What are 'Working Interests'
Working interests refer to a form of investment in oil and gas drilling operations in which the investor is directly liable for a portion of the ongoing costs associated with exploration, drilling and production. In a similar fashion, working interest owners also fully participate in the profits of any successful wells. This stands in contrast to royalty interests, in which an investor's cost is usually limited to the initial investment, also resulting in a lower potential for large profits.
BREAKING DOWN 'Working Interests'Working interests, also referred to as operating interests, allow investors a percentage ownership of the drilling operation, functioning as a form of lease providing the investor a right to participate in drilling activities and a right to the resources produced from that activity. Along with deriving an income from the production of the resource, the investors are also responsible for a percentage of the expenses related to its acquisition.
How a Working Interest Works
All investors within the arrangement select a well operator, who then also fills a role as a working interest. The well operator, after all operating expenses have been covered, divides any additional funds between those holding a working interest, creating a source of income. Those holding a working interest may deduct certain costs, such as those associated to depreciation of equipment, when determining what will amount to a form of self-employment income.
Tax Implications of Working Interest Income
Since most working interest income is treated as self-employment income, it will generally be taxed as such. Since regular income tax payments are not automatically withheld from these funds, investors may be responsible for making estimated tax payments based on the current Internal Revenue Service (IRS) standards and rates.
Additionally, if the investor receives free resources, such as natural gas service to their property, from the company with the associated leasing rights, these amounts may also qualify as income and may be taxed as such.
Investors with working interests are often eligible for certain tax deductions based on the operating costs associated with the business. This can include business expenses of a tangible or intangible nature, such as equipment costs or utility payments.
Risks of Working Interests
While the idea of earning long-term income from owning a working interest in a natural gas or oil well might sound secure, the potential downside is the higher risks associated with working interest in comparison to other investment options. Limited liability royalty interests may provide an opportunity to participate in oil and natural gas investments with a lower level of risk than a working interest.
While working investments require continuous input from investors in regards to expenses, risking larger losses if expenses outweigh income, royalty interests generally require no additional funding from those investors, making additional losses beyond the initial investment less likely.