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
Exhibit 8
July 25, 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 natural gas and oil drilling limited partnerships (each a
"Partnership" or collectively the "Partnerships"), all of which will be formed
under the Delaware Revised Uniform Limited Partnership Act before they begin
their drilling activities. 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 each 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") included as Exhibit (A) to the
Prospectus.
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.
Any material inaccuracy in your representations may render our opinions
inapplicable. Included among your representations are the following:
o The Partnership Agreement of each Partnership will be executed
by the Managing General Partner and its Participants and
recorded in all places required under the Delaware Revised
Uniform Limited Partnership Act and any other applicable
limited partnership act. Also, each Partnership, when formed,
will be operated in accordance with the terms of the
Partnership Agreement, the Prospectus,
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and the Delaware Revised Uniform Limited Partnership Act and
any other applicable limited partnership act.
o Each Partnership will be subject to the partnership provisions
of the Code and will not elect to be taxed as a corporation.
o Each 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 for each Partnership will
be duly executed and will govern the drilling and, if
warranted, the completion and operation of the Partnership's
wells.
o Based on the information it has concerning drilling rates of
third-party drilling companies in the Appalachian Basin, the
estimated costs of non-affiliated persons to drill and equip
the wells in the Appalachian Basin as reported for 2001 by an
independent industry association which surveyed other
non-affiliated operators in the area, and information it has
concerning increases in drilling costs in the area since 2001,
the amounts that will be paid by each Partnership 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 by
each Partnership 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 each Partnership's subscriptions
are received, the Managing General Partner anticipates that
Atlas America Public #12-2003 Limited Partnership will prepay
in 2003 most, if not all, of its Intangible Drilling Costs for
drilling activities that will begin in 2004. In addition, the
Managing General Partner anticipates that Atlas America Public
#12-2004(B) Limited Partnership, which may close on December
31, 2004, may prepay in 2004 most, if not all, of its
Intangible Drilling Costs for drilling activities that will
begin in 2005.
o Each Partnership will own only Working Interests in all of its
Prospects, and will elect to deduct currently all Intangible
Drilling Costs.
o Each Partnership will have a calendar year taxable year and
use the accrual method of accounting.
o Based on the Managing General Partner's experience (see "Prior
Activities" in the Prospectus) and the intended operations of
each 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 any of the Partnerships exceed twice
the amounts invested by the Managing General Partner and the
Participants, respectively, in any of the Partnerships. Thus,
the Managing General Partner will not register any of the
Partnerships with the IRS as a "tax shelter."
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o The Investor General Partner Units in each Partnership will
not be converted to Limited Partner Units before all of the
wells in the Partnership have been drilled and completed. The
Managing General Partner intends that the conversion will be
in the calendar year following the calendar year in which all
of the Partnership's wells have been drilled and completed.
o The Units of each Partnership will not be traded on an
established securities market.
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 in each Partnership 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 any of
the Partnerships will elect to be treated as an "electing
large partnership" under the Code for reporting and audit
purposes.
o In any administrative or judicial proceedings with the IRS,
the Managing General Partner, as Tax Matters Partner, will
provide the Participants with notices of the proceedings and
other information as required by the Code and the Partnership
Agreement.
o Each Partnership will provide its Participants with the tax
information applicable to their respective investments in the
Partnership necessary to prepare their federal, state and
local income 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, other than as a creditor, 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;
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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.
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 the possibility that:
o a tax return will not be audited;
o an issue will not be raised on audit; or
o 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. The Partnerships, as such, will not
pay any federal income taxes, and all items of income, gain,
loss and deduction of the Partnerships 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 Each Partnership's income and gain from its natural
gas and oil properties which are allocated to its
Limited Partners, other than net income and gain in
the case of 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.
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(See "- Limitations on Passive Activities.")
(3) Not a Publicly Traded Partnership. Assuming that no more than 10% of
any Partnership's Units are transferred in any taxable year of the
Partnership, other than in private transfers described in Treas. Reg.
ss.1.7704-1(e), none of the Partnerships will be treated as a "publicly
traded partnership" under the Code. (See "- Limitations on Passive
Activities - Publicly Traded Partnership Rules.")
