The Mark Perlberg CPA Podcast
The Mark Perlberg CPA Podcast
EP 118 - Tax Showdown: Oil & Gas Investing vs. Retirement Account Investing
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Let's examine the tax advantages and disadvantages of investing in oil and gas versus traditional retirement accounts, helping you determine which strategy aligns best with your financial goals and tax situation.
• Oil and gas investments typically provide 70-90% tax deductions through intangible drilling costs while retirement accounts offer dollar-for-dollar tax savings
• Retirement accounts reduce both federal and state taxes while oil and gas investments primarily offset federal taxes
• When taking distributions, oil and gas profits benefit from a 15% depletion allowance that reduces taxable income
• Retirement account withdrawals before 59½ face penalties while oil and gas distributions have no age restrictions
• Oil and gas interests can be gifted to family members for income-shifting strategies while retirement accounts cannot
• Retirement accounts have contribution limits ($23,000 for employee 401k contributions) while oil and gas deductions can offset up to $313,000 (single) or $626,000 (married) of non-business income
• Retirement accounts offer creditor protection and investment diversification while oil and gas investments carry higher risk
• Strategic tax planning should consider income thresholds for SALT deductions ($500,000) and qualified business income deductions ($400,000)
If you're interested in learning more about these tax strategies, visit ProsperalCPA.com/apply for a personalized opportunity report or TaxPlanningChecklist.com for a free tax planning checklist and mini-course.
Oil and gas versus retirement accounts. How are they similar in their ways to reduce your taxes and how are they different? Which is going to save you more taxes now and in the future and which is the best fit for you? That's the topic we're going to cover today, so stay tuned. There's going to be lots of information. This one. I'm going to be diving really deep and if you are thinking about putting more money into those tax deferred 401ks or IRAs or maybe getting started in oil and gas or maybe you don't do either, or maybe you don't even know why anybody would invest in oil and gas or even if you're a seasoned expert, stay tuned because we're going to have some fun diving into this topic. We're going to discuss how to save money when you invest in each of these strategies and the tax treatment when you pull the money out of the retirement accounts or when you receive your funds from your oil and gas investing. We'll talk about transferring these funds or retirement accounts to other members and how that can fit into your strategy and what are the limitations. We'll also discuss risk and flexibility of each strategy, planning opportunities and how you can think about this as it fits into your tax plan and ultimately, when you've listened to this conversation, you will be closer towards making a decision and understanding what is the best strategy for you or combination of strategies based on your situation and what's most important to you. So let's dive into it.
Speaker 1:First, let's talk about what they have in common. So oil and gas investing is going to allow you to reduce your adjusted gross income pretty much the income we look at before we take all the deductions out for itemized deductions and other below the line deductions. Both oil and gas and retirement accounts, your IRAs and your 401ks will reduce your adjusted gross income. That also reduces your taxable income and you are potentially going to be taxed in the future. When you put your money into these tax-deferred vehicles, you're reducing your taxes and it grows tax-deferred to be taxed at a later date. When you put the money into oil and gas, you get an immediate tax deduction for what's called intangible drilling cost deduction. That we'll dive into in a little bit. And then, when the money comes in and you get your return on investment, that is going to be taxable income In both situations when you take the money out of your retirement account or where you get your distributions from your oil and gas. Both instances, you'll be taxed at your marginal rate. Now, in both of these strategies, these are going to be helpful if you're looking for an immediate deduction and you are going to be moving and smoothing out your tax bracket, so you get a deduction when you put the money in and eventually the money is going to hit your account, whether it's through the distribution or through your profit share, and that will create future taxation.
Speaker 1:Now let's talk about the limits. How much can I deduct from my retirement accounts? Well, that depends. Now there are pension plans and cash balance plans that we don't have enough time to dive into, but for most of you listening, you're likely going to be looking at 401ks, solo 401ks, and IRAs, and maybe SEP IRAs. So, when it comes to 401ks, you, as an employee either of your own company that you own or where you are employed, the most that you can put in is typically going to be $23,000 per year. There is a catch up when you're over 50. You can put an extra $7,500 into that tax deferred 401k. Now, the employer may be able to contribute as well, and that would bring now consider that this is, for the 2025 year the maximum that you can put in when you combine the employer and employee contributions is going to be $69,000. Now, if we have traditional IRAs, we have $7,000 per year that each you and your spouse can put in. But there are income phase outs and as of right now, it starts to phase out when your income gets between $123,000 and $143,000 when you're single $230,000 to $240,000 if you're married, filing joint. So not a ton of tax savings created here with traditional IRAs. And if you have a SEP, it's going to be 25% of compensation up to $69,000 in 2025. Well, that probably wasn't the most exciting part of this conversation. You can really listen to it if you want, but I just had to throw that in there to talk about the comparisons.
