Shale Law in the Spotlight: Oil and Natural Gas Severance Taxes in the United States (Indiana, Kentucky, Alabama, and Mississippi)

Written by Chloe Marie – Research Fellow

This series addresses severance taxes on oil and natural gas imposed by various states, and this fifth article will review the severance tax systems for the states of Indiana, Kentucky, Alabama, and Mississippi. In prior articles, we addressed the severance tax systems for the states of Pennsylvania, Ohio, and West Virginia; the states of Texas, Oklahoma, Louisiana, and Wyoming; the states of North Dakota, Arkansas, Colorado, and New Mexico; and the states of Kansas, South Dakota, Montana, and Utah.

Indiana

In the state of Indiana, there is a petroleum severance tax assessed at a rate of 1% of the value of the oil and gas; or $0.03 per 1,000 MCF for natural gas and $0.24 per barrel of oil – whichever is greater (IC 6-8-1-8). Money received from the petroleum severance tax is collected by the state Department of Revenue, and then distributed to the state general fund (IC 6-8-1-27). More precisely, the proceeds paid into the general fund are to pay for the expenses of administering the petroleum severance tax regulations, for the purpose of administering IC 14-37 by the oil and gas division of the department of natural resources and for research pertaining to the exploration for, development of, and wise use of petroleum resources in Indiana.

According to the Indiana Department of Revenue, the state general fund received a total of $902,172.92 in 2016, including $188,399.67 from the severance of natural gas and $713,773.25 from the severance of oil.

Kentucky

Kentucky legislation provides for the imposition of a severance tax on oil and natural gas with a rate set at 4.5% of the market value of all crude petroleum produced in the state (KRS 137.120) and 4.5% of the gross value of natural gas and all other natural resources severed or processed in the state (KRS 143A.020).

The Kentucky statute also provides for a tax credit against the natural gas severance tax in cases where natural gas is severed and produced from a recovered inactive well (KRS 143A.033) – i.e. a well that has been inactive for a consecutive two-year period or a well that has been plugged and abandoned based on the determination of the Kentucky Energy and Environment Cabinet, Division of Oil and Gas.

Alabama

The state of Alabama provides that any person engaging in the business of producing or severing oil and gas is taxed at a rate of 8% of the gross value based on the oil and gas produced (AL Code 40-20-2). The legislation also specifies that for specified offshore oil and gas production, the severance tax must be based on gross proceeds instead of gross production.

In addition, the legislation provides for the imposition of a severance tax for incremental oil and gas production from a qualified enhanced recovery project at a rate of 4% of gross production at the point of production of oil and gas. This severance tax rate also applies to wells producing 25 barrels or less of oil per day or producing 200,000 cubic feet or less of gas per day.

For oil and gas produced from onshore discovery wells, a severance tax rate of 6% of oil and gas production gross value applies provided that drilling began within 4 years of the well completion date and is producing from a depth of 6,000 feet or greater, or is within 2 years of the well completion date and is producing from a depth less than 6,000 feet. This 6% rate is applicable for a period of 5 years starting at the production date.

The legislation provides for tax reduction incentives for wells permitted on or after July 1, 1988 at a rate of 2%, and for wells permitted on or after July 1, 1996, and before July 1, 2002, at a rate reduced by 50% for a period of 5 years after first commercial production. A rate of 2% will apply at the end of the five-year period.

90% of the money received from the oil and gas severance tax, collected by the state Department of Revenue, is deposited to the state General Fund. The remaining 10% is allocated by the Comptroller and distributed to the oil and gas producing-counties and related institutions for county purposes (AL Code 40-20-8).

Mississippi

The state of Mississippi levies a severance tax based on the value of the oil and natural gas produced within the state using different tax rate formulas depending on the type of well or project classification (Miss Code 27-25-503 and Miss. Code 27-25-703). Those tax rates are as follows:

-          6% on the value of the oil and natural gas;

-          3% on the value of the oil produced from enhanced oil recovery project using carbon dioxide;

-          1.3% on the value of the oil and natural gas produced from horizontally drilled wells or horizontally drilled recompletion wells with an initial date of production from and after July 1, 2013, over a period of 30 months. The rate will be increased to 6% thereafter for the life of the well. This reduced 1.3% rate will end on July 1, 2018.

The Mississippi Code also provides exemptions from the severance tax and tax reduction incentives for a certain period of time, depending on the type of wells and date drilling first occurred (Miss. Code 27-25-703(3) to (7) and Miss. Code 27-25-503(3) to (5)).  

The money received from the oil and gas severance tax is collected by the state Department of Revenue and deposited in the state Treasury, and then distributed to the state and oil and gas producing counties based on different formulas depending on whether the money came from oil (Miss. Code 27-25-505) or natural gas (Miss. Code 27-25-705).