Exhibit 8
OPINION OF
KUNZMAN & BOLLINGER, INC.
AS TO
TAX MATTERS
KUNZMAN & BOLLINGER, INC.
ATTORNEYS-AT-LAW
5100 N. BROOKLINE, SUITE 600
OKLAHOMA CITY, OKLAHOMA 73112
Telephone (405) 942-3501
Fax (405) 942-3527
May 27, 2003
Atlas Resources, Inc.
311 Rouser Road
Moon Township, Pennsylvania 15108
RE: ATLAS AMERICA PUBLIC #12-2003 PROGRAM
Gentlemen:
You have requested our opinions on the material federal income tax issues
pertaining to Atlas America Public #12-2003 Program (the "Program"), a series of
up to three limited partnerships to be formed under the Delaware Revised Uniform
Limited Partnership Act. We have acted as Special Counsel to the Program with
respect to the offering of Units in the Partnerships. Atlas Resources, Inc. will
be the Managing General Partner of the Partnerships. Capitalized terms used and
not otherwise defined in this letter have the respective meanings assigned to
them in the form of Agreement of Limited Partnership for the Partnerships (the
"Partnership Agreement").
Our opinions are based in part on our review of:
o the Registration Statement on Form S-1 for the
Partnerships as originally filed with the SEC, and
amendments to the Registration Statement, including the
Prospectus and the Drilling and Operating Agreement and
the Partnership Agreement included as exhibits to the
Prospectus;
o other corporate records, certificates, agreements,
instruments and documents as we deemed relevant and
necessary to review as a basis for our opinions; and
o existing statutes, rulings and regulations as presently
interpreted by judicial and administrative bodies, which
are subject to change. Any changes in existing law could
result in different tax consequences and could render our
opinions inapplicable.
In rendering our opinions, we have inquired as to all relevant facts and
obtained from you representations with respect to certain relevant facts
relating to the Partnerships. Based on the foregoing, we are satisfied that our
opinions take into account all relevant facts, and that the material facts
(including factual assumptions and representations) are accurately and
completely described in this letter and, where appropriate, in the Prospectus
and the applicable promotional materials listed in "Sales Material" in the
Prospectus. Any material inaccuracy in your representations may render our
opinions inapplicable. Included among your representations are the following:
o The Partnership Agreement will be executed by the
Managing General Partner and the Participants and
recorded in all places required under the Delaware
Revised Uniform Limited Partnership Act and any other
applicable limited partnership act. Also, the
Partnerships, when formed, will be operated in
accordance with the terms of the Partnership Agreement,
the Prospectus, and the Delaware Revised Uniform Limited
Partnership Act and any other applicable limited
partnership act.
Atlas Resources, Inc.
May 27, 2003
Page 2
o The Partnerships will be subject to the partnership
provisions of the Code and will not elect to be taxed as
a corporation.
o A Partnership will own legal title to its Working
Interest in all of its Prospects, although initially
title to the Prospects will be held in the name of the
Managing General Partner, its Affiliates or other third-
parties as nominee for the Partnership, in order to
facilitate the acquisition of the Leases.
o The Drilling and Operating Agreement will be duly
executed and will govern the drilling and, if warranted,
the completion and operation of a Partnership's wells.
o Based on the estimated costs of non-affiliated persons
to drill and equip wells in the Appalachian Basin in
2001 as reported by an independent industry association
which surveyed other non-affiliated operators in the
area, the amounts that will be paid by the Partnerships
to the Managing General Partner or its Affiliates under
the Drilling and Operating Agreement to drill and
complete the Partnership Wells are amounts that
ordinarily would be paid for similar services in similar
transactions between Persons having no affiliation and
dealing with each other "at arms' length."
o Based on the Managing General Partner's experience and
its knowledge of industry practices in the Appalachian
Basin, the allocation of the drilling and completion
price to be paid to the Managing General Partner or its
Affiliates as a third-party general drilling contractor
to drill and complete a well between Intangible Drilling
Costs and Tangible Costs as set forth in the Prospectus
and "-Intangible Drilling Costs," below is reasonable.
o Depending primarily on when the Partnership
subscriptions are received, the Managing General Partner
anticipates that the Partnership designated Atlas
America Public #12-2003 will prepay in 2003 most of the
Intangible Drilling Costs for drilling activities that
will begin in 2004. The same may be true for the
partnerships designated Atlas America Public #12-
2004(___) one of which may close on December 31, 2004.
o The Partnership will own only Working Interests in all of
its Prospects, and will elect to deduct currently all
Intangible Drilling Costs.
o The Partnership will have a calendar year taxable year.
o Based on the Managing General Partner's experience (see
"Prior Activities" in the Prospectus) and the intended
operations of the Partnership, the Managing General
Partner reasonably believes that the aggregate
deductions, including depletion deductions, and 350% of
the aggregate credits, if any, which will be claimed by
the Managing General Partner and the Participants, will
not during the first five tax years following the
funding of the Partnership exceed twice the amounts
invested by the Managing General Partner and the
Participants, respectively. Thus, the Managing General
Partner will not register the Partnership with the IRS
as a "tax shelter."
o The Investor General Partner Units will not be converted
to Limited Partner Units before all of the wells in each
Partnership have been drilled and completed.
o The Units will not be traded on an established securities
market.
Atlas Resources, Inc.
May 27, 2003
Page 3
o The principal purpose of each Partnership is to locate,
produce and market natural gas and oil on a profitable
basis, apart from tax benefits.
o A typical Participant will be a natural person who
purchases Units in the offering and is a U.S. citizen.
o The Managing General Partner does not anticipate that the
Partnerships will elect to be treated as an "electing
large partnership" under the Code for reporting and audit
purposes.
o In the event of an audit of a Partnership's tax return,
the Managing General Partner, pursuant to advice of
counsel, will take all actions necessary, in its
discretion, to preserve the rights of the Participants.
All expenses of any proceedings undertaken by the
Managing General Partner, which might be substantial,
will be paid for by the Partnership. The Managing
General Partner is not obligated to contest adjustments
made by the IRS.
o Each Partnership will provide a Participant with the tax
information applicable to his investment in the
Partnership necessary to prepare his tax returns.
In rendering our opinions we have further assumed that:
o each Participant has an objective to carry on the
business of the Partnership in which he invested for
profit;
o any amount borrowed by a Participant and contributed to
a Partnership will not be borrowed from a Person who has
an interest in the Partnership, other than as a
creditor, or a "related person", as that term is defined
in ss.465 of the Code, to a Person, other than the
Participant, having an interest in the Partnership, and
the Participant will be severally, primarily, and
personally liable for the borrowed amount; and
o no Participant will have protected himself from loss for
amounts contributed to the Partnership in which he
invested through nonrecourse financing, guarantees, stop
loss agreements or other similar arrangements.
We have considered the provisions of 31 CFR, Part 10, ss.10.33 (Treasury
Department Circular No. 230) on tax law opinions and this letter fully and
fairly addresses all material federal income tax issues associated with an
investment in the Units by a typical Participant. We consider material those
issues which:
o would affect significantly a Participant's deductions or
losses arising from his investment in a Partnership and
with respect to which, under present law, there is a
reasonable possibility of challenge by the IRS;
o are expected to be of fundamental importance to a
Participant, but as to which a challenge by the IRS is
unlikely; or
o could have a significant impact (whether beneficial or
adverse) on a Participant under any reasonably
foreseeable circumstances.
Atlas Resources, Inc.
May 27, 2003
Page 4
The issues which involve a reasonable possibility of challenge by the IRS are
inherently factual in nature, or have not been definitely resolved by statutes,
rulings or regulations, as presently interpreted by judicial or administrative
bodies. With respect to some of the issues, existing law provides little
guidance. Although our opinions express what we believe a court would probably
conclude if presented with the applicable issues, our opinions are only
predictions of the outcome of the particular tax issues being addressed. There
is no assurance that the IRS will not challenge our interpretations or that the
challenge would not be sustained in the courts and cause adverse tax
consequences to the Participants. Taxpayers bear the burden of proof to support
claimed deductions, and opinions of counsel are not binding on the IRS or the
courts. Because of the inherent uncertainty created by the foregoing factors,
our opinions set forth below state whether it is "more likely than not" that the
predicted tax treatment is the proper tax treatment.
Also, in ascertaining that all material federal tax issues have been
considered, evaluating the merits of those issues and evaluating whether the
federal tax treatment set forth in our opinions is the proper tax treatment, we
have not taken into account:
o the possibility that a tax return will not be audited;
o that an issue will not be raised on audit; or
o that an issue may be settled.
Accordingly, in our opinion it is more likely than not that the following tax
treatment with respect to a typical Participant is the proper tax treatment and
will be upheld on the merits if challenged by the IRS and litigated:
(1) Partnership Classification. Each Partnership will be
classified as a partnership for federal income tax
purposes, and not as a corporation. Each Partnership, as
such, will not pay any federal income taxes, and all
items of income, gain, loss and deduction of the
Partnership will be reportable by the Partners in the
Partnership in which they invest. (See "- Partnership
Classification.")
(2) Passive Activity Classification.
o Generally, the passive activity limitations on
losses under ss.469 of the Code will apply to
Limited Partners, but will not apply to Investor
General Partners before the conversion of
Investor General Partner Units to Limited Partner
Units.
o The Partnership's income and gain from its
natural gas and oil properties which are
allocated to Limited Partners, other than
converted Investor General Partners, generally
will be characterized as passive activity income
which may be offset by passive activity losses.
o Income or gain attributable to investments of
working capital of each Partnership will be
characterized as portfolio income, which cannot
be offset by passive activity losses.
(See "- Limitations on Passive Activities.")
(3) Not a Publicly Traded Partnership. Assuming that no more
than 10% of the Units are transferred in any taxable year
of a Partnership, other than in private transfers
described in Treas. Reg. ss.1.7704-1(e), a Partnership
will not be treated as a "publicly traded partnership"
under the Code. (See "- Limitations on Passive Activities
- Publicly Traded Partnership Rules.")
Atlas Resources, Inc.
May 27, 2003
Page 5
(4) Availability of Certain Deductions. Business expenses,
including payments for personal services actually
rendered in the taxable year in which accrued, which are
reasonable, ordinary and necessary and do not include
amounts for items such as Lease acquisition costs,
organization and syndication fees and other items which
are required to be capitalized, are currently deductible.
(See "-2003 and 2004 Expenditures," "- Availability of
Certain Deductions" and "- Partnership Organization and
Syndication Fees.")
(5) Intangible Drilling Costs. Each Partnership will elect to
deduct currently all Intangible Drilling Costs. However,
a Participant in a Partnership may elect instead to
capitalize and deduct all or part of his share of the
Intangible Drilling Costs ratably over a 60 month period
as discussed in "Minimum Tax - Tax Preferences," below.
