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
September 3, 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 addition, many of the material federal income tax consequences of an
investment in a Partnership depend in part on determinations which are
inherently factual in nature. Thus, 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 which we have assumed for
purposes of our opinions. Based on the foregoing, we are satisfied that our
opinions take into account all relevant facts, and that the material facts
(including our factual assumptions and your 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
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Partnership Act and any other applicable limited partnership act.
Also, each Partnership, when formed, will be operated as described in
the Prospectus and in accordance with the terms of the Partnership
Agreement, 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 The amounts that will be paid by each Partnership to the Managing
General Partner or its Affiliates under the Partnership Agreement are
reasonable 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," including the amounts that
will be paid to the Managing General Partner or its Affiliates under
the Drilling and Operating Agreement to drill and complete the
Partnership Wells based on information the Managing General Partner
has concerning drilling rates of third-party drilling companies in the
Appalachian Basin, the estimated costs of non-affiliated persons to
drill and equip 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 the Managing
General Partner has concerning increases in drilling costs in the area
since 2001.
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 has determined 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
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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."
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.
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.
o The Managing General Partner will attempt to eliminate or reduce any
gain to a Partnership from a Farmout, if any.
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 significantly shelter from federal income taxes a Participant's
income from sources other than the Partnership in which he invests by
providing deductions in excess of the income from the Partnership in
any year;
o are expected to be of fundamental importance to a Participant; or
o could have a significant impact (whether beneficial or adverse) on a
Participant under any reasonably foreseeable circumstances.
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;
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o an issue will not be raised on audit; or
o an issue may be settled.
Although our opinions express what we believe a court would probably conclude if
presented with the applicable issues, our opinions are only predictions, and are
not guarantees, 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 our opinions are not binding on the IRS or the courts.
Subject to the foregoing, in our opinion 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.
(See "- Limitations on Passive Activities.")
(3) Not a Publicly Traded Partnership. 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 Offering Costs.")
(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
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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 reasonable
consideration based on the Managing General Partner's representations,
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 reasonable consideration based on the Managing
General Partner's representations, 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
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. Subject to the
foregoing, 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 productive wells which are
completed and made capable of production, i.e. placed in service,
before January 1, 2005. This
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additional first-year depreciation allowance will reduce the
Partnership's remaining regular MACRS depreciation allowances
beginning with the year in which the wells are placed in service.
However, none of the MACRS depreciation deductions for a
Partnership's "qualified" Tangible Costs will increase the
alternative minimum taxable income of that Partnership's
Participants. (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, assuming that:
o each Participant has an objective to carry on the business of the
Partnership in which he invests 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 invests through
nonrecourse financing, guarantees, stop loss agreements or other
similar arrangements.
(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. Assuming that each Participant has an objective to
carry on the business of the Partnership in which he invests for
profit, the Partnerships will possess the requisite profit motive
under ss.183 of the Code. 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 representations that each
Partnership will be operated as described in the Prospectus and 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 for Atlas America Public
#12-2003 Limited Partnership included in Appendix A to the
Prospectus). (See "- Disallowance of Deductions Under Section 183 of
the Code.")
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(14) No Tax Shelter Registration. None of the Partnerships is required to
register with the IRS as a tax shelter. This opinion is based in part
on the Managing General Partner's representations that none of the
Partnerships has a tax shelter ratio greater than 2 to 1 and each
Partnership will be operated as described in the Prospectus. (See "-
Lack of Registration as a Tax Shelter.")
(15) Anti-Abuse Rules and Judicial Doctrines. Assuming that each
Participant has an objective to carry on the business of the
Partnership in which he invests for profit, 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 representations that each Partnership will be
operated as described in the Prospectus and 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 for Atlas America Public #12-2003 Limited Partnership
included in Appendix A to the Prospectus). (See "-Anti-Abuse Rules
and Judicial Doctrines.")
(16) 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 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, will be realized if challenged by the IRS. The
discussion in the Prospectus under the caption "MATERIAL FEDERAL
INCOME TAX CONSEQUENCES," insofar as it contains statements of
federal income tax law, is correct in all material respects.
* * * * * * * * * * * * *
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.
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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 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:
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 in which
he is a limited partner, a limited liability company or an 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
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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 indefinitely, 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.
