IRS Confirms 15% Percentage Depletion Rate for Marginal Oil and Gas Properties for 2026

WASHINGTON — The Internal Revenue Service announced on June 15 that the percentage depletion rate for oil and gas produced from marginal properties will remain at 15% for the 2026 calendar year. The confirmation came in IRS Notice 2026-35, providing certainty for independent producers and royalty owners as they plan their tax strategies for the upcoming year.

This annual announcement, while seemingly routine, is a critical data point for financial planning within the energy sector. For the small and mid-sized independent producers that form the backbone of domestic energy production, having this rate confirmed allows for more predictable cash flow modeling and tax liability forecasting, which is essential in a notoriously volatile industry.

The rate is determined by a formula tied to the reference price of crude oil for the preceding calendar year, as outlined in Internal Revenue Code Section 613A. The IRS calculated the reference price for crude oil for calendar year 2025 to be $63.40 per barrel. Because this price is significantly above the $20-per-barrel threshold that triggers an increase in the depletion allowance, the rate holds steady at its statutory floor of 15%.

Under the law, the 15% rate is designed to increase by one percentage point for each whole dollar that the reference price for crude oil falls below $20. This provision, capped at a maximum depletion rate of 25%, was established to provide tax relief and incentivize production from smaller wells during periods of exceptionally low energy prices. Given that crude oil prices have remained well above the $20 mark for many years, the rate has consistently been set at 15%.

The percentage depletion allowance specifically benefits independent producers and royalty owners, not large, integrated oil companies. The tax code defines “marginal production” as domestic crude oil or natural gas from properties that are either “stripper wells” or produce substantially all heavy oil. A stripper well property is one whose average daily production is 15 barrel equivalents or less per day. This distinction targets the tax incentive toward smaller-scale operations that are more sensitive to price fluctuations and have higher per-barrel operating costs.

Depletion is a form of tax deduction that allows owners of natural resource assets to account for the reduction, or depletion, of their reserves as they are produced and sold. Taxpayers can generally calculate their depletion deduction using one of two methods: cost depletion or percentage depletion. Cost depletion is based on the property’s cost basis, while percentage depletion is calculated as a fixed percentage of the gross income from the property. Businesses are permitted to deduct the larger of the two amounts, and the percentage depletion method often provides a greater tax benefit.

Crucially, because percentage depletion is calculated on gross income rather than the asset's original cost, total deductions over the life of a well can exceed the initial capital investment. This makes it a powerful incentive for domestic energy exploration and production. However, the deduction is subject to several significant limitations. The annual deduction for a given property cannot exceed 100% of the net income from that property. Furthermore, a taxpayer's total percentage depletion deduction across all properties cannot exceed 65% of their overall taxable income for the year.

In our experience, navigating these limitations is where many producers encounter challenges. The interplay between the property-level net income limit and the taxpayer's overall taxable income limit requires careful, forward-looking analysis. A miscalculation can lead to a surprisingly large tax bill or, conversely, a failure to maximize an available deduction. This is precisely the kind of complex scenario where our tax preparation and compliance services become invaluable for clients in the energy sector, ensuring every available deduction is properly calculated and claimed.

The stability of the 15% rate contrasts with periods in the past, particularly in the late 1990s, when lower oil prices caused the rate to fluctuate. The current environment of relatively stable, higher prices has removed that element of uncertainty from near-term tax planning, but the mechanism remains in the tax code as a safeguard for the industry.

The stability of the 15% rate for 2026 provides a solid foundation for strategic planning, but the energy market's inherent volatility means producers must always be prepared for change. Proactive financial management is key. For businesses looking to optimize their tax strategy in light of these and other industry-specific regulations, C&S Finance Group LLC at csfinancegroup.com provides expert guidance to navigate the complexities of the tax code.

Looking ahead, oil and gas producers will monitor the movement of crude oil prices throughout the remainder of 2026, as the average reference price for this year will be used to set the depletion percentage for the 2027 tax year. While a significant price collapse that would trigger an increase in the rate seems unlikely in the current global market, it remains a variable that producers must factor into their long-term financial models.