Subject to the foregoing, Intangible Drilling Costs paid
by a Partnership under the terms of bona fide drilling
contracts for the Partnership's wells will be deductible
in the taxable year in which the payments are made and
the drilling services are rendered, assuming the amounts
are fair and reasonable consideration and subject to
certain restrictions summarized below, including basis
and "at risk" limitations, and the passive activity loss
limitation with respect to the Limited Partners. (See "-
Intangible Drilling Costs" and "- Drilling Contracts.")
(6) Prepayments of Intangible Drilling Costs. Depending
primarily on when the Partnership subscriptions are
received, the Managing General Partner anticipates that
the Partnership designated Atlas America Public #12-2003
will prepay in 2003 most of the Intangible Drilling Costs
for drilling activities that will begin in 2004. The same
may be true for the partnerships designated Atlas America
Public #12-2004(___) one of which may close on December
31, 2004. Assuming that these amounts are fair and
reasonable, and based in part on the factual assumptions
set forth below, in our opinion the prepayments of
Intangible Drilling Costs will be deductible in the year
in which they are made even though all Working Interest
owners in the well may not be required to prepay
Intangible Drilling Costs, subject to certain
restrictions summarized below, including basis and "at
risk" limitations, and the passive activity loss
limitation with respect to the Limited Partners. (See "-
Drilling Contracts," below.)
The foregoing opinion is based in part on the assumptions
that:
(a) the Intangible Drilling Costs will be required to
be prepaid in the year in which they are made for
specified wells under the Drilling and Operating
Agreement;
(b) under the Drilling and Operating Agreement the
drilling of the wells is required to be, and
actually is, begun on or before March 31, of the
year after which the prepayment is made, and the
wells are continuously drilled until completed,
if warranted, or abandoned; and
(c) the required prepayments are not refundable to
the Partnership which made the prepayment and any
excess prepayments are applied to Intangible
Drilling Costs of substitute wells.
(7) Depletion Allowance. The greater of cost depletion or
percentage depletion will be available to qualified
Participants as a current deduction against the natural
gas and oil production income from the Partnership in
which he invested, subject to certain restrictions
summarized below. (See "- Depletion Allowance.")
(8) MACRS. Each Partnership's reasonable costs for equipment
placed in the wells which cannot be deducted immediately
("Tangible Costs") will be eligible for cost recovery
deductions under the
Atlas Resources, Inc.
May 27, 2003
Page 6
Modified Accelerated Cost Recovery System ("MACRS"),
generally over a seven year "cost recovery period,"
subject to certain restrictions summarized below,
including basis and "at risk" limitations, and the
passive activity loss limitation in the case of the
Limited Partners. (See "- Depreciation - Modified
Accelerated Cost Recovery System ("MACRS").")
(9) Tax Basis of Units. Each Participant's adjusted tax basis
in his Units will be increased by his total subscription
proceeds. (See "- Tax Basis of Units.")
(10) At Risk Limitation on Losses. Each Participant initially
will be "at risk" to the full extent of his subscription
proceeds. (See "- 'At Risk' Limitation For Losses.")
(11) Allocations. Assuming the effect of the allocations of
income, gain, loss and deduction, or items thereof, set
forth in the Partnership Agreement, including the
allocations of basis and amount realized with respect to
natural gas and oil properties, is substantial in light
of a Participant's tax attributes that are unrelated to
the Partnership in which he invests, the allocations will
have "substantial economic effect" and will govern each
Participant's distributive share of the items to the
extent the allocations do not cause or increase deficit
balances in the Participants' Capital Accounts. (See "-
Allocations.")
(12) Subscription. No gain or loss will be recognized by the
Participants on payment of their subscriptions.
(13) Profit Motive and No Tax Shelter Registration. Based on
the results of the previous partnerships sponsored by the
Managing General Partner set forth in "Prior Activities"
in the Prospectus and the Managing General Partner's
representations to us, including that the principal
purpose of each Partnership is to locate, produce and
market natural gas and oil on a profitable basis apart
from tax benefits (which is supported by the geological
evaluations and other information for the proposed
Prospects included in Appendix A to the Prospectus, which
will cover a portion of the Prospects to be drilled in
Atlas America Public #12-2003), the Partnerships will
possess the requisite profit motive under ss.183 of the
Code and is not required to register with the IRS as a
tax shelter. (See "- Disallowance of Deductions Under
Section 183 of the Code" and "- Lack of Registration as a
Tax Shelter.")
(14) Anti-Abuse Rules and Judicial Doctrines. Based on the
results of the previous partnerships sponsored by the
Managing General Partner set forth in "Prior Activities"
in the Prospectus and the Managing General Partner's
representations to us, including that the principal
purpose of each Partnership is to locate, produce and
market natural gas and oil on a profitable basis apart
from tax benefits (which is supported by the geological
evaluations and other information for the proposed
Prospects included in Appendix A to the Prospectus, which
will cover a portion of the Prospects to be drilled in
Atlas America Public #12-2003), potentially relevant
statutory or regulatory anti-abuse rules and judicial
doctrines will not have a material adverse effect on the
tax consequences of an investment in the Partnerships by
a typical Participant as described in our opinions.
(See "-Anti-Abuse Rules and Judicial Doctrines.")
(15) Overall Evaluation of Tax Benefits. Based on our
conclusion that substantially more than half of the
material tax benefits of each Partnership, in terms of
their financial impact on a typical Participant, more
likely than not will be realized if challenged by the
IRS, the tax benefits of each Partnership, in the
aggregate, which are a significant feature of an
investment in each Partnership by a typical original
Participant more likely than not will be realized as
contemplated by the Prospectus. The discussion in
Atlas Resources, Inc.
May 27, 2003
Page 7
the Prospectus under the caption "TAX ASPECTS," insofar
as it contains statements of federal income tax law, is
correct in all material respects. (See "Tax Aspects" in
the Prospectus.)
* * * * * * * * *
In General
The following is a summary of all of the material federal income tax
consequences of the purchase, ownership and disposition of Investor General
Partners Units and Limited Partner Units which will apply to typical
Participants. However, there is no assurance that the present laws or
regulations will not be changed and adversely affect a Participant. The IRS may
challenge the deductions claimed by a Partnership or a Participant, or the
taxable year in which the deductions are claimed, and no guaranty can be given
that the challenge would not be upheld if litigated.
The practical utility of the tax aspects of any investment depends largely
on each Participant's particular income tax position in the year in which items
of income, gain, loss, deduction or credit are properly taken into account in
computing his federal income tax liability. In addition, except as otherwise
noted, different tax considerations may apply to foreign persons, corporations,
partnerships, trusts and other prospective Participants which are not treated as
individuals for federal income tax purposes. Also, the treatment of the tax
attributes of a Partnership may vary among its Participants. Thus, each
Participant is urged to seek qualified, professional assistance in the
preparation of his federal, state and local tax returns with specific reference
to his own tax situation.
Partnership Classification
For federal income tax purposes a partnership is not a taxable entity. Thus,
the partners, rather than the partnership, receive all items of income, gain,
loss, deduction, credit and tax preference from the operations engaged in by the
partnership.
Under the regulations a business entity with two or more members is
classified for federal tax purposes as either a corporation or a partnership.
Treas. Reg. ss.301.7701-2(a). The term corporation includes a business entity
organized under a State statute which describes the entity as a corporation,
body corporate, body politic, joint-stock company or joint-stock association.
Treas. Reg. ss.301.7701-2(b). Each Partnership will be formed under the Delaware
Revised Uniform Limited Partnership Act which describes each Partnership as a
"partnership." Thus, each Partnership automatically will be classified as a
partnership unless it elects to be classified as a corporation. In this regard,
the Managing General Partner has represented to us that the Partnerships will
not elect to be taxed as a corporation.
Limitations on Passive Activities
Under the passive activity rules of ss.469 of the Code, all income of a
taxpayer who is subject to the rules is categorized as:
o income from passive activities such as limited partners'
interests in a business;
o active income such as salary, bonuses, etc.; or
o portfolio income. "Portfolio income" consists of
o interest, dividends and royalties, unless earned in the
ordinary course of a trade or business; and
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May 27, 2003
Page 8
o gain or loss not derived in the ordinary course of a
trade or business on the sale of property that generates
portfolio income or is held for investment.
Losses generated by passive activities can offset only passive income and cannot
be applied against active income or portfolio income.
The passive activity rules apply to individuals, estates, trusts, closely
held C corporations which generally are corporations with five or fewer
individuals who own directly or indirectly more than 50% of the stock, and
personal service corporations other than corporations where the owner-employees
together own less than 10% of the stock. However, a closely held C corporation,
other than a personal service corporation, may use passive losses and credits to
offset taxable income of the company figured without regard to passive income or
loss or portfolio income.
Passive activities include any trade or business in which the taxpayer does
not materially participate on a regular, continuous, and substantial basis.
Under the Partnership Agreement, Limited Partners will not have material
participation in the Partnership in which they invest and generally will be
subject to the passive activity rules.
Investor General Partners also do not materially participate in the
Partnership in which they invest. However, because the Partnership in which they
invest will own only Working Interests in its wells and Investor General
Partners will not have limited liability under the Delaware Revised Uniform
Limited Partnership Act until they are converted to Limited Partners, their
deductions generally will not be treated as passive deductions before the
conversion. I.R.C. ss.469(c)(3). (See "- Conversion from Investor General
Partner to Limited Partner," below.) However, if an Investor General Partner
invests in a Partnership through an entity which limits his liability, for
example, a limited partnership, limited liability company or S corporation, then
he generally will be subject to the passive activity limitations the same as a
Limited Partner. Contractual limitations on the liability of Investor General
Partners under the Partnership Agreement such as insurance, limited
indemnification, etc. will not cause Investor General Partners to be subject to
the passive activity limitations.
A Limited Partner's "at risk" amount is reduced by losses allowed under
ss.465 of the Code even if the losses are suspended by the passive loss
limitation. (See "- 'At Risk' Limitation For Losses," below.) Similarly, a
Limited Partner's basis is reduced by deductions even if the deductions are
disallowed under the passive loss limitation. (See "- Tax Basis of Units,"
below.)
Suspended losses may be carried forward, but not back, and used to offset
future years' passive activity income. A suspended loss is allowed in full when
the entire interest is sold to an unrelated third-party in a taxable transaction
and in part on the disposition of substantially all of the passive activity if
the suspended loss as well as current gross income and deductions can be
allocated to the part disposed of with reasonable certainty. In an installment
sale, passive losses become available in the same ratio that gain recognized
each year bears to the total gain on the sale.