(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
each Partnership's subscriptions are received, the Managing General
Partner anticipates that Atlas America Public #12-2003 Limited
Partnership will prepay in 2003 most, if not all of its Intangible
Drilling Costs for drilling activities that will begin in 2004. In
addition, the Managing General Partner anticipates that Atlas America
Public #12-2004(B) Limited Partnership, which may close on December 31,
2004, may prepay in 2004 most, if not all, of its Intangible Drilling
Costs for drilling activities that will begin in 2005. Assuming that
the amounts of any prepaid Intangible Drilling Costs of a Partnership
are fair and reasonable consideration, and based in part on the factual
assumptions set forth below, 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.")
The foregoing opinion is based in part on the assumptions that:
o 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;
o under the Drilling and Operating Agreement the drilling of all
of the wells is required to be, and actually is, begun before
the close of the 90th day after the close of the taxable year
in which the prepayment is made, and the wells are
continuously drilled until completed, if warranted, or
abandoned; and
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o 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 their share of the natural gas and oil production
income of the Partnership in which they invest, 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 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. The Partnerships will
possess the requisite profit motive underss.183 of the Code and are not
required to register with the IRS as a tax shelter. This opinion is
based in part 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 representation 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 for
Atlas America Public #12-2003 Limited Partnership). (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. 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 a
Partnership by a typical Participant as described in our opinions. This
opinion is based in part 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
representation 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
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information for the proposed Prospects included in Appendix A to the
Prospectus for Atlas America Public #12-2003 Limited Partnership). (See
"-Anti-Abuse Rules and Judicial Doctrines.")
(15) Overall Evaluation of Tax Benefits. The tax benefits of each
Partnership, in the aggregate, which are a significant feature of an
investment in a Partnership by a typical Participant more likely than
not will be realized as contemplated by the Prospectus. This opinion is
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 discussion in 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 in a Partnership. 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 as a limited
partnership 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 none of the Partnerships will 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:
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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
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 limitations.
Investor General Partners also do not materially participate in the
Partnership in which they invest. However, because each Partnership 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 activity
limitations. (See "- `At Risk' Limitation For Losses," below.) Similarly, a
Limited Partner's basis is reduced by deductions even if the deductions are
suspended under the passive activity limitations. (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 in a passive activity is sold to an unrelated
third-party in a taxable transaction and in part on the disposition of
substantially all of the interest in a 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.
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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 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 our opinion 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. If a
Participant invests in a Partnership 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 the calendar year after the
calendar year in which all of the Partnership's wells have been drilled and
completed. After the Investor General Partner Units have been converted to
Limited Partner Units, each former Investor General Partner will have limited
liability as a limited partner under the Delaware Revised Uniform Limited
Partnership Act with respect to his Partnership's activities after the date of
the conversion.
Concurrently, the former Investor General Partner will become subject
to the passive activity limitations as a limited partner. However, because the
former Investor General Partner previously will have received a non-passive loss
as an Investor General Partner in the year in which he invested in the
Partnership as a result of the Partnership's deduction for Intangible Drilling
Costs, the Code requires that his net income from the Partnership Wells after
his conversion to a limited partner 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 Investor
General Partner 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
Taxable Year. Each Partnership intends to adopt a calendar year taxable
year . I.R.C. ss.ss.706(a) and (b). 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%.
Method of Accounting. Each Partnership will use the accrual method of
accounting for federal income tax purposes. I.R.C. ss.448(a). 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
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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.
o A special rule in the Code, however, provides that there is
economic performance in the current taxable year with respect
to amounts paid in that taxable 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 taxable year. I.R.C. ss.461(i). (See
"-Drilling Contracts," below.)