Speaker 1:Now let's talk about the oil and gas and how much we can deduct from our investments into oil and gas. When you invest into oil and gas, you're typically going to get an intangible drilling cost deduction. Now, when I say when you invest into oil and gas, in this example you are investing into working interest, into an oil and gas fund. That is typically going to be a partnership. In some instances it may be a sole proprietorship, but usually our clients and most investors will come in to this structured as a partnership. Your deduction when you invest in oil and gas is typically going to be around 70 to 90 cents per dollar, but there are different funds with different business models and different offers. We usually ballpark it at 80% to kind of give what we typically see for these investments. It can be higher, it can be lower.
Speaker 1:Now, one advantage of the tax-deferred vehicles over oil and gas is it will reduce your state taxes as well as your federal. Usually, the oil and gas will not offset your state taxes. It's usually domiciled in a place like Texas, and if you don't live in Texas, that activity is not going to hit the state return in the same manner and it likely will not reduce your state taxes of where you live. So if we're looking for what's going to give you the most amount of tax deductions when you put the money in and the most amount of savings, the clear winner is going to be the 401k and the IRA, because you get a dollar for dollar tax savings instead of somewhere between 70 to 90 cents per dollar, and it can offset your state taxes. Now let's talk about when the money hits our account, whether we're talking about through distributions or through taking the funds out of our retirement accounts. So when you are getting your profit distributions from the oil and gas, the profit is going to be taxed at your ordinary rate.
Speaker 1:On the federal side Now you will have what's called a depletion deduction is to account for the reduce or the running out of the resources in your project, and it's typically going to be around 15 percent of the revenue. And this is a paper deduction. So you're not spending anything to get this paper deduction of depletion, spending anything to get this paper deduction of depletion. So this is really exciting here, because how great is it when the money comes in and you don't pay taxes on all of it? So clearly this is going to be treated far more advantageously than your W-2 job. When you get paid and all this money comes out right, you're not going to be paying taxes on all the cash that hits your account. You may even get what's called a qualified business income tax deduction on that oil and gas investment as well, depending on your circumstances.
Speaker 1:Now, when the money comes in, when you take a distribution from your retirement account, or let's say you do a Roth conversion, it is taxed at your marginal rate. And now in this instance, because we've deferred our state taxes, we're more likely to pay taxes at our state level. Now, with the oil and gas, you're more likely to use those unused losses if they didn't offset your taxes to offset future taxable income at the state level. Eventually you likely will see some state taxable income on the profits of oil and gas if you live in a state with state taxes. Side note here's a really cool idea is if you can move and retire in a state with no taxes, and we see this when people move from New York to Florida. They retire in Florida, they defer the taxes in New York and then they recognize the retire in Florida, they defer the taxes in New York and then they recognize the income in Florida and they don't pay any of the state taxes permanent state tax reduction. But anyways, you're going to see a little bit difference here because you're going to see that the oil and gas is going to give you an opportunity to pay less taxes on the money that comes in.