Any suspended losses remaining at a taxpayer's death are allowed as
deductions on his final return, subject to a reduction to the extent the basis
of the property in the hands of the transferee exceeds the property's adjusted
basis immediately before the decedent's death. If a taxpayer makes a gift of his
entire interest in a passive activity, the basis in the property of the person
receiving the gift is increased by any suspended losses and no deductions are
allowed. If the interest is later sold at a loss, the basis in the property of
the person receiving the gift is limited to the fair market value on the date
the gift was made.
Publicly Traded Partnership Rules. Net losses of a partner from each
publicly traded partnership are suspended and carried forward to be netted
against income from that publicly traded partnership only. In addition, net
losses from
Atlas Resources, Inc.
May 27, 2003
Page 9
other passive activities may not be used to offset net passive income from a
publicly traded partnership. I.R.C. ss.ss.469(k)(2) and 7704. However, in the
opinion of Special Counsel it is more likely than not that each Partnership will
not be characterized as a publicly traded partnership under the Code so long as
no more than 10% of the Units in the Partnership are transferred in any taxable
year of the Partnership, other than in private transactions described in Treas.
Reg. ss.1.7704-1(e).
Conversion from Investor General Partner to Limited Partner. Depending
primarily on when the Partnership subscriptions are received, the Managing
General Partner anticipates that the Partnership designated Atlas America Public
#12-2003 will prepay in 2003 most of the Intangible Drilling Costs for drilling
activities that will begin in 2004. The same may be true for the partnerships
designated Atlas America Public #12-2004(___) one of which may close on December
31, 2004. If a Participant invests as an Investor General Partner, then his
share of the Partnership's deduction for Intangible Drilling Costs in the year
in which he invests will not be subject to the passive activity limitations
because the Investor General Partner Units will not be converted by the Managing
General Partner to Limited Partner Units until after all of the Partnership
Wells have been drilled and completed, which the Managing General Partner
anticipates will be approximately seven to eight months after the Partnership's
Offering Termination Date. Thereafter, each Investor General Partner will have
limited liability as a limited partner under the Delaware Revised Uniform
Limited Partnership Act with respect to his interest in the Partnership.
Concurrently, the Investor General Partner will become subject to the
passive activity limitations. However, because an Investor General Partner will
have a non-passive loss in the year in which he invests as a result of the
Partnership's deduction for Intangible Drilling Costs, the Code requires that
his net income from Partnership Wells following the conversion must continue to
be characterized as non-passive income which cannot be offset with passive
losses. I.R.C. ss.469(c)(3)(B). An Investor General Partner's conversion of his
Units into Limited Partner Units should not have any other adverse tax
consequences unless the Investor General Partner's share of any Partnership
liabilities is reduced as a result of the conversion. Rev. Rul. 84-52, 1984-1
C.B. 157. A reduction in a partner's share of liabilities is treated as a
constructive distribution of cash to the partner, which reduces the basis of the
partner's interest in the partnership and is taxable to the extent it exceeds
his basis. (See "-Tax Basis of Units," below.)
Taxable Year and Method of Accounting
Each Partnership intends to adopt a calendar year taxable year and the
accrual method of accounting for federal income tax purposes. I.R.C.
ss.ss.706(a) and (b) and 448(a). The taxable year of a Partnership is important
to a Participant because the Partnership's deductions, income and other items of
tax significance must be taken into account in computing the Participant's
taxable income for his taxable year within or with which the Partnership's
taxable year ends. The tax year of a partnership generally must be the tax year
of one or more of its partners who have an aggregate interest in partnership
profits and capital of greater than 50%. Under the accrual method of accounting,
income is taken into account for the year in which all events have occurred
which fix the right to receive it and the amount is determinable with reasonable
accuracy, rather than the time of receipt. Consequently, Participants may have
income tax liability resulting from the Partnership's accrual of income in one
tax year that it does not receive until the next tax year. Expenses are deducted
for the year in which all events have occurred that determine the fact of the
liability, the amount is determinable with reasonable accuracy and the economic
performance test is satisfied. Under ss.461(h) of the Code, if the liability of
the taxpayer arises out of the providing of services or property to the taxpayer
by another person, economic performance occurs as the services or property,
respectively, are provided. If the liability of the taxpayer arises out of the
use of the property by the taxpayer, economic performance occurs as the property
is used. Under ss.461(i) of the Code, however, a special rule provides that
there is economic performance in the current tax year with respect to amounts
paid in that tax year for intangible drilling costs of drilling a natural gas or
oil well so long as the drilling of the well begins before the close of the 90th
day after the close of the tax year. (See "-Drilling Contracts," below.)
Atlas Resources, Inc.
May 27, 2003
Page 10
2003 and 2004 Expenditures
The Managing General Partner anticipates that all of a Partnership's
subscription proceeds will be expended in the year in which the Participant
invests and the related income and deductions, including the deduction for
Intangible Drilling Costs, will be reflected on the Participants' federal income
tax returns for that period. (See "Capitalization and Source of Funds and Use of
Proceeds" and "Participation in Costs and Revenues" in the Prospectus.)
Depending primarily on when each Partnership's subscription proceeds are
received, the Managing General Partner anticipates that the Partnership will
prepay in the year in which the Participant invests most, if not all, of its
Intangible Drilling Costs for wells the drilling of which will begin in the
following year. The deductibility in the year in which the Participant invests
of these advance payments cannot be guaranteed. (See " - Drilling Contracts,"
below.)
Availability of Certain Deductions
Ordinary and necessary business expenses, including reasonable compensation
for personal services actually rendered, are deductible in the year incurred.
Treasury Regulation ss.1.162-7(b)(3) provides that reasonable compensation is
only the amount as would ordinarily be paid for like services by like
enterprises under like circumstances. The Managing General Partner has
represented to Special Counsel that the amounts payable to the Managing General
Partner and its Affiliates, including the amounts paid to the Managing General
Partner or its Affiliates as general drilling contractor, are the amounts which
would ordinarily be paid for similar services in similar transactions. (See "-
Drilling Contracts," below.)
The fees paid to the Managing General Partner and its Affiliates will not be
currently deductible to the extent it is determined by the IRS or the courts
that they are:
o in excess of reasonable compensation;
o properly characterized as organization or syndication fees or
other capital costs such as the acquisition cost of the Leases;
or
o are not "ordinary and necessary" business expenses.
(See " - Partnership Organization and Syndication Fees," below.) In the event of
an audit, payments to the Managing General Partner and its Affiliates by a
Partnership will be scrutinized by the IRS to a greater extent than payments to
an unrelated party.
Intangible Drilling Costs
Assuming a proper election and subject to the passive activity loss rules in
the case of Limited Partners, each Participant will be entitled to deduct his
share of Intangible Drilling Costs, which include items which do not have
salvage value, such as labor, fuel, repairs, supplies and hauling necessary to
the drilling of a well. I.R.C. ss.263(c), Treas. Reg. ss.1.612-4(a). (See
"Participation in Costs and Revenues" in the Prospectus and "- Limitations on
Passive Activities," above.) These deductions are subject to recapture as
ordinary income rather than capital gain on the sale or other disposition of the
property or a Participant's Units. (See " - Sale of the Properties" and " -
Disposition of Units," below.) Also, productive-well Intangible Drilling Costs
may subject a
Atlas Resources, Inc.
May 27, 2003
Page 11
Participant to an alternative minimum tax in excess of regular tax unless the
Participant elects to deduct all or part of these costs ratably over a 60
month period. (See "- Minimum Tax - Tax Preferences," below.)
The Managing General Partner estimates that on average approximately 78% of
the total price to be paid by each Partnership for all of its completed wells
will be Intangible Drilling Costs which are charged 100% to the Participants
under the Partnership Agreement. Under the Partnership Agreement, not less than
90% of the subscription proceeds received by each Partnership from the
Participants will be used to pay Intangible Drilling Costs. The IRS could
challenge the characterization of a portion of these costs as deductible
Intangible Drilling Costs and recharacterize the costs as some other item which
may be non-deductible. However, this would have no effect on the allocation and
payment of the Intangible Drilling Costs by the Participants under the
Partnership Agreement.
In the case of corporations, other than S corporations, which are
"integrated oil companies," the amount allowable as a deduction for Intangible
Drilling Costs in any taxable year is reduced by 30%. I.R.C. ss.291(b)(1).
Integrated oil companies are:
o those taxpayers who directly or through a related person engage
in the retail sale of natural gas and oil and whose gross
receipts for the calendar year from such activities exceed
$5,000,000; or
o those taxpayers and related persons who have refinery production
in excess of 50,000 barrels on any day during the taxable year.
Amounts disallowed as a current deduction are allowable as a deduction ratably
over the 60-month period beginning with the month in which the costs are paid or
incurred.
Each Participant is urged to consult with his personal tax advisor concerning
the tax benefits to him of the deduction for Intangible Drilling Costs in the
Partnership in which he invests in light of the Participant's own tax situation.
Drilling Contracts
Each Partnership will enter into the Drilling and Operating Agreement with
the Managing General Partner or its Affiliates, as a third-party general
drilling contractor, to drill and complete the Partnership's Development Wells
on a Cost plus 15% basis. For its services as general drilling contractor, the
Managing General Partner anticipates that on average over all of the wells
drilled and completed by the Partnership it will have reimbursement of general
and administrative overhead of $14,142 per well and a profit of 15%
(approximately $26,083 assuming a 100% interest in each well) per well, with
respect to the Intangible Drilling Costs and portion of Tangible Costs paid by
the Participants as described in "Compensation - Drilling Contracts" in the
Prospectus. However, the actual cost of drilling and completing the wells may be
more or less than the estimated amount, due primarily to the uncertain nature of
drilling operations, and the Managing General Partner's profit per well also
could be more or less than the dollar amount estimated by the Managing General
Partner.
The Managing General Partner believes the prices under the Drilling and
Operating Agreement are competitive in the proposed areas of operation.
Nevertheless, the amount of the profit realized by the Managing General Partner
under the Drilling and Operating Agreement could be challenged by the IRS as
unreasonable and disallowed as a deductible Intangible Drilling Cost. (See "-
Intangible Drilling Costs," above, and "Compensation" and "Proposed Activities"
in the Prospectus.)
Depending primarily on when the Partnership subscriptions are received, the
Managing General Partner anticipates that the Partnership designated Atlas
America Public #12-2003 will prepay in 2003 most of the Intangible Drilling
Costs
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May 27, 2003
Page 12
for drilling activities that will begin in 2004. The same may be true for
the partnerships designated Atlas America Public #12-2004(___) one of which may
close on December 31, 2004. (See "- Limitations on Passive Activities," above.)
In Keller v. Commissioner, 79 T.C. 7 (1982), aff'd 725 F.2d 1173 (8th Cir.
1984), the Tax Court applied a two-part test for the current deductibility of
prepaid intangible drilling and development costs:
o the expenditure must be a payment rather than a refundable
deposit; and
o the deduction must not result in a material distortion of income
taking into substantial consideration the business purpose
aspects of the transaction.