2003 and 2004 Expenditures
The Managing General Partner anticipates that all of each Partnership's
subscription proceeds will be expended in the year in which its Participants
invest in the Partnership 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 Atlas America Public
#12-2003 Limited Partnership will prepay in 2003 most, if not all, of its
Intangible Drilling Costs for wells the drilling of which will begin in 2004. In
addition, the Managing General Partner anticipates that Atlas America Public
#12-2004(B) Limited Partnership, which may close on December 31, 2004, may
prepay in 2004 most, if not all, of its Intangible Drilling Costs for drilling
activities that will begin in 2005. The deductibility of these advance payments
in the year in which a Participant invests in the Partnership cannot be
guaranteed. (See "- Drilling Contracts," below.) In addition, wells which are
prepaid in 2004 and drilled and completed in 2005, if any, will not be eligible
for the additional 50% first-year depreciation deduction discussed in "-
Depreciation - Modified Accelerated Cost Recovery System ("MACRS"), 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 us 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 not "ordinary and necessary" business expenses.
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Atlas Resources, Inc.
July 25, 2003
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(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 his Partnership's 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 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 under the Partnership
Agreement 100% to its Participants. Also, under the Partnership Agreement not
less than 90% of the subscription proceeds received by each Partnership from its
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 nondeductible. 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 taxable 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. I.R.C.ss.291(b)(4).
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. The Partnerships will not be integrated oil companies.
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 each Partnership, assuming a 100% Working Interest in
each well, it will have reimbursement of general and administrative overhead of
$14,142 per well and a profit of 15%
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Atlas Resources, Inc.
July 25, 2003
Page 12
(approximately $26,083) per well, with respect to the Intangible Drilling Costs
and the 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 each Partnership's subscriptions are
received, the Managing General Partner anticipates that Atlas America Public
#12-2003 Limited Partnership will prepay in 2003 most, if not all, of its
Intangible Drilling Costs for drilling activities that will begin in 2004. In
addition, the Managing General Partner anticipates that Atlas America Public
#12-2004(B) Limited Partnership, which may close on December 31, 2004, may
prepay in 2004 most, if not all, of its Intangible Drilling Costs for drilling
activities that will begin in 2005. 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.
The test is:
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
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July 25, 2003
Page 13
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.
Each Partnership will attempt to comply with the guidelines set forth
in Keller with respect to any prepaid Intangible Drilling Costs. The Drilling
and Operating Agreement will require each Partnership to prepay Intangible
Drilling Costs in the year in which the Participant invests for specified wells
the drilling of which may 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 each Partnership to prepay the
Intangible Drilling Costs of drilling and completing its wells in order to
enable the Operator to:
o begin 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 in the
well. 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 owners of Working Interests in the wells. However, in our view,
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 the wells.
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 in which the prepayment was made.
I.R.C.
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Atlas Resources, Inc.
July 25, 2003
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ss.461(i). (See "- Taxable Year and Method of Accounting," above.) Under the
Drilling and Operating Agreement, the Managing General Partner as operator and
general drilling contractor will use its best efforts to begin drilling each
Partnership's wells before the close of the 90th day after the close of the
Partnership's taxable year in which the prepayment was made. However, the
drilling of any Partnership Well may be delayed due to circumstances beyond the
control of the Managing General Partner or the drilling subcontractors. These
circumstances include, for example:
o the unavailability of drilling rigs;
o decisions of third-party operators to delay drilling the
wells;
o poor 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 is made by the Managing General
Partner under the Drilling and Operating Agreement that the drilling of all
wells prepaid by a Partnership will actually begin before the close of the 90th
day after the close of the Partnership's taxable year in which the prepayment
was made. If the drilling of a prepaid Partnership Well does not begin by that
date, deductions claimed by a Participant for prepaid Intangible Drilling Costs
for the well in the year in which the Participant invests in the Partnership
would be disallowed and deferred to the next taxable year when the well is
actually drilled.
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 in that Partnership for the
year in which they invest in that Partnership, or that the challenge would not
ultimately be sustained. In the event of disallowance, the deduction for prepaid
Intangible Drilling Costs would be available in the next year when the wells are
actually drilled as discussed in "- Intangible Drilling Costs," above.
