tax?
Severance tax is a state tax imposed on the extraction of non-renewable natural resources that are intended for consumption in other states. These natural resources include such as crude oil, condensate and natural gas, coalbed methane, timber, uranium, and carbon dioxide.
Understanding Severance Tax
Severance tax is charged to resource producers, or anyone with a working or royalty interest in oil, gas, or mineral operations in the imposing states. The tax is calculated based on either the value or volume of production, though sometimes states use a combination of both. The severance tax is imposed to compensate the states for the loss or "severance" of the non-renewable source and also to cover the costs associated with extracting these resources. However, it is only imposed when a drilling well can produce above a certain level of natural resources, as determined by the individual state government.
Severance tax is a state tax imposed on the extraction of non-renewable natural resources intended for consumption by other states.
Severance tax is intended to compensate states for the loss of the non-renewable resources.
Several tax incentives in the form of credits or lower tax rates are often allowed in situations where the tax rate might be burdensome enough for extractors to plug and abandon the wells. Thus, these tax breaks are provided to encourage the production and expansion of oil and gas operations.
Royalty owners must pay their pro rata share of oil severance taxes. This deduction is captured on their monthly royalty owner revenue statement. These owners may be charged severance tax even if they do not realize a net profit on their investment. However, state severance taxes are deductible against federal corporate income tax liabilities. It is important to note that severance tax is different from income tax, and royalty owners and producers still have to pay all federal and state income taxes on oil and gas income in addition to severance tax.
Certain wells may be exempt from severance tax based on the amount they produce. Different states have different rules. For example, in Colorado, an oil well that produces less than an average of 15 barrels per producing day or a gas well that produces less than an average of 90,000 cubic feet per producing day is exempt from this tax.
Pennsylvania's Senate passed a budget that includes, for the first time, a severance tax on natural gas produced within the state. The state still remains the only major gas-producing state in the country that does not tax production, as of 2020. Instead, it levies a per-well impact fee, charging an annual fee to all unconventional (i.e. shale) wells. Gas companies pay the impact fee for each well they drill, which is unlike the severance tax, which gas companies pay based on how much gas is produced.
Severance taxes accounts for a very small percentage of overall government revenue—except for a few resource-rich states, such as North Dakota and Wyoming.
National Conference on State Legislatures. "State Oil and Gas Severance Taxes." Accessed Feb. 5, 2020.
State of Kansas. "K-39, Credit for Plugging an Abandoned Oil or Gas Well," Page 2. Accessed Feb. 5, 2020.
Internal Revenue Service. "Part 4, Examining Process. Chapter 41, Oil and Gas Industry. Section 1, Oil and Gas Handbook." Accessed Feb. 5, 2020.
Colorado Department of Revenue. "FYI General 4 Severance Tax Information for Owners of any Interest in any Oil and Gas Produced in Colorado," Page 2. Accessed May 27, 2020.
Internal Revenue Service. "Publication 525, Taxable and Nontaxable Income," Page 17. Accessed Feb. 5, 2020.
Colorado Department of Revenue, Taxation Division. "Oil & Gas Severance Tax, Stripper Well Exemption." Accessed Feb. 5, 2020.
Office of Governor Tom Wolf. "Restore Pennsylvania." Accessed Dec. 12, 2020.
Pennsylvania Public Utility Commission. "Act 13 (Impact Fee)." Accessed Feb. 5, 2020.
Tax Policy Center. "The State of State (and Local) Tax Policy," Page 33. Accessed May 27, 2020.
What Is Shale Oil?
Shale oil is a type of oil found in shale rock formations that must be hydraulically fractured to extract. Read about the pros and cons of shale oil.
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What Is a Payroll Tax?
A payroll tax is a percentage withheld from an employee's salary and paid to a government to fund public programs. Learn more about payroll taxes here.
A carbon tax is paid by businesses and industries that produce carbon dioxide through their operations.
What Is the Percentage Depletion Deduction?
Percentage depletion is a federal tax deduction for depreciation related to the business of extracting nonrenewable resources from the earth.
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