The drilling partnership in Keller entered into footage and daywork drilling
contracts which permitted it to terminate the contracts at any time without
default by the driller, and receive a return of the prepaid amounts less amounts
earned by the driller. The Tax Court found that the right to receive, by
unilateral action, a refund of the prepayments on the footage and daywork
drilling contracts rendered the prepayments deposits instead of payments.
Therefore, the prepayments were held to be nondeductible in the year they were
paid to the extent they had not been earned by the driller. The Tax Court
further found that the drilling partnership failed to show a convincing business
purpose for prepayments under the footage and daywork drilling contracts.
The drilling partnership in Keller also entered into turnkey drilling
contracts which permitted it to stop work under the contract at any time and
apply the unearned balance of the prepaid amounts to another well to be drilled
on a turnkey basis. The Tax Court found that these prepayments constituted
"payments" and not nondeductible deposits, despite the right of substitution.
Further, the Tax Court noted that the turnkey drilling contracts obligated "the
driller to drill to the contract depth for a stated price regardless of the
time, materials or expenses required to drill the well," thereby locking in
prices and shifting the risks of drilling from the drilling partnership to the
driller. Since the drilling partnership, a cash basis taxpayer, received the
benefit of the turnkey obligation in the year of prepayment, the Tax Court found
that the amounts prepaid on turnkey drilling contracts clearly reflected income
and were deductible in the year of prepayment.
In Leonard T. Ruth, TC Memo 1983-586, a drilling program entered into nine
separate turnkey contracts with a general contractor, the parent corporation of
the drilling program's corporate general partner, to drill nine program wells.
Each contract identified the prospect to be drilled, stated the turnkey price,
and required the full price to be paid in 1974. The program paid the full
turnkey price to the general contractor on December 31, 1974; the receipt of
which was found by the court to be significant in the general contractor's
financial planning. The program had no right to receive a refund of any of the
payments. The actual drilling of the nine wells was subcontracted by the general
contractor to independent contractors who were paid by the general contractor in
accordance with their individual contracts. The drilling of all wells commenced
in 1975 and all wells were completed that year. The amount paid by the general
contractor to the independent driller for its work on the nine wells was
approximately $365,000 less than the amount prepaid by the program to the
general contractor. The program claimed a deduction for intangible drilling and
development costs in 1974. The IRS challenged the timing of the deduction,
contending that there was no business purpose for the payments in 1974, that the
turnkey arrangements were merely "contracts of convenience" designed to create a
tax deduction in 1974, and that the turnkey contracts constituted assets having
a life beyond the taxable year and that to allow a deduction for their entire
costs in 1974 distorted income. The Tax Court, relying on Keller, held that the
program could deduct the full amount of the payments in 1974. The court found
that the program entered into turnkey contracts, paid a premium to secure the
turnkey obligations, and thereby locked in the drilling price and shifted the
risks of drilling to the general contractor. Further, the court found that by
signing and paying the turnkey obligation, the program got its bargained-for
benefit in 1974, therefore the deduction of the payments in 1974 clearly
reflected income.
Atlas Resources, Inc.
May 27, 2003
Page 13
The Partnership will attempt to comply with the guidelines set forth in
Keller with respect to prepaid Intangible Drilling Costs. The Drilling and
Operating Agreement will require the Partnership to prepay Intangible Drilling
Costs in the year in which the Participant invests for specified wells the
drilling of which will begin in the following year. Prepayments should not
result in a loss of current deductibility where:
o there is a legitimate business purpose for the required
prepayment;
o the contract is not merely a sham to control the timing of the
deduction; and
o there is an enforceable contract of economic substance.
The Drilling and Operating Agreement will require the Partnership to prepay the
Intangible Drilling Costs of drilling and completing the wells in order to
enable the Operator to:
o commence site preparation for the wells;
o obtain suitable subcontractors at the then current prices; and
o insure the availability of equipment and materials.
Under the Drilling and Operating Agreement excess prepaid amounts, if any, will
not be refundable to the Partnership, but will be applied to Intangible Drilling
Costs to be incurred in drilling and completing substitute wells. Under Keller,
a provision for substitute wells should not result in the prepayments being
characterized as refundable deposits.
The likelihood that prepayments will be challenged by the IRS on the grounds
that there is no business purpose for the prepayment is increased if prepayments
are not required with respect to 100% of the Working Interest. It is possible
that less than 100% of the Working Interest will be acquired by a Partnership in
one or more wells and prepayments may not be required of all holders of the
Working Interest. However, in the view of Special Counsel, a legitimate business
purpose for the required prepayments may exist under the guidelines set forth in
Keller, even though prepayment is not required, or actually received, by the
drilling contractor with respect to a portion of the Working Interest.
In addition, a current deduction for prepaid Intangible Drilling Costs is
available only if the drilling of the wells begins before the close of the 90th
day after the close of the taxable year. The Managing General Partner will
attempt to cause the drilling of all prepaid Partnership Wells to begin on or
before March 31, 2003. However, the drilling of any Partnership Well may be
delayed due to circumstances beyond the control of the Partnership or the
drilling contractor. Such circumstances include, for example:
o the unavailability of drilling rigs;
o weather conditions;
o inability to obtain drilling permits or access right to the
drilling site; or
o title problems.
Due to the foregoing factors no guaranty can be given that the drilling of all
prepaid Partnership Wells required by the Drilling and Operating Agreement to
begin on or before March 31, of the year after which the Participant invests,
will
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May 27, 2003
Page 14
actually begin by that date. In that event, deductions claimed in the year
in which the Participant invests for prepaid Intangible Drilling Costs would be
disallowed and deferred to the next taxable year.
No assurance can be given that on audit the IRS would not disallow the
current deductibility of a portion or all of any prepayments of Intangible
Drilling Costs under a Partnership's drilling contracts, thereby decreasing the
amount of deductions allocable to the Participants for the current taxable year,
or that the challenge would not ultimately be sustained. In the event of
disallowance, the deduction would be available in the year the work is actually
performed.
Depletion Allowance
Proceeds from the sale of each Partnership's natural gas and oil production
will constitute ordinary income. A certain portion of that income will not be
taxable because of the depletion allowance which permits the deduction from
gross income for federal income tax purposes of either the percentage depletion
allowance or the cost depletion allowance, whichever is greater. I.R.C.
ss.ss.611, 613 and 613A. These deductions are subject to recapture as ordinary
income rather than capital gain on the disposition of the property or a
Participant's Units. (See " - Sale of the Properties" and " - Disposition of
Units," below.)
Cost depletion for any year is determined by dividing the adjusted tax basis
for the property by the total units of natural gas or oil expected to be
recoverable from the property and then multiplying the resultant quotient by the
number of units actually sold during the year. Cost depletion cannot exceed the
adjusted tax basis of the property to which it relates.
Percentage depletion generally is available to taxpayers other than
integrated oil companies. (See "- Intangible Drilling Costs," above.) Percentage
depletion is based on the Participant's share of a Partnership's gross income
from its natural gas and oil properties. Generally, percentage depletion is
available with respect to 6 million cubic feet of average daily production of
natural gas or 1,000 barrels of average daily production of domestic crude oil.
Taxpayers who have both natural gas and oil production may allocate the
production limitation between the production.
The rate of percentage depletion is 15%. However, percentage depletion for
marginal production increases 1%, up to a maximum increase of 10%, for each
whole dollar that the domestic wellhead price of crude oil for the immediately
preceding year is less than $20 per barrel without adjustment for inflation.
I.R.C. ss.613A(c)(6). The term "marginal production" includes natural gas and
oil produced from a domestic stripper well property, which is defined as any
property which produces a daily average of 15 or less equivalent barrels of oil,
which is 90 MCF of natural gas, per producing well on the property in the
calendar year. Most, if not all, of each Partnership's wells will qualify for
these potentially higher rates of percentage depletion. The rate of percentage
depletion for marginal production in 2003 is 15%. This rate fluctuates from year
to year depending on the price of oil, but will not be less than the statutory
rate of 15% nor more than 25%.
Also, percentage depletion:
(i) may not exceed 100% of the net income from each natural gas and
oil property before the deduction for depletion; and
(ii) is limited to 65% of the taxpayer's taxable income for a year
computed without regard to percentage depletion, net operating
loss carry-backs and capital loss carry-backs.
With respect to marginal properties, however, which will include most, if not
all, of each Partnership's wells, the 100% of net income property limitation is
suspended for 2003. I.R.C. ss.613A(c)(6)(H).
Atlas Resources, Inc.
May 27, 2003
Page 15
Availability of percentage depletion must be computed separately for each
Participant and not by the Partnership or for Participants as a whole. Potential
Participants are urged to consult their own tax advisors with respect to the
availability of percentage depletion to them.
Depreciation - Modified Accelerated Cost Recovery System ("MACRS")
Tangible Costs and the related depreciation deductions generally are charged
and allocated under the Partnership Agreement 66% to the Managing General
Partner and 34% to the Participants. However, if the total Tangible Costs for
all of a Partnership's wells that would be charged to the Participants exceeds
an amount equal to 10% of the Partnership's subscription proceeds, then the
excess, together with the related depreciation deductions, will be charged and
allocated to the Managing General Partner. These deductions are subject to
recapture as ordinary income rather than capital gain on the disposition of the
property or a Participant's Units. (See " - Sale of the Properties" and " -
Disposition of Units," below.) The cost of most equipment placed in service by a
Partnership will be recovered through depreciation deductions over a seven year
cost recovery period using the 200% declining balance method, with a switch to
straight-line to maximize the deduction. I.R.C. ss.168(c). In the case of a
short tax year the MACRS deduction is prorated on a 12-month basis. No
distinction is made between new and used property and salvage value is
disregarded. Except as discussed below, depreciation for alternative minimum tax
purposes is computed using the 150% declining balance method, switching to
straight-line, for most personal property, and all property assigned to the
7-year class generally is treated as placed in service, or disposed of, in the
middle of the year.
Notwithstanding the foregoing, under the Job Creation and Worker Assistance
Act of 2002 ("2002 Act"), for federal income tax purposes a Partnership will be
entitled to accelerate in the year in which the equipment is placed in service
an additional depreciation allowance based on 30% of the adjusted basis of those
qualified Tangible Costs. See ss.168(k) of the Code. The basis of this property
will be reduced by the additional 30% first-year depreciation allowance for
purposes of calculating the regular MACRS depreciation allowances beginning in
2002. Although not specifically mentioned in the 2002 Act, the examples provided
in the Technical Explanation of the 2002 Act do not reduce the 30% additional
depreciation allowance by the half- year convention discussed above.