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 under 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" as that term is defined in "- Intangible Drilling
Costs," above, which does not include the Partnerships. Percentage depletion is
based on a Participant's share of his 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
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Atlas Resources, Inc.
July 25, 2003
Page 15
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 equivalent to 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 may
fluctuate 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.
Availability of percentage depletion must be computed separately by
each Participant and not by a Partnership or for Participants in a Partnership
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 of each
Partnership generally are charged and allocated under the Partnership Agreement
66% to the Managing General Partner and 34% to the Participants in the
Partnership. However, if the total Tangible Costs for all of the 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 each 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, all property assigned to the 7-year class generally is treated as placed
in service, or disposed of, in the middle of the year, and depreciation for
alternative minimum tax purposes is computed using the 150% declining balance
method, switching to straight-line, for most personal property.
Notwithstanding the foregoing, under the Jobs and Growth Tax Relief
Reconciliation Act of 2003 ("2003 Tax Act"), for federal income tax purposes
each Partnership will be entitled to an additional first-year depreciation
allowance based on 50% of the adjusted basis of its "qualified" Tangible Costs.
For this purpose, a Partnership's "qualified" Tangible Costs means the
Partnership's equipment costs for productive wells which are completed and made
capable of production, i.e. placed in service, before January 1, 2005. I.R.C.
ss.168(k)(2) and (4). Thus, with respect to Atlas America Public #12-2004(B)
Limited Partnership, which may close on December 31, 2004, this additional
first-year depreciation allowance would not be available for wells, if any,
which are prepaid by the Partnership and drilled and completed after January 1,
2005. (See "- Drilling Contracts," above.) The basis of this qualified equipment
will be
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Atlas Resources, Inc.
July 25, 2003
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reduced by the additional 50% first-year depreciation allowance for
purposes of calculating the regular MACRS depreciation allowances beginning with
the year the wells are placed in service. The examples provided in the Technical
Explanation of the Job Creation and Worker Assistance Act of 2002 ("2002 Tax
Act") which provided a similar accelerated depreciation allowance of 30%, do not
reduce the 30% additional depreciation allowance by the half-year convention
discussed above. Nevertheless, because this situation is not clearly addressed
by either the 2002 Tax Act or the 2003 Tax Act, it is possible that the
half-year convention or a mid-quarter convention, depending on when a
Partnership's wells are placed in service, ultimately may be determined to apply
under the 2003 Tax Act.
o Also, a Participant will not incur any alternative minimum tax
adjustment with respect to his share of a Partnership's
additional 50% first-year depreciation allowance, nor any of
its other depreciation deductions for the costs of the
qualified equipment it places in the wells.
I.R.C.ss.168(k)(2)(F).
Lease Acquisition 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 his Partnership's losses 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 Participant's 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
(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 deductions, 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 Partnership liabilities, if
any, is considered a cash distribution to the Participant. Although Participants
will not be personally liable on any Partnership loans 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 to a Participant from his Partnership
exceed the tax basis of the Participant's Units, taxable gain would result to
the extent of the excess. (See "- Distributions From a Partnership," below.)
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Atlas Resources, Inc.
July 25, 2003
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"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 his 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. However, 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.
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 Participant'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.
A Participant's cash subscription payment to the Partnership in which
he invests is 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 a 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. (Seess.5.04(d) of the Partnership
Agreement.) Other distributions of cash, disproportionate distributions of
property, and liquidating distributions of a Partnership may result in taxable
gain or loss to the Participants. (See "- Disposition of Units" and
" - Termination of a Partnership," below.)
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Atlas Resources, Inc.