Speaker 1:Now here's something I also want to clarify when we take the distributions or eventually pay the taxes on those tax-deferred vehicles, even though you're investing in things like stocks that have capital gains, you're not going to be taxed at the favorable capital gains rate, you are going to be paying taxes at your ordinary marginal rate, regardless of the type of income that is. You don't see that favorable 15% tax rate. So another thing that you just may want to consider here is when you take the funds, when you get your cash from your profit shares of the oil and gas, while it could be taxed at your marginal rates, a lot of our clients will be reinvesting their profits year after year after year and building up just a larger and larger collection of investments into the oil and gas and usually offsetting the profits until they find that they're not in the position where they want to put the funds into those. Now let's talk about a little bit here on transferability, especially if you're thinking about estate planning. So if you are investing through a IRA Roth, ira, 401k the only way that it can transfer through is through inheritance. You can't gift anybody your own interests in your retirement accounts. Now what's cool here and a lot of people are missing this opportunity, by the way is you can gift interest in oil and gas and this can be a really cool and exciting income shifting strategy where you can take the tax deduction for your investment into the oil and gas and then you can gift it to another family member and then they receive the profits taxed at their lower marginal rate. So if you're looking to support someone else and if you're looking for an advantageous, outside of the box and very creative and powerful way to create a tax deduction while gifting someone money, look at oil and gas Really cool stuff here. I mean we can dive in deep to this topic. There's all sorts of fun and exciting advanced tax reduction strategies that go along with oil and gas that we have so much fun with with our clients. And you really got to know the client situation and what they're looking to accomplish to determine which of these strategies we can loop in and kind of align with what they're overall trying to do. On the side note, by the way, if you are interested in seeing how these topics can apply to you, always remember you can go to prosperalcpacom slash apply, that is, prosper with an L cpacom slash apply. Now, if you're not ready to talk to us and have that conversation, you can go to taxplanningchecklistcom for a free tax planning checklist and mini course to get you starting to think about how these concepts may apply.
Speaker 1:Let's get on with the conversation here. Let's talk about timing and the flexibility here. So when it comes to timing, mechanisms and strategies here, the retirement accounts are going to be a clear winner Hands down, no question about it. Here's why, with oil and gas investing, you have to put the money in the funds before the end of the year. So if you want to save money in 2025, you better have put some money into a fund before December 31st of 2025. Now, if you are looking to reduce your taxes for the current year and you want to use an IRA or a 401k, you actually don't have to put the money in before the end of the year. You typically just have to put it in before you file.
Speaker 1:Now what I like about this is, let's say, you want to hold on to your cash a little longer. You say, hey, I want to get a $50,000 tax deduction because it'll drive me into this rate where I qualify for additional credits and tax deductions. But I don't know, I might really need this $50,000 right now. I got to buy a new house. I just had this new operation set up. I have this new acquisition. My wife just lost her job.
Speaker 1:I think I need to hold on to this a little more. I'm not ready to give it up so we can see how the dust settles and see if you have the liquidity and maybe in March of the following year we can put the money into those tax deferred accounts. We just got to make sure they're set up. The accounts are set up before the end of the calendar year and we're good to go. And when I think about this, we, in both instances we're getting the current year deduction right. So again, if you're looking to we'll talk about the planning instances in a little bit here but certainly we can take more time to see how things shake out, clean up our books, see how the following year is going, maybe in 2026, we say, oh, actually we're in a really low bracket in 26. Let's get the deduction for 25. There's so many ways that we can maneuver this to optimize your situation, especially when you're being strategic with your tax advisor. So, the flexibility of putting the money in we're going to have a clear winner, which is the retirement accounts.
Speaker 1:But what about taking the money out? Well, here's where it gets tricky because typically you got to wait until you're 59 and a half to take your money out of your 401ks or IRAs without paying any penalties, money out of your 401ks or IRAs without paying any penalties. Now you could convert them into a Roth, but you still are not going to be able to take advantage of that profit without paying some sort of a 10% tax. However, when you're talking about oil and gas because you're not going to see so many restrictions it's not like you have all these rules that you have around the retirement accounts You're going to be able to see your participation in the cash flow and you're going to get your distributions and your share of that income, regardless of how old you are. So we're not waiting until we're 59 and a half. We can enjoy the results of our investing and the after tax impact of all of this, which is you put money in and, if it works well, you get your profit. You don't pay taxes on all of your profit because your depletion deduction and maybe even in the years where you receive your profit is a year where you're taxed at a lower bracket, and this becomes especially popular when you do advanced tax reduction planning.
Speaker 1:Now let's talk about risk and volatility here. So when you put your money into oil and gas, it's kind of stuck there until you get your distributions. It's really hard to exit out of these working interests into the oil and gas, so you're taking on more risk. Right Now, when you have a retirement account, you can diversify. You can spread your risk out among multiple different types of investments. You can invest into real estate with a self-directed retirement account. You can invest into stocks. You can collect interest. There are so many things you can do with retirement accounts. You can be as safe as possible and invest in index funds and notes, so there's all sorts of ways we can manage our risk with our retirement accounts. Now, another thing we can think about here is when it comes to the flexibility. However, while the retirement accounts let you to invest into all these different things, you're going to see a little more flexibility in how you set up your oil and gas.