Nevertheless, because this situation is not clearly addressed by the 2002 Act it
is possible the half-year convention or a mid-quarter convention, depending on
when the Partnership's equipment is placed in service, ultimately may be
determined to apply. Also, there will not be any alternative minimum tax
adjustment with respect to a Partnership's additional 30% first-year
depreciation allowance, nor any of the other depreciation deductions allowable
in 2002 or later years for the costs of equipment it places in the wells. I.R.C.
ss.168(k)(2)(F).
Leasehold Costs and Abandonment
Lease acquisition costs, together with the related cost depletion deduction
and any abandonment loss for Lease costs, are allocated under the Partnership
Agreement 100% to the Managing General Partner, which will contribute the Leases
to each Partnership as a part of its Capital Contribution.
Tax Basis of Units
A Participant's share of a Partnership loss is allowable only to the extent
of the adjusted basis of his Units at the end of the Partnership's taxable year.
I.R.C. ss.704(d). The adjusted basis of the Units will be adjusted, but not
below zero, for any gain or loss to the Participant from a disposition by the
Partnership of a natural gas and oil property, and will be increased by his:
(i) cash subscription payment;
(ii) share of Partnership income; and
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May 27, 2003
Page 16
(iii) share, if any, of Partnership debt.
The adjusted basis of a Participant's Units will be reduced by his:
(i) share of Partnership losses;
(ii) share of Partnership expenditures that are not deductible
in computing its taxable income and are not properly
chargeable to capital account;
(iii) depletion deduction, but not below zero; and
(iv) cash distributions from the Partnership. I.R.C.
ss.ss.705, 722 and 742.
The reduction in a Participant's share of a Partnership's liabilities, if
any, is considered a cash distribution. Participants will not be personally
liable on any Partnership loans; however, Investor General Partners will be
liable for other obligations of the Partnership. (See "Risk Factors - Risks
Related to an Investment In a Partnership - If You Choose to Invest as a General
Partner, Then You Have a Greater Risk Than a Limited Partner" in the
Prospectus.) Should cash distributions exceed the tax basis of the Participant's
Units, taxable gain would result to the extent of the excess.
(See "- Distributions From the Partnership," below.)
"At Risk" Limitation For Losses
Subject to the limitations on "passive losses" generated by each Partnership
in the case of Limited Partners and a Participant's basis in his Units, each
Participant may use his share of the Partnership's losses to offset income from
other sources. (See "- Limitations on Passive Activities" and "- Tax Basis of
Units," above.) However, a Participant, other than a corporation which is
neither an S corporation nor a corporation in which five or fewer individuals
own more than 50% of the stock, who sustains a loss in connection with the
Partnership's natural gas and oil activities may deduct the loss only to the
extent of the amount he has "at risk" in the Partnership at the end of a taxable
year. I.R.C. ss.465.
A Participant's initial "at risk" amount is limited to the amount of money
he pays for his Units. Any amounts borrowed by a Participant to buy his Units
will not be considered "at risk" if the amounts are borrowed from any person who
has an interest, other than as a creditor, in the Partnership or from a related
person to a person, other than the taxpayer, having such an interest.
"Loss" means the excess of allowable deductions for a taxable year from a
Partnership over the amount of income actually received or accrued by the
Participant during the year from the Partnership. The amount a Participant has
"at risk" may not include the amount of any loss that the Participant is
protected against through:
o nonrecourse loans;
o guarantees;
o stop loss agreements; or
o other similar arrangements.
Atlas Resources, Inc.
May 27, 2003
Page 17
The amount of any loss that is disallowed will be carried over to the next
taxable year, to the extent a Participant is "at risk." Further, a taxpayer's
"at risk" amount in subsequent taxable years with respect to a Partnership will
be reduced by that portion of the loss which is allowable as a deduction.
The Participants' cash subscription payments to the Partnership in which he
invests are usually "at risk." Since income, gains, losses, and distributions of
the Partnership affect the "at risk" amount, the extent to which a Participant
is "at risk" must be determined annually. Previously allowed losses must be
included in gross income if the "at risk" amount is reduced below zero. The
amount included in income, however, may be deducted in the next taxable year to
the extent of any increase in the amount which the Participant has "at risk."
Distributions From the Partnership
Generally, a cash distribution from a Partnership to a Participant in
excess of the adjusted basis of the Participant's Units immediately before the
distribution is treated as gain from the sale or exchange of his Units to the
extent of the excess. I.R.C. ss.731(a)(1). No loss is recognized by the
Participants on these types of distributions. I.R.C. ss.731(a)(2). No gain or
loss is recognized by the Partnership on these types of distributions. I.R.C.
ss.731(b). If property is distributed by the Partnership to the Managing
General Partner and the Participants, certain basis adjustments may be made by
the Partnership, the Managing General Partner and the Participants. I.R.C.
ss.ss.732, 733, 734, and 754. (See ss.5.04(d) of the Partnership Agreement.)
Other distributions of cash, disproportionate distributions of property, and
liquidating distributions may result in taxable gain or loss. (See " -
Disposition of Units" and " - Termination of the Partnership," below.)
Sale of the Properties
Generally, adjusted net long-term capital gains of a noncorporate taxpayer
on the sale of assets held more than a year are taxed at a maximum rate of 20%,
or 10% if they would be subject to tax at a rate below 25% if they were not
eligible for long-term capital gains treatment. These rates are 18% and 8%,
respectively, for gain on qualifying assets held for more than five years.
I.R.C. ss.1(h). The capital gain rates also apply for purposes of the
alternative minimum tax. (See "- Minimum Tax - Tax Preferences," below.) The
annual capital loss limitation for noncorporate taxpayers is the amount of
capital gains plus the lesser of $3,000, which is reduced to $1,500 for married
persons filing separate returns, or the excess of capital losses over capital
gains. I.R.C. ss.1211(b).
Gains and losses from sales of natural gas and oil properties held for more
than 12 months generally will be treated as a long-term capital gain, while a
net loss will be an ordinary deduction, except to the extent of depreciation
recapture on equipment and recapture of any Intangible Drilling Costs, depletion
deductions and certain losses on previous sales, if any, of the Partnership's
assets as discussed below. Other gains and losses on sales of natural gas and
oil properties will generally result in ordinary gains or losses.
Intangible Drilling Costs that are incurred in connection with a natural gas
or oil property may be recaptured as ordinary income when the property is
disposed of by a Partnership. Generally, the amount recaptured is the lesser of:
o the aggregate amount of expenditures which have been
deducted as Intangible Drilling Costs with respect to the
property and which, but for being deducted, would be
reflected in the adjusted basis of the property; or
o the excess of (i) the amount realized, in the case of a
sale, exchange or involuntary conversion; or (ii) the
fair market value of the interest, in the case of any
other disposition; over the adjusted basis of the
property. I.R.C. ss.1254(a).
Atlas Resources, Inc.
May 27, 2003
Page 18
(See "- Intangible Drilling Costs," above.)
In addition, the deductions for depletion which reduced the adjusted basis
of the property are subject to recapture as ordinary income, and all gain on
disposition of equipment is treated as ordinary income to the extent of MACRS
deductions claimed by the Partnership. I.R.C. ss.1254(a). (See "- Depletion
Allowance" and "- Depreciation - Modified Accelerated Cost Recovery System
("MACRS"), above.)
Disposition of Units
The sale or exchange, including a purchase by the Managing General Partner,
of all or part of a Participant's Units held by him for more than 12 months will
generally result in a recognition of long-term capital gain or loss. However,
previous deductions for depreciation, depletion and Intangible Drilling Costs
may be recaptured as ordinary income rather than capital gain. (See "- Sale of
the Properties," above.) If the Units are held for 12 months or less, the gain
or loss generally will be short-term gain or loss. Also, a Participant's pro
rata share of a Partnership's liabilities, if any, as of the date of the sale or
exchange must be included in the amount realized. Therefore, the gain recognized
may result in a tax liability greater than the cash proceeds, if any, from the
disposition. In addition to gain from a passive activity, a portion of any gain
recognized by a Limited Partner, other than a converted Investor General
Partner, on the sale or other disposition of his Units will be characterized as
portfolio income under ss.469 of the Code to the extent the gain is attributable
to portfolio income, e.g. interest on investment of working capital. Treas. Reg.
ss.1.469-2T(e)(3). (See "- Limitations on Passive Activities," above.)
A gift of a Participant's Units may result in federal and/or state income
tax and gift tax liability to the Participant, and interests in different
partnerships do not qualify for tax-free like-kind exchanges. I.R.C.
ss.1031(a)(2)(D). Other dispositions of a Participant's Units, including a
purchase of the Units by the Managing General Partner, may or may not result in
recognition of taxable gain. However, no gain should be recognized by an
Investor General Partner on the conversion of the Investor General Partner Units
to Limited Partner Units so long as there is no change in the Investor General
Partner's share of the Partnership's liabilities or certain Partnership assets
as a result of the conversion. Rev. Rul. 84-52, 1984-1 C.B. 157.
A Participant who sells or exchanges all or part of his Units is required by
the Code to notify the Partnership in which he invested within 30 days or by
January 15 of the following year, if earlier. I.R.C. ss.6050K. After receiving
the notice, the Partnership is required to make a return with the IRS stating
the name and address of the transferor and the transferee and any other
information as may be required by the IRS. The Partnership must also provide
each person whose name is set forth in the return a written statement showing
the information set forth on the return.
If a Participant dies, sells or exchanges all of his Units, the taxable year
of the Partnership in which he invested will close with respect to that
Participant, but not the remaining Participants, on the date of death, sale or
exchange, with a proration of partnership items for the Partnership's taxable
year. I.R.C. ss.706(c)(2). If a Participant sells less than all of his Units,
the Partnership's taxable year will not terminate with respect to the selling
Participant, but his proportionate share of items of income, gain, loss and
deduction will be determined by taking into account his varying interests in the
Partnership during the taxable year. Deductions generally may not be allocated
to a person acquiring Units from a selling Participant for a period before the
purchaser's admission to the Partnership. I.R.C. ss.706(d).
Participants are urged to consult their tax advisors before any disposition
of a Unit, including purchase of the Unit by the Managing General Partner.
<page>
Atlas Resources, Inc.
May 27, 2003
Page 19
Minimum Tax - Tax Preferences
With limited exceptions, all taxpayers are subject to the alternative
minimum tax. I.R.C. ss.55. If the alternative minimum tax exceeds the regular
tax, the excess is payable in addition to the regular tax. The alternative
minimum tax is intended to insure that no one with substantial income can avoid
tax liability by using exclusions, deductions and credits. The alternative
minimum tax accomplishes this objective by not treating favorably certain items
that are treated favorably for purposes of the regular tax. Individual tax
preferences or adjustments may include, but are not limited to: accelerated
depreciation except as discussed in "-Depreciation - Modified Accelerated Cost
Recovery System ("MACRS")" above, Intangible Drilling Costs, incentive stock
options and passive activity losses.