July 25, 2003
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Sale of the Properties
Under the Jobs and Growth Tax Relief Reconciliation Act of 2003 ("2003
Tax Act"), the maximum tax rates on a noncorporate taxpayer's adjusted net
capital gain on the sale of assets held more than a year of 20%, or 10% to the
extent it would have been taxed at a 10% or 15% rate if it had been ordinary
income, have been reduced to 15% and 5%, respectively, for most capital assets
sold or exchanged after May 5, 2003. In addition, for 2008 only, the 5% tax rate
on adjusted net capital gain is reduced to 0%. The 2003 Tax Act also eliminated
the former maximum tax rates of 18% and 8%, respectively, on qualified five-year
gain. I.R.C. ss.1(h). The new capital gain rates also apply for purposes of the
alternative minimum tax. I.R.C. ss.55(b)(3). (See " - Minimum Tax - Tax
Preferences," below.) However, the former tax rates are scheduled to be
reinstated January 1, 2009, as if the 2003 Tax Act had never been enacted.
"Adjusted net capital gain" means net capital gain, less certain types of net
capital gain that are taxed a maximum rate of 28% (such as gain on the sale of
most collectibles and gain on the sale of certain small business stock); or 25%
(gain attributable to real estate depreciation). "Net capital gain" means the
excess of net long-term gain (excess of long-term gains over long-term losses)
over net short-term loss (excess of short-term gains over short-term losses).
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 a 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).
(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.ss.1254(a) and 1245(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 generally will 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
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Atlas Resources, Inc.
July 25, 2003
Page 19
loss generally will be short-term gain or loss. Also, a Participant's pro rata
share of his 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 to a Participant greater than the cash proceeds,
if any, received by the Participant from the disposition. In addition to gain
from a passive activity, a portion of any gain recognized by a Limited 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. Also, 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 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 his Investor General Partner
Units to Limited Partner Units so long as there is no change in the Investor
General Partner's share of his 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.
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. Regular tax personal
exemptions are not available for purposes of the alternative minimum tax. Under
the Jobs and Growth Tax Relief Reconciliation Act of 2003, for tax years 2003
and 2004, the exemption amount from alternative minimum tax is increased from
$49,000 to $58,000 for married couples filing jointly and surviving spouses;
from $35,750 to $40,250 for single filers, and from $24,500 to $29,000 for
married persons filing separately. For these tax years only, married persons
filing separately must increase their alternative
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minimum taxable income by the lesser of 25% of the excess of alternative minimum
taxable income over $191,000; or $29,000.
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. These post-2004 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.
Also, 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.
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 alternative
minimum tax purposes, and the amount of the deductions suspended or recaptured
may differ for regular and alternative 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, which does not include the Partnerships, the 1992 National Energy
Bill repealed:
o the preference for excess Intangible Drilling Costs; and
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.
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Also, each Participant may elect under ss.59(e) of the Code to
capitalize all or part of his share of his Partnership's Intangible Drilling
Costs 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 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
alternative 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 his
Partnership before his 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 generally includes:
o gross income from interest, rents, and royalties;
o any excess of net gain from dispositions of investment
property over net capital gain determined by gains and losses
from dispositions of investment property, and any portion of
the net capital gain or net gain, if less, that the taxpayer
elects to include in investment income;
o portfolio income under the passive activity rules, which
includes working capital investment income;
o dividends that do not qualify to be taxed at capital gain
rates and dividends that the taxpayer elects to treat as not
qualified to be taxed at capital gain rates; and
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 they are converted to Limited Partners. Investment
expenses include deductions, other
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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
his Partnership's income, gains, losses and deductions, including the deductions
for Intangible Drilling Costs and depreciation. 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.)
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.
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.
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.