Speaker 1:Actually, before I dive into that, I just want to talk a little more about risk. So, when you invest in oil and gas, it is considered a riskier investment. There is risk of a dry well, there's market volatility, there's changes in the pricing of oil based on global events, and then you're also going to consider the fact that, unlike with retirement accounts here's something that a lot of you probably are overlooking here. When you have a retirement account, you're protected against creditors. They cannot go after retirement accounts. When you have oil and gas, that's just one of many assets that you can be exposing yourself to creditors in case something ever goes wrong and they're after your stuff. Now the asset protection specialists who are listening to this are like man, why is this guy using such third grade language? But I'm going to stick with that word stuff for this conversation. I know a lot of the other CPAs out there like to sound smart. I'd rather just make sure you guys get the points here.
Speaker 1:Another thing to think about here is if you are a business owner, you also got to navigate all the rules when it comes to setting up retirement accounts. You can't just set up this massive pension plan and defer all your taxes and give yourself all these benefits and not give them to your other employees. There are certain rules you have to follow. I've seen all sorts of business owners try to create all these other entities and workarounds and sub-entities that they can kind of use to divert their funds away from their business and not give anyone else benefits, and a lot of times they're probably breaking the law. So you also have to consider. If you're a business owner, you do have to maintain compliant and be aware that, as an employer, these are fringe benefits and they should apply. There should be some form of a policy that can apply to all the members of the company.
Speaker 1:I want to backtrack a little bit here on the investing limitations here. So we talked earlier about all these different criteria for the maximum amounts you can put into your 401ks and IRAs. When you're putting money into the oil and gas funds, the limitations on how much you can reduce your taxes by are going to give you a little bit more opportunity to take taxes to create savings. Here A couple of reasons why there's no limit as far as how much you can put into an oil and gas fund with working interest. You can put a million dollars, you can put a billion dollars, it doesn't matter. No one's going to restrict you. But how much can you use it to offset your income? Well, that depends.
Speaker 1:If you are a W-2 earner, the maximum amount of tax savings that you can create, or tax deductions that you can create, is based on what we call the excess business loss limitation. So if you are a single filer, for 2025, that amount should be $313,000. That is the most amount of losses from oil and gas you can take to offset your W-2 income or any other non-business income, and what I would consider non-business income. In this example, that could be interest and dividends from stocks or other types of interest income Essentially, all those other items that you're going to see on your 1099B. Now, if you're a business owner, you can offset 100% of your business profits with the losses from oil and gas and, by the way, if you're married, filing joint, that amount doubles for 2025 to get you a maximum of $626,000 deductions to offset your non-business income. And this amount will be increasing for inflation year after year. So, if you're listening, in a later year it's probably a little higher. So obviously you can max out your retirement accounts and maybe you decide to put more into the oil and gas.
Speaker 1:And let's talk about some other concepts here when it comes to planning opportunities. Here, when it comes to planning opportunities, whether you're using oil and gas or retirement accounts, some of the things you may want to think about when you're working with a tax advisor is to get to that sweet spot of AGI and taxable income, and for each of you this amount may be different, but you're going to find, especially with the recent changes in the One Big Beautiful Bill Act, there are going to be certain areas where you get to this certain taxable threshold and you're maximizing certain incentives for entrepreneurs in particular and other just income earners. And what are the factors and what am I talking about? Well, remember how we have this new SALT cap state and local tax deduction. It now goes to $40,000. So instead of maxing out what we can deduct of our state taxes against federal, state and local taxes it used to be $10,000. Now we can get an additional $30,000 deduction, but that is phased out as our income increases between $400,000 and $500,000. Now, sorry, it's not phased out. We're going to do some editing in the cutting room floor here and I think it's $500,000.
Speaker 1:Let's see here. Okay, so if your modified adjusted gross income is $500,000 or less, you get the full amount and then it's phased out between $500,000 and $600,000. So for some of you who are paying state taxes, you might want to drive yourself into that $500,000 bracket and then when you get between $500,000, five and 600,000, as you lose that deduction, you may see a really strong spike in your overall taxes. So these tax deferral vehicles are not just going to reduce your taxes temporarily. They're going to open up the opportunity for that additional tax deduction and that's more of a form of permanent tax elimination.