Generally, the alternative minimum tax rate for individuals is 26% on
alternative minimum taxable income up to $175,000, $87,500 for married
individuals filing separate returns, and 28% thereafter. See "- Sale of the
Properties," above, for the tax rates on capital gains. For tax years through
2004, the exemption amount is $49,000 for married couples filing jointly and
surviving spouses; $35,750 for single filers, and $24,500 for married persons
filing separately. Also, for these tax years only, married persons filing
separately must increase their alternative minimum taxable income by the lesser
of 25% of the excess of alternative minimum taxable income over $173,000; or
$24,500. After 2004, the exemption amount for individuals is $45,000 for married
couples filing jointly and surviving spouses, $33,750 for single filers, and
$22,500 for married persons filing separately. After 2004, married individuals
filing separately must increase alternative minimum taxable income by the lesser
of: (i) 25% of the excess of alternative minimum taxable income over $165,000;
or (ii) $22,500. These exemption amounts are reduced by 25% of the alternative
minimum taxable income in excess of:
o $150,000 for joint returns and surviving spouses;
o $75,000 for married persons filing separately; and
o $112,500 for single taxpayers.
Regular tax personal exemptions are not available for purposes of the
alternative minimum tax. The only itemized deductions allowed for minimum tax
purposes are those for casualty and theft losses, gambling losses to the extent
of gambling gains, charitable deductions, medical deductions in excess of 10% of
adjusted gross income, qualified housing interest, investment interest expense
not exceeding net investment income, and certain estate taxes. The net operating
loss for alternative minimum tax purposes generally is the same as for regular
tax purposes, except:
o current year tax preference items are added back to
taxable income; and
o individuals may use only those itemized deductions as
modified under ss.172(d) of the Code allowable in
computing alternative minimum taxable income.
Code sections suspending losses, such as the rules concerning a Participant's
"at risk" amount and his basis in his Units, are recomputed for minimum tax
purposes, and the amount of the deductions suspended or recaptured may differ
for regular and minimum tax purposes.
Alternative minimum taxable income generally is taxable income, plus or
minus various adjustments, plus preferences. For taxpayers other than integrated
oil companies as that term is defined in "- Intangible Drilling Costs," above,
the 1992 National Energy Bill repealed:
o the preference for excess Intangible Drilling Costs; and
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o the excess percentage depletion preference for natural
gas and oil.
The repeal of the excess Intangible Drilling Costs preference, however, under
current law may not result in more than a 40% reduction in the amount of the
taxpayer's alternative minimum taxable income computed as if the excess
Intangible Drilling Costs preference had not been repealed. I.R.C.
ss.57(a)(2)(E). Under the prior rules, the amount of Intangible Drilling Costs
which is not deductible for alternative minimum tax purposes is the excess of
the "excess intangible drilling costs" over 65% of net income from natural gas
and oil properties. Net natural gas and oil income is determined for this
purpose without subtracting excess Intangible Drilling Costs. Excess Intangible
Drilling Costs is the regular Intangible Drilling Costs deduction minus the
amount that would have been deducted under 120-month straight-line amortization,
or, at the taxpayer's election, under the cost depletion method. There is no
preference item for costs of nonproductive wells.
Also, each Participant may elect to capitalize all or part of his share of
the Intangible Drilling Costs in the Partnership in which he invests and deduct
the costs ratably over a 60-month period beginning with the month in which the
costs were paid or incurred. This election also applies for regular tax purposes
and can be revoked only with the IRS' consent. Making this election, therefore,
generally will result in the following consequences to the Participant:
o the Participant's regular tax deduction in for Intangible
Drilling Costs in the year in which he invests will be
reduced because the Participant must spread the deduction
for the amount of Intangible Drilling Costs which the
Participant elects to capitalize over the 60-month
amortization period; and
o the capitalized Intangible Drilling Costs will not be
treated as a preference that is included in the
Participant's alternative minimum taxable income.
Potential Participants are urged to consult with their personal tax advisors
as to the likelihood of the Participant incurring, or increasing, any minimum
tax liability because of an investment in a Partnership.
Limitations on Deduction of Investment Interest
Investment interest expense is deductible by a noncorporate taxpayer only to
the extent of net investment income each year, with an indefinite carryforward
of disallowed investment interest. I.R.C. ss.163. Investment interest expense
generally includes all interest on debt not incurred in a person's active trade
or business except consumer interest, qualified residence interest, and passive
activity interest under ss.469 of the Code. Accordingly, an Investor General
Partner's share of any interest expense incurred by the Partnership in which he
invests before the Investor General Partner Units are converted to Limited
Partner Units will be subject to the investment interest limitation. In
addition, an Investor General Partner's income and losses, including Intangible
Drilling Costs, from the Partnership will be considered investment income and
losses for purposes of this limitation. Losses allocable to an Investor General
Partner will reduce his net investment income and may affect the deductibility
of his investment interest expense, if any.
Net investment income is the excess of investment income over investment
expenses. Investment income includes:
o gross income from interest, dividends, rents, and
royalties;
o portfolio income under the passive activity rules, which
includes working capital investment income; and
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o income from a trade or business in which the taxpayer
does not materially participate if the activity is not a
"passive activity" under ss.469 of the Code.
In the case of Investor General Partners, this includes the Partnership in which
he invests before the conversion of Investor General Partner Units to Limited
Partner Units, and possibly Partnership net income allocable to former Investor
General Partners after the conversion. Investment expenses include deductions,
other than interest, that are directly connected with the production of net
investment income, including actual depreciation or depletion deductions
allowable. Investment income and investment expenses do not include income or
expense taken into account in computing income or loss from a passive activity
loss under ss.469 of the Code. (See "-Limitations on Passive Activities,"
above.)
Allocations
The Partnership Agreement allocates to each Participant his share of the
income, gains, losses and deductions, including the deductions for Intangible
Drilling Costs and depreciation in the Partnership in which he invests.
Allocations of certain items are made in ratios that are different than
allocations of other items. (See "Participation in Costs and Revenues" in the
Prospectus.) The Capital Accounts of the Participants are adjusted to reflect
these allocations and the Capital Accounts, as adjusted, will be given effect in
distributions made to the Participants on liquidation of the Partnership or any
Participant's Units. Generally, the basis of natural gas and oil properties
owned by the Partnership for computation of cost depletion and gain or loss on
disposition will be allocated and reallocated when necessary in the ratio in
which the expenditure giving rise to the tax basis of each property was charged
as of the end of the year. (See ss.5.03(b) of the Partnership Agreement.)
Allocations made in a manner that is disproportionate to the respective
interests of the partners in a partnership of any item of partnership income,
gain, loss, deduction or credit will not be given effect unless the allocation
has "substantial economic effect." I.R.C. ss.704(b). An allocation generally
will have economic effect if throughout the term of a partnership:
o the partners' capital accounts are maintained in
accordance with rules set forth in the regulations, which
generally are based on tax accounting principles;
o liquidation proceeds are distributed in accordance with
the partners' capital accounts; and
o any partner with a deficit balance in his capital account
following the liquidation of his interest in the
partnership is required to restore the amount of the
deficit to the partnership.
Generally, a Participant's Capital Account is increased by:
o the amount of money he contributes to the Partnership in
which he invests; and
o allocations to him of income and gain;
and decreased by:
o the value of property or cash distributed to him; and
o allocations to him of loss and deductions.
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The regulations also require that there must be a reasonable possibility that
the allocation will affect substantially the dollar amounts to be received by
the partners from the partnership, independent of tax consequences.
Participants are not required to restore deficit balances in their Capital
Accounts with additional Capital Contributions. However, an allocation which is
not attributable to nonrecourse debt will be considered to have economic effect
to the extent it does not cause or increase a deficit balance in a Participant's
Capital Account if the partners' capital accounts are maintained in accordance
with rules set forth in the regulations, which generally are based on tax
accounting principles and liquidation proceeds are distributed in accordance
with the partners' capital accounts as set forth above are met, and the
partnership agreement provides that a partner who unexpectedly incurs a deficit
balance in his Capital Account because of certain adjustments, allocations, or
distributions will be allocated income and gain sufficient to eliminate the
deficit balance as quickly as possible. Treas. Reg. ss.1.704- l(b)(2)(ii)(d).
(See ss.5.03(h) of the Partnership Agreement.)
Special provisions apply to deductions related to nonrecourse debt. If the
Managing General Partner or an Affiliate makes a nonrecourse loan to a
Partnership ("partner nonrecourse liability"), Partnership losses, deductions,
or ss.705(a)(2)(B) expenditures attributable to the loan must be allocated to
the Managing General Partner. Also, if there is a net decrease in partner
nonrecourse liability minimum gain with respect to the loan, the Managing
General Partner must be allocated income and gain equal to the net decrease.
(See ss.ss.5.03(a)(1) and 5.03(i) of the Partnership Agreement.)
In the event of a sale or transfer of a Participant's Unit, the death of a
Participant, or the admission of an additional Participant, Partnership income,
gain, loss and deductions generally will be allocated among the Participants
according to their varying interests in the Partnership in which they invest
during the taxable year. In addition, in the discretion of the Managing General
Partner, Partnership property may be revalued on the admission of additional
Participants, or if certain distributions are made to the Participants, to
reflect unrealized income, gain, loss or deduction, inherent in the
Partnership's property for purposes of adjusting the Participants' Capital
Accounts.
It should also be noted that each Participant's share of items of income,
gain, loss and deduction in the Partnership in which he invests must be taken
into account whether or not there is any distributable cash. A Participant's
share of Partnership revenues applied to the repayment of loans or the reserve
for plugging wells, for example, will be included in his gross income in a
manner analogous to an actual distribution of the income to him. Thus, a
Participant may have tax liability on taxable income from the Partnership in
which he invests for a particular year in excess of any cash distributions from
the Partnership to him with respect to that year. To the extent the Partnership
has cash available for distribution, however, it is the Managing General
Partner's policy that Partnership distributions will not be less than the
Managing General Partner's estimate of the Participants' income tax liability
with respect to Partnership income.
If any allocation under the Partnership Agreement is not recognized for
federal income tax purposes, each Participant's share of the items subject to
the allocation generally will be determined in accordance with his interest in
the Partnership, determined by considering relevant facts and circumstances. To
the extent deductions allocated by the Partnership Agreement exceed deductions
which would be allowed under a reallocation by the IRS, Participants may incur a
greater tax burden. However, assuming the effect of the special allocations set
forth in the Partnership Agreement is substantial in light of a Participant's
tax attributes that are unrelated to the Partnership, in the opinion of Special
Counsel it is more likely than not that the allocations will have "substantial
economic effect" and will govern each Participant's share of those items to the
extent the allocations do not cause or increase deficit balances in the
Participants' Capital Accounts.