Even though the Participants in each Partnership are not required under
the Partnership Agreement to restore deficit balances in their Capital Accounts
with additional Capital Contributions, an allocation which is not attributable
to
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nonrecourse debt still will be considered under the regulations to have
economic effect to the extent it does not cause or increase a deficit balance in
a Participant's Capital Account if:
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 the Partnership Agreement provides that a Participant 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). These provisions are included in the
Partnership Agreement (See ss.ss.5.02, 5.03(h), and 7.02(a) 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 by him whether or not there is any distributable cash. A
Participant's share of Partnership revenues applied by his Partnership 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 his Partnership for a particular year in excess of any cash distributions
from the Partnership to him with respect to that year. To the extent a
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 that Partnership's 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 in which he invests, 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 allocations set forth in the Partnership Agreement is substantial in
light of a Participant's tax attributes that are unrelated to the Partnership in
which he invests, in our opinion 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 Partnerships. The use of Partnership revenues
taxable to Participants to repay borrowings by their Partnership could create
income tax liability for the Participants in excess of cash distributions to
them from the Partnership, 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" by the Managing General
Partner or its Affiliates to a Partnership 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 in the
Partnerships, 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 each Partnership's
Organization and Offering Costs. Thus, 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 its Partnership
property on the transfer of a Unit in the Partnership 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
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Atlas Resources, Inc.
July 25, 2003
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o which would be allowed as a deduction if paid or incurred in
connection with the expansion of an existing business.
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 his 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 in
which a Participant invests 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
the 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).) In
our opinion it is more likely than not that the Partnerships will possess the
requisite profit motive. This opinion is based in part 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
representation 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 for Atlas
America Public #12-2003 Limited Partnership).
Termination of a Partnership
Under ss.708(b) of the Code, a 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 the 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, 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 a 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 this purpose, a "tax shelter" generally is
defined to include an investment 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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July 25, 2003
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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 each 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 a tax shelter registration number for the Partnership in
which he invests 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 in part on the representations of the Managing General Partner,
in our opinion 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 its 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, any Participant 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. All
expenses of any proceedings undertaken by the Managing General Partner as Tax
Matters 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.
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Tax Returns. A Participant's income tax returns are the responsibility
of the Participant. Each Partnership will provide its Participants with the tax
information applicable to their investment in the Partnership necessary to
prepare their 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
o adequately disclosed on the taxpayer's return and there was a
reasonable basis for the tax treatment.
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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 from the Partnership in which he
invests.
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 a
Partnership, and the relative weight of these 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 its Participants and enhance the tax benefits of their investment in
a 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.
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.
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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.
In our opinion it is more likely than not that 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 a
Partnership by a typical Participant as described in our opinions. This opinion
is based in part 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 representation 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 for Atlas America Public #12-2003 Limited Partnership).
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 its
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.
Each Partnership will operate in states and localities which impose a
tax on its assets or its income, or on each of its Participants. Deductions
which may be available to Participants for federal income tax purposes, such as
the accelerated 50% 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 the net income or net loss of the Partnership in which he
invests 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
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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.
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 yet 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 in that Partnership would be required to include their 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 generally will be required to withhold and pay income
tax to the IRS at the highest rate under the Code applicable to Partnership
income allocable to its foreign Participants, even if no cash distributions are
made to them. A purchaser of a 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. Under the Code, for withholding purposes, a foreign partner
means a partner who is a nonresident alien individual or a foreign corporation,
partnership, trust or estate, if the partner has not certified to the
partnership the partner's nonforeign status.
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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 Tax Act"),
the maximum estate and gift tax rate of 49% in 2003 will be 48% in 2004 and will
be further reduced in stages until it is 45% from 2007 to 2009. 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 Tax Act, the federal estate tax will be repealed in 2010, and the
maximum gift tax rate in 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
Tax Act was enacted.
Changes in the Law
A Participant's investment in a Partnership may be affected by changes
in the tax laws. For example, under the Jobs and Growth Tax Relief
Reconciliation Act of 2003, the top four federal income tax brackets for
individuals have been reduced, including reducing the top bracket to 35% from
38.6%: These changes are retroactive to January 1, 2003, and are scheduled to
expire December 31, 2010. The lower federal income tax rates will reduce to some
degree the amount of taxes a Participant saves by virtue of his share of his
Partnership's deductions for Intangible Drilling Costs, depletion and
depreciation. However, the lower federal income tax rates also will reduce the
amount of federal income tax liability incurred by a Participant on his share of
the net income of his Partnership. There is no assurance that the federal income
tax rates discussed above will not be changed again 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.