Rev. Rul. 55-315

Advice has been requested whether the tax imposed by the State of Colorado upon the portion of the gross income of every person which is derived from the production or extraction of crude oil, natural gas, or both crude oil and natural gas from petroleum deposits located within the State is deductible in computing adjusted gross income under section 22(n) of the Internal Revenue Code of 1939.

Chapter 84A, Paragraph 6(1), of the Colorado Statutes annotated, as amended by the Laws of 1953, Sections 1-3, 352-354, provides that in addition to the tax imposed by subsections (2), (3), (4) and (5) there shall be levied, collected and paid for each taxable year ending on and after December 31, 1953, upon that portion of the gross income of every person which is derived from the production or extraction of crude oil, natural gas, or both crude oil and natural gas from petroleum deposits located within the State of Colorado a special income tax.

All State and local ad valorem property taxes imposed upon leaseholds, royalties and other interests in oil and gas deposits located within the State, except ad valorem taxes imposed upon drilling production, storage and transportation equipment and facilities, may be claimed as a credit against this special income tax. The tax is collected by withholding at the rate of 3 percent from payments made by every producer or first purchaser of oil or gas. The tax withheld may be claimed as a credit by the taxpayer on his Federal income tax return. This special gross income tax described above is not allowed as a credit against the general income tax of the State.

Section 22(n) of the Code provides in part as follows:

(n) DEFINITION OF `ADJUSTED GROSS INCOME'.-As used in this chapter the term `adjusted gross income' means the gross income minus-

(1) TRADE AND BUSINESS DEDUCTIONS.-The deductions allowed by section 23 which are attributable to a trade or business carried on by the taxpayer. * * *;

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(4) DEDUCTIONS ATTRIBUTABLE TO RENTS AND ROYALTIES.-The deductions (other than those provided in paragraph (1), (5), or (6)) allowed by section 23 which are attributable to property held for the production of rents or royalties;

Section 39.22(n)-1 of Regulations 118 provides that taxes are deductible in arriving at adjusted gross income only if they constitute expenditures directly attributable to the trade or business or to property from which rents or royalties are derived. Property taxes paid or incurred on real property used in the trade or business are deductible, but general state income taxes are not deductible in computing adjusted gross income, even though the taxpayer's income is derived from the conduct of a trade or business or from property held for the production of rents or royalties. However, the special Colorado income tax on gross income from oil and gas production applies only to income from the production or extraction of oil or gas from properties in that State. Such tax is, therefore, directly attributable to interest in oil and gas properties and is designed to complement State and local ad valorem taxation of such interests. To the extent that such ad valorem taxes are paid by the taxpayer they may be credited against his liability for this special income tax. The tax is not allowed as a credit against the general income tax imposed by the State. There is such a proximate connection between the tax and the property producing the income that the tax is, within the meaning of the regulations, directly attributable to the trade or business of the taxpayer or to property from which royalties are derived by the taxpayer. See Robert J. Koshland, executor under the will of Corinne S. Koshland v. Commissioner , 19 T.C. 860, affirmed per curiam, 216 Fed.(2d) 751, and I.T. 3829, C.B. 1946-2, 38.

Accordingly, the tax is allowable to the owner of an operating interest in oil and gas properties as a deduction attributable to a trade or business under section 22(n)(1) of the 1939 Code and to the owner of a royalty interest, such as a lessor or sublessor, as a deduction attributable to property held for the production of rents or royalties under section 22(n)(4) of the 1939 Code