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Partnership Borrowings
Under the Partnership Agreement the Managing General Partner and its
Affiliates may make loans to the Partnership in which you invest. The use of
Partnership revenues taxable to Participants to repay Partnership borrowings
could create income tax liability for the Participants in excess of cash
distributions to them, since repayments of principal are not deductible for
federal income tax purposes. In addition, interest on the loans will not be
deductible unless the loans are bona fide loans that will not be treated as
Capital Contributions. In Revenue Ruling 72-135, 1972-1 C.B. 200, the IRS ruled
that a nonrecourse loan from a general partner to a partnership engaged in
natural gas and oil exploration represented a capital contribution by the
general partner rather than a loan. Whether a "loan" to the Partnership in which
you invest represents in substance debt or equity is a question of fact to be
determined from all the surrounding facts and circumstances.
Partnership Organization and Syndication Fees
Expenses connected with the issuance and sale of the Units, such as
promotional expense, the Dealer-Manager fee, Sales Commissions, reimbursements
to the Dealer-Manager and other selling expenses, professional fees, and
printing costs, which are charged 100% to the Managing General Partner under the
Partnership Agreement, are not deductible. However, expenses incident to the
creation of a partnership may be amortized over a period of not less than 60
months. These amortizable organization expenses also will be paid by the
Managing General Partner as part of a Partnership's Organization and Offering
Costs and any related deductions, which the Managing General Partner does not
anticipate
will be material in amount, will be allocated to the Managing General Partner.
I.R.C. ss.709; Treas. Reg. ss.ss.1.709-1 and 2.
Tax Elections
Each Partnership may elect to adjust the basis of Partnership property on
the transfer of a Unit by sale or exchange or on the death of a Participant, and
on the distribution of property by the Partnership to a Participant (the ss.754
election). The general effect of this election is that transferees of the Units
are treated, for purposes of depreciation and gain, as though they had acquired
a direct interest in the Partnership assets and the Partnership is treated for
these purposes, on certain distributions to the Participants, as though it had
newly acquired an interest in the Partnership assets and therefore acquired a
new cost basis for the assets. Any election, once made, may not be revoked
without the consent of the IRS. Each Partnership also may make various elections
for federal tax reporting purposes which could result in various items of
income, gain, loss and deduction being treated differently for tax purposes than
for accounting purposes.
Code ss.195 permits taxpayers to elect to capitalize and amortize "start- up
expenditures" over a 60-month period. These items include amounts:
o paid or incurred in connection with:
o investigating the creation or acquisition of an
active trade or business;
o creating an active trade or business; or
o any activity engaged in for profit and for the
production of income before the day on which the
active trade or business begins, in anticipation
of the activity becoming an active trade or
business; and
o which would be allowed as a deduction if paid or
incurred in connection with the expansion of an existing
business.
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Start-up expenditures do not include amounts paid or incurred in connection with
the sale of the Units. If it is ultimately determined by the IRS or the courts
that any of a Partnership's expenses constituted start-up expenditures, the
Partnership's deductions for those expenses would be deferred over the 60-month
period.
Disallowance of Deductions Under Section 183 of the Code
Under ss.183 of the Code, a Participant's ability to deduct his share of a
Partnership's losses on his federal income tax return could be lost if the
Partnership lacks the appropriate profit motive as determined from an
examination of all facts and circumstances at the time. Section 183 of the Code
creates a presumption that an activity is engaged in for profit if, in any three
of five consecutive taxable years, the gross income derived from the activity
exceeds the deductions attributable to the activity. Thus, if a Partnership
fails to show a profit in at least three out of five consecutive years this
presumption will not be available and the possibility that the IRS could
successfully challenge the Partnership deductions claimed by a Participant would
be substantially increased.
The fact that the possibility of ultimately obtaining profits is uncertain,
standing alone, does not appear to be sufficient grounds for the denial of
losses under ss.183. (See Treas. Reg. ss.1.183-2(c), Example (5).) Based on the
results of the previous partnerships sponsored by the Managing General Partner
set forth in "Prior Activities" in the Prospectus and the Managing General
Partner's representations to us, including that the principal purpose of each
Partnership is to locate, produce and market natural gas and oil on a profitable
basis apart from tax benefits (which is supported by the geological evaluations
and other information for the proposed Prospects included in Appendix A to the
Prospectus, which will cover a portion of the Prospects to be drilled in Atlas
America Public #12- 2003), in the opinion of Special Counsel it is more likely
than not that the Partnerships will possess the requisite profit motive.
Termination of the Partnership
Under ss.708(b) of the Code, each Partnership will be considered as
terminated for federal income tax purposes if within a 12 month period there is
a sale or exchange of 50% or more of the total interest in Partnership capital
and profits. The closing of each Partnership year may result in more than 12
months' income or loss of the Partnership being allocated to certain
Participants for the year of termination, for example, in the case of
Participants using fiscal years other than the calendar year. Under ss.731 of
the Code, a Participant will realize taxable gain on a termination of the
Partnership to the extent that money regarded as distributed to him exceeds the
adjusted basis of his Units. The conversion of Investor General Partner Units to
Limited Partner Units, however, will not terminate a Partnership. Rev. Rul.
84-52, 1984-1 C.B. 157.
Lack of Registration as a Tax Shelter
Section 6111 of the Code generally requires an organizer of a "tax shelter"
to register the tax shelter with the Secretary of the Treasury, and to obtain an
identification number which must be included on the tax returns of investors in
the tax shelter. For purposes of these provisions, a "tax shelter" generally is
defined to include investments with respect to which any person could reasonably
infer that the ratio that:
o the aggregate amount of the potentially allowable deductions and
350% of the potentially allowable credits with respect to the
investment during the first five years of the investment bears
to;
o the amount of money and the adjusted basis of property
contributed to the investment;
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exceeds 2 to 1. The Managing General Partner does not believe that the
Partnerships will have a tax shelter ratio greater than 2 to 1. Accordingly, the
Managing General Partner does not intend to register the Partnerships with the
IRS as a tax shelter.
If it is subsequently determined by the IRS or the courts that the
Partnerships were required to be registered with the IRS as a tax shelter, the
Managing General Partner would be subject to certain penalties, including a
penalty of 1% of the aggregate amount invested in a Partnership for failing to
register and $100 for each failure to furnish a Participant a tax shelter
registration number. Also, each Participant would be liable for a $250 penalty
for failure to include the tax shelter registration number on his tax return
unless the failure was due to reasonable cause. A Participant also would be
liable for a penalty of $100 for failing to furnish the tax shelter registration
number to any transferee of his Units. However, based on the representations of
the Managing General Partner to us, Special Counsel has expressed the opinion
that the Partnerships, more likely than not, are not required to register with
the IRS as a tax shelter.
Issuance of a registration number does not indicate that an investment or
the claimed tax benefits have been reviewed, examined, or approved by the IRS.
Investor Lists
Section 6112 of the Code requires that if requested by the IRS each
Partnership must identify the Participants and provide the IRS with certain
information concerning each Participant's investment in the Partnership and tax
benefits from the investment, even though the Partnership is not registered with
the IRS as a tax shelter.
Tax Returns and Audits
In General. The tax treatment of all partnership items generally is
determined at the partnership, rather than the partner, level; and the
partners generally are required to treat partnership items on their individual
returns in a manner which is consistent with the treatment of the partnership
items on the partnership return. I.R.C. ss.ss.6221 and 6222. Regulations
define "partnership items" for this purpose as including distributive share
items that must be allocated among the partners, such as partnership
liabilities, data pertaining to the computation of the depletion allowance,
and guaranteed payments. Treas. Reg. ss.301.6231(a)(3)-1.
Generally, the IRS must conduct an administrative determination as to
partnership items at the partnership level before conducting deficiency
proceedings against a partner, and the partners must file a request for an
administrative determination before filing suit for any credit or refund. The
period for assessing tax against the Participants attributable to a partnership
item may be extended by agreement between the IRS and the Managing General
Partner, which will serve as each Partnership's representative ("Tax Matters
Partner") in all administrative and judicial proceedings conducted at the
partnership level. The Tax Matters Partner generally may enter into a settlement
on behalf of, and binding on, Participants owning less than a 1% profits
interest if there are more than 100 partners in a Partnership. In addition, a
partnership with at least 100 partners may elect to be governed under simplified
tax reporting and audit rules as an "electing large partnership." I.R.C. ss.771.
These rules also facilitate the matching of partnership items with individual
partner tax returns by the IRS. The Managing General Partner does not anticipate
that the Partnerships will make this election. By executing the Partnership
Agreement, each Participant agrees that he will not form or exercise any right
as a member of a notice group and will not file a statement notifying the IRS
that the Tax Matters Partner does not have binding settlement authority.
In the event of an audit of a Partnership's tax return, the Managing General
Partner, pursuant to advice of counsel, will take all actions necessary, in its
discretion, to preserve the rights of the Participants. All expenses of any
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proceedings undertaken by the Managing General Partner, which might be
substantial, will be paid for by the Partnership being audited. The Managing
General Partner is not obligated to contest adjustments made by the IRS.
Tax Returns. A Participant's income tax returns are the responsibility of
the Participant. A Partnership will provide each Participant with the tax
information applicable to his investment in the Partnership necessary to prepare
his tax returns.
Penalties and Interest
In General. Interest is charged on underpayments of tax, and various civil
and criminal penalties are included in the Code.
Penalty for Negligence or Disregard of Rules or Regulations. If any portion
of an underpayment of tax is attributable to negligence or disregard of rules or
regulations, 20% of that portion is added to the tax. Negligence is strongly
indicated if a Participant fails to treat partnership items on his tax return in
a manner that is consistent with the treatment of those items on the
Partnership's return or to notify the IRS of the inconsistency. The term
"disregard"
includes any careless, reckless or intentional disregard of rules or
regulations. There is no penalty, however, if the position (other than
negligence) is adequately disclosed and has at least a reasonable basis, or
the position is taken with reasonable cause and in good faith, or the position
is contrary to an IRS ruling or notice but has a realistic possibility of
being sustained on its merits. Treas. Reg. ss.ss.1.6662-3 and 1.6662-7.
Valuation Misstatement Penalty. There is an addition to tax of 20% of the
amount of any underpayment of tax of $5,000 or more, $10,000 in the case of
corporations other than S corporations or personal holding companies, which is
attributable to a substantial valuation misstatement. There is a substantial
valuation misstatement if:
o the value or adjusted basis of any property claimed on a return
is 200% or more of the correct amount; or
o the price for any property or services, or for the use of
property, claimed on a return is 200% or more, or 50% or less, of
the correct price.
If there is a gross valuation misstatement, which is 400% or more of the
correct value or adjusted basis or the undervaluation is 25% or less of the
correct amount, then the penalty is 40%. I.R.C. ss.6662(e) and (h).