Speaker 1:And some other variables we want to consider is if you are a business owner, getting qualified business income deduction, that can be as much as 20% of your profits and that starts to phase out at different income levels as well. We like to see around $400,000 of total income to optimize that in many situations. But obviously there are so many other variables depending on how much you're paying your staff. But this could be a big deduction that, especially if you are a professional like a doctor, attorney or a lawyer, keeping you around $400,000 is a really good sweet spot of AGI where we get the 40K of state deductions and we can get you your qualified business income and then we have the child tax credits. So there's all these different things that we can navigate to get you in this sweet spot of taxable income and adjusted gross income to maximize all these little additional tax deductions and credits that phase in and phase out and these deferral strategies not only temporarily reduce your taxes but they give you these additional opportunities that you wouldn't find elsewhere by driving down those amounts. So we want to navigate the volatility in all these situations as well.
Speaker 1:So, while oil and gas is risky, as we talked about earlier, I don't think that you should avoid it. We have lots of clients investing in it and they love the oil and gas. It's a little less predictable. They don't always know exactly when the distributions will start. So if you're banking on that money to live on, that may be the oil and gas is not the best strategy, but it can be highly profitable and advantageous, especially when you maxed out your retirement accounts.
Speaker 1:And then, with all these strategies, our hope is, in addition to creating profits, we are moving income into lower bracket years. So let's say we have a million dollars in profit. We had a breakthrough year. This is a good year to put the money to the oil and gas and get that deduction, get you out of that 37% federal bracket and in the future years the money's going to come in. And if that was an anomalous year, now you're going to be recognizing income at a lower bracket. Not only at a lower bracket, but you're going to have that depletion deduction, further reducing your taxable income. So you're paying less on the profits than the cash that hits your account and hopefully, with some planning, they're going to be taxed at a lower bracket as well.
Speaker 1:Huge opportunities here with oil and gas. Now, in both of these strategies, however, there's some really wonderful opportunities where you're building long-term wealth and you're investing in vehicles that are going to drive profit, that combine the two. Not only can you stack your retirement account investments with your oil and gas investments, but you can even invest in oil and gas with your retirement accounts, and when you understand the law and the opportunities associated with this, there are some really interesting ways by which you can use this to not only create additional wealth vehicles and diversify, but you can actually reduce the amount that is taxed when you convert it from an IRA or 401k into the Roth Some really advanced strategies regarding the evaluation and the timing. So if you're interested, again, you can reach out at prosperalcpacom. We can talk about how that may work for you. Now, we just talked about a lot of stuff and, for those of you who are tax geeks or overpaying in taxes, hopefully you have some new ideas and inspiration, and let's wrap this up now with a discussion on how are you going to make a decision on oil and gas versus retirement accounts or both.
Speaker 1:Well, here's the thing If you're looking to maximize your diversification and be as risk adverse as possible and you want to get the state tax savings and you want the opportunity to do Roth conversions and move the income into tax-free buckets in the future and you want to have more control over the timing because you can't control that oil and gas fund, but you can control a little more of when you put the money into your own account or your Roth then the retirement account strategy will be most applicable to you. Now for oil and gas, however, if you want to maximize how much you can deduct against your taxes, if you want a faster way to access the cash from your investments without having to wait until you're 59 and a half and you want to pay less in taxes, or at least recognize less in taxes, and you want to have you're OK with less diversification of this vehicle and you're okay with the greater risk, then maybe oil and gas makes sense. Now, regardless, if you are an employee, you always want to take the free match, that's free money. Make sure you get that. So I hope I gave you some ideas here and obviously, for a lot of you listening, you may want to combine both strategies and it'll really be helpful if you're collaborating with a tax professional as you make these decisions and obviously, as you know, you know where to find us prosperocpacom at slash apply.
Speaker 1:If you want that free opportunity report and a personalized video from me talking about how this can save you money in taxes me talking about how this can save you money in taxes and then again you can go to taxplanningchecklistcom for an introductory course and free checklist on advanced tax reduction planning and some basic strategies and how it may apply to you. I hope you enjoyed this conversation. Let me know if you have any questions at all. Really had fun thinking about this and how it may apply to all of our clients and stay tuned. We have more great stuff coming your way. At the very least, get the tax planning checklist, get on the mailing list. Can't wait to share some new ideas and maybe invite you some free live events. So make sure you're on it. All right, you guys, have a great day and keep in touch. Happy tax saving.