1. Introduction

Clarke Oil & Gas JV, LP (“COGJV”) is committed to providing investors with a clear and efficient tax reporting structure that aligns with IRS regulations and industry best practices. A common point of inquiry involves why COGJV does not issue Form 1065 Schedule K-1s to investors who participate directly in non-operating working interests in oil and gas prospect offerings. Instead, COGJV issues Form 1099-NEC along with a summary capital activity statement to provide investors and their tax professionals with the necessary data to optimize tax filings. This white paper outlines the legal, structural, and tax considerations that support this practice.

2. Legal Basis for Tax Treatment

COGJV facilitates investor participation in oil and gas prospect development through direct ownership of non-operating working interests rather than an equity stake in a partnership entity.

A. Investors Are Not Equity Partners in COGJV

• Subscription Agreement as the Governing Document: Investors acquire fractional undivided working interests in specific wells rather than equity in COGJV itself. This distinction means they are not considered partners for tax reporting purposes.
• Private Placement Memorandum (PPM): The PPM, particularly the sections “Application of Proceeds” and “AFE (Authorization for Expenditure),” outlines how investment funds are allocated and establishes that investors are direct owners of the working interests, not members of a partnership structure.
• COGJV Partnership Agreement (Section 7.2 & 3.2): Confirms that investors hold economic interests without equity ownership, reinforcing why a partnership tax structure does not apply.

Since investors are not legal partners, the issuance of a Form 1065 Schedule K-1, which is required only for true partnership structures, is not applicable.

3. IRS Tax Classification of Non-Operating Working Interests

The IRS classifies working interest holders in oil and gas ventures as engaged in an active trade or business, which has direct implications for tax reporting:

A. Working Interest Income is Not Partnership Income

• Unlike limited partnership income, working interest income is reported as ordinary non-passive income and may be subject to self-employment tax if actively managed.
• Investors must report their share of revenue, expenses, and deductions individually, rather than through partnership-level tax filings.

B. Form 1099-NEC is the Appropriate Reporting Mechanism

• The IRS requires payors to issue Form 1099-NEC when compensating nonemployees for services or direct participation in an income-generating activity.
• Investors receive gross revenue allocations rather than distributive shares of a partnership, aligning with the 1099-NEC structure.

4. The Role of the Summary Capital Activity Statement

In addition to Form 1099-NEC, COGJV provides a Summary Capital Activity Statement to ensure investors and their CPAs have all necessary information for tax optimization. This document includes:

• Gross Divisional Interest Income: Total revenue allocated to the investor’s working interest.
• Taxes: Including severance and production taxes where applicable.
• Operating Expenses: Monthly operating costs and lease expenses.
• Other Expenses: Additional deductible expenses relevant to well operations.

This summary allows tax professionals to properly allocate intangible drilling costs (IDCs), tangible expenses, lease operating costs, and depletion deductions when preparing the investor’s tax return.

5. Cost Depletion and Tax Optimization

Investors who own non-operating working interests are eligible to claim cost depletion, which can be calculated by determining the adjusted cost basis of the investment and applying the appropriate depletion percentage, ensuring an accurate reduction in taxable income.

The Summary Capital Activity Statement provides the necessary data to calculate depletion, allowing investors to:

• Determine the adjusted cost basis of their working interest.
• Apply percentage or cost depletion methods based on individual tax scenarios.
• Offset income with allowable deductions to minimize tax liability effectively.

By structuring tax reporting in this manner, COGJV ensures compliance while maximizing investor flexibility by allowing them to independently manage their tax liabilities based on their unique financial situations.

6. Conclusion

COGJV’s tax reporting structure is specifically designed to reflect the legal and financial realities outlined in IRS regulations governing non-operating working interests, such as IRS Publication 535. This ensures compliance with tax laws while simplifying investors’ reporting obligations. By issuing Form 1099-NEC alongside a comprehensive summary capital activity statement, we provide investors with the exact information needed for accurate, optimized tax filings while avoiding the unnecessary complexity and misclassification associated with Form 1065 Schedule K-1s.

This approach aligns with IRS regulations, industry best practices, and investor tax efficiency. Investors are encouraged to work with their tax professionals to leverage the provided documentation fully and optimize their tax positions based on their individual financial circumstances.

For further inquiries, please contact COGJV’s investor relations team.

Clarke Oil & Gas JV, LP
Clarke Energy Fund Management, LLC