Substantial Understatement Penalty. There is also an addition to tax of 20%
of any underpayment if the difference between the tax required to be shown on
the return over the tax actually shown on the return exceeds the greater of:
o 10% of the tax required to be shown on the return; or
o $5,000, $10,000 in the case of corporations other than S
corporations or personal holding companies. I.R.C. ss.6662(d).
The amount of any understatement generally will be reduced to the extent it is
attributable to the tax treatment of an item:
o supported by substantial authority; or
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o adequately disclosed on the taxpayer's return and there was a
reasonable basis for the tax treatment.
However, in the case of "tax shelters," which includes each Partnership for
this purpose, the understatement may be reduced only if the tax treatment of an
item attributable to a tax shelter was supported by substantial authority and
the taxpayer establishes that he reasonably believed that the tax treatment
claimed was more likely than not the proper treatment. I.R.C. ss.6662(d)(2)(C).
Disclosure of partnership items should be made on each Partnership's return;
however, a Participant also may make adequate disclosure on his individual
return with respect to pass-through items.
Anti-Abuse Rules and Judicial Doctrines.
We have considered the possible application to each Partnership and its
intended activities of all potentially relevant statutory and regulatory anti-
abuse rules and judicial doctrines. In doing so, we have taken into account the
Participants' non-tax purposes (e.g. cash distributions and portfolio
diversification) and tax purposes (e.g. Intangible Drilling Costs and
depreciation deductions, and the depletion allowance) for investing in the
Partnership, and the relative weight of such purposes. We have also taken into
account the Managing General Partner's purposes for structuring each Partnership
in the manner in which it is structured (e.g. to help the Partnership produce a
profit for the Participants and enhance the tax benefits of their investment in
the Partnership).
Statutory and Regulatory Anti-Abuse Rules. Under Treas. Reg. ss.1.701-2,
if a principal purpose of a partnership is to reduce substantially the
partners' federal income tax liability in a manner that is inconsistent with
the intent of the partnership rules of the Code, based on all the facts and
circumstances, the IRS is authorized to remedy the abuse. For illustration
purposes, the following factors may indicate that a partnership is being used
in a prohibited manner:
o the partners' aggregate federal income tax liability is
substantially less than had the partners owned the
partnership's assets and conducted its activities directly;
o the partners' aggregate federal income tax liability is
substantially less than if purportedly separate transactions
are treated as steps in a single transaction;
o one or more partners are needed to achieve the claimed tax
results and have a nominal interest in the partnership or are
substantially protected against risk;
o substantially all of the partners are related to each other;
o income or gain are allocated to partners who are not expected
to have any federal income tax liability;
o the benefits and burdens of ownership of property nominally
contributed to the partnership are retained in substantial part
by the contributing party; and
o the benefits and burdens of ownership of partnership property are
in substantial part shifted to the distributee partners before or
after the property is actually distributed to the distributee
partners.
Based on the Managing General Partner's representations to us, in our opinion it
is more likely than not that the anti-abuse rule set forth in Treas. Reg.
ss.1.701-2, and any other potentially relevant statutory and regulatory anti-
abuse rules will not have a material adverse effect on the tax consequences of
an investment in each Partnership by a typical Participant as described in our
opinions.
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Judicial Doctrines. We also have considered the possible application to each
Partnership and its intended activities of all potentially relevant judicial
doctrines including those set forth below.
o Step Transactions. This doctrine is that where a series of
transactions would give one tax result if viewed independently,
but a different tax result if viewed together, then the separate
transactions may be combined by the IRS.
o Business Purpose. This doctrine involves a determination of
whether the taxpayer has a business purpose, other than tax
avoidance, for engaging in the transaction, i.e. a "profit
objective."
o Economic Substance. This doctrine requires a determination of
whether, from an objective viewpoint, a transaction is likely to
produce economic benefits in addition to tax benefits, and
involves a comparison of the potential economic return with the
investment made. This test is met when there is a realistic
potential for profit when the investment is made, in accordance
with the standards applicable to the relevant industry, so that a
reasonable businessman, using those standards, would make the
investment.
o Substance Over Form. This doctrine holds that the substance of
the transaction, rather than the form in which it is cast,
governs. It applies where the taxpayer seeks to characterize a
transaction as one thing, rather than another thing which has
different tax results. Under this doctrine, the transaction must
have practical economical benefits other than the creation of
income tax losses.
o Sham Transactions. Under this doctrine, a transaction lacking
economic substance may be ignored for tax purposes. Economic
substance requires that there be business realities and tax-
independent considerations, rather than just tax-avoidance
features, i.e. the transaction must have a reasonable objective
possibility of providing a profit aside from tax benefits.
Shams would include, for example, transactions entered into
solely to reduce taxes, which is not a profit motive because
there is no intent to produce taxable income.
Based on the results of the previous partnerships sponsored by the Managing
General Partner set forth in "Prior Activities" in the Prospectus and the
Managing General Partner's representations to us, including that the principal
purpose of the Partnership is to locate, produce and market natural gas and oil
on a profitable basis apart from tax benefits (which is supported by the
geological evaluations and other information for the proposed Prospects included
in Appendix A to the Prospectus, which will cover a portion of the Prospects to
be drilled in Atlas America Public #12-2003), we have concluded that none of the
potentially relevant judicial doctrines considered by us, including those
specifically discussed above, will have a material adverse effect on the tax
consequences of an investment in each Partnership by a typical Participant as
described in our opinions.
State and Local Taxes
Under Pennsylvania law each Partnership is required to withhold state income
tax at the rate of 2.8% of Partnership income allocable to Participants who are
not residents of Pennsylvania. This requirement does not obviate Pennsylvania
tax return filing requirements for Participants who are not residents of
Pennsylvania. In the event of overwithholding, a Pennsylvania income tax return
must be filed by Participants who are not residents of Pennsylvania in order to
obtain a refund.
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Each Partnership will operate in states and localities which impose a tax on
its assets or its income, or on each Participant. Deductions which are available
to Participants for federal income tax purposes, such as the accelerated 30%
first year depreciation deduction discussed in "-Depreciation - Modified
Accelerated Cost Recovery System ("MACRS") above, may not be available for state
or local income tax purposes. A Participant's distributive share of a
Partnership's net income or net loss generally must be included in determining
his reportable income for state or local tax purposes in the jurisdiction in
which he is a resident. To the extent that a non-resident Participant pays tax
to a state because of Partnership operations within that state, he may be
entitled to a deduction or credit against tax owed to his state of residence
with respect to the same income. To the extent that the Partnership operates in
certain jurisdictions, state or local estate or inheritance taxes may be payable
on the death of a Participant in addition to taxes imposed by his own domicile.
Prospective Participants are urged to consult with their own tax advisors
concerning the possible effect of various state and local taxes on their
personal tax situations.
Severance and Ad Valorem (Real Estate) Taxes
Each Partnership may incur various ad valorem or severance taxes imposed by
state or local taxing authorities. Currently, these taxes are not imposed in
Mercer County, Pennsylvania.
Social Security Benefits and Self-Employment Tax
A Limited Partner's share of income or loss from a Partnership is excluded
from the definition of "net earnings from self-employment." No increased
benefits under the Social Security Act will be earned by Limited Partners and if
any Limited Partners are currently receiving Social Security benefits, their
shares of Partnership taxable income will not be taken into account in
determining any reduction in benefits because of "excess earnings."
An Investor General Partner's share of income or loss from a Partnership
will constitute "net earnings from self-employment" for these purposes. I.R.C.
ss.1402(a). The ceiling for social security tax of 12.4% in 2003 is $87,000 and
the ceiling for 2004 is not known. There is no ceiling for medicare tax of 2.9%.
Self-employed individuals can deduct one-half of their self-employment tax.
Farmouts
Under a Farmout by a Partnership, if a property interest, other than an
interest in the drilling unit assigned to the Partnership Well in question, is
earned by the farmee (anyone other than the Partnership) from the farmor (the
Partnership) as a result of the farmee drilling or completing the well, then the
farmee must recognize income equal to the fair market value of the outside
interest earned, and the farmor must recognize gain or loss on a deemed sale
equal to the difference between the fair market value of the outside interest
and the farmor's tax basis in the outside interest. Neither the farmor nor the
farmee would have received any cash to pay the tax. The Managing General Partner
will attempt to eliminate or reduce any gain to the Partnership from a Farmout,
if any. However, if the IRS claims that a Farmout by a Partnership results in
taxable income to the Partnership and its position is ultimately sustained, the
Participants would be required to include their distributive share of the
resulting taxable income on their respective personal income tax returns, even
though the Partnership and the Participants received no cash from the Farmout.
Foreign Partners
Each Partnership will be required to withhold and pay to the IRS tax at the
highest rate under the Code applicable to Partnership income allocable to
foreign Participants, even if no cash distributions are made to them. A
purchaser of a
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Atlas Resources, Inc.
May 27, 2003
Page 30
foreign Participant's Units may be required to withhold a portion
of the purchase price and the Managing General Partner may be required to
withhold with respect to taxable distributions of real property to a foreign
Participant. These withholding requirements do not obviate United States tax
return filing requirements for foreign Participants. In the event of
overwithholding a foreign Participant must file a United States tax return to
obtain a refund.
Estate and Gift Taxation
There is no federal tax on lifetime or testamentary transfers of property
between spouses. The gift tax annual exclusion in 2003 is $11,000 per donee
which will be adjusted in subsequent years for inflation. Under the Economic
Growth and Tax Relief Reconciliation Act of 2001 (the "2001 Act"), between 2002
and 2009 the maximum estate and gift tax rate will be reduced in stages until it
is 45% in 2009, and estates of $1 million in 2003 and $1.5 million in 2004,
which further increases in stages to $3.5 million by 2009, or less generally are
not subject to federal estate tax. Under the 2001 Act, the federal estate tax
will be repealed in 2010, and the top gift tax rate for 2010 will be 35%. In
2011 the federal estate and gift taxes are scheduled to be reinstated under the
rules in effect before the 2001 Act.
Changes in the Law
A Participant's investment in a Partnership may be affected by changes in
the tax laws. For example, under the Economic Growth and Tax Relief
Reconciliation Act of 2001 the federal income tax rates are being reduced in
stages between 2001 and 2006, including reducing the top rate from:
o 39.1% for 2001 to 38.6% for 2002 and 2003;
o 37.6% for 2004 and 2005; and
o 35% for 2006 through 2010.
This will reduce to some degree the amount of taxes a Participant saves by
virtue of his share of the Partnership's deductions for Intangible Drilling
Costs, depletion and depreciation. There is no assurance that the federal income
tax rates discussed above will not be changed in the future.
We consent to the use of this letter as an exhibit to the Registration
Statement, and all amendments to the Registration Statement, and to all
references to this firm in the Prospectus.
Very truly yours,
/s/ Kunzman & Bollinger, Inc.
KUNZMAN & BOLLINGER, INC.