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 none of the Partnerships will be treated as a publicly
traded partnership under the Code.
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 after all of the Partnership's
wells have been drilled and completed. (See "Actions to be Taken by Managing
General Partner to Reduce Risks of Additional Payments by Investor General
Partners" in the Prospectus and "- Drilling Contracts," below.) 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, 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.
Therefore, 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.)
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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 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 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. 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
KUNZMAN & BOLLINGER, INC.
Atlas Resources, Inc.
September 3, 2003
Page 11
circumstances. The Managing General Partner has represented that the amounts
payable to the Managing General Partner and its Affiliates, including the
amounts payable to the Managing General Partner or its Affiliates as general
drilling contractor, are reasonable 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.
(See " - Partnership Organization and Offering Costs," 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).
KUNZMAN & BOLLINGER, INC.
Atlas Resources, Inc.
September 3, 2003
Page 12
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% (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.
KUNZMAN & BOLLINGER, INC.
Atlas Resources, Inc.
September 3, 2003
Page 13
The drilling partnership in Keller also entered into turnkey drilling
contracts which permitted it to stop work under the contract at any time and
apply the unearned balance of the prepaid amounts to another well to be drilled
on a turnkey basis. The Tax Court found that these prepayments constituted
"payments" and not nondeductible deposits, despite the right of substitution.
Further, the Tax Court noted that the turnkey drilling contracts obligated "the
driller to drill to the contract depth for a stated price regardless of the
time, materials or expenses required to drill the well," thereby locking in
prices and shifting the risks of drilling from the drilling partnership to the
driller. Since the drilling partnership, a cash basis taxpayer, received the
benefit of the turnkey obligation in the year of prepayment, the Tax Court found
that the amounts prepaid on turnkey drilling contracts clearly reflected income
and were deductible in the year of prepayment.
In Leonard T. Ruth, TC Memo 1983-586, a drilling program entered into nine
separate turnkey contracts with a general contractor, the parent corporation of
the drilling program's corporate general partner, to drill nine program wells.
Each contract identified the prospect to be drilled, stated the turnkey price,
and required the full price to be paid in 1974. The program paid the full
turnkey price to the general contractor on December 31, 1974; the receipt of
which was found by the court to be significant in the general contractor's
financial planning. The program had no right to receive a refund of any of the
payments. The actual drilling of the nine wells was subcontracted by the general
contractor to independent contractors who were paid by the general contractor in
accordance with their individual contracts. The drilling of all wells commenced
in 1975 and all wells were completed that year. The amount paid by the general
contractor to the independent driller for its work on the nine wells was
approximately $365,000 less than the amount prepaid by the program to the
general contractor. The program claimed a deduction for intangible drilling and
development costs in 1974. The IRS challenged the timing of the deduction,
contending that there was no business purpose for the payments in 1974, that the
turnkey arrangements were merely "contracts of convenience" designed to create a
tax deduction in 1974, and that the turnkey contracts constituted assets having
a life beyond the taxable year and that to allow a deduction for their entire
costs in 1974 distorted income. The Tax Court, relying on Keller, held that the
program could deduct the full amount of the payments in 1974. The court found
that the program entered into turnkey contracts, paid a premium to secure the
turnkey obligations, and thereby locked in the drilling price and shifted the
risks of drilling to the general contractor. Further, the court found that by
signing and paying the turnkey obligation, the program got its bargained-for
benefit in 1974, therefore the deduction of the payments in 1974 clearly
reflected income.
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.
KUNZMAN & BOLLINGER, INC.
Atlas Resources, Inc.
September 3, 2003
Page 14
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 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.
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.
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
KUNZMAN & BOLLINGER, INC.
Atlas Resources, Inc.
September 3, 2003
Page 15
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 production income from
its natural gas and oil properties. Generally, percentage depletion is available
with respect to 6 million cubic feet of average daily production of natural gas
or 1,000 barrels of average daily production of domestic crude oil. Taxpayers
who have both natural gas and oil production may allocate the production
limitation between the production.
The rate of percentage depletion is 15%. However, percentage depletion for
marginal production increases 1%, up to a maximum increase of 10%, for each
whole dollar that the domestic wellhead price of crude oil for the immediately
preceding year is less than $20 per barrel without adjustment for inflation.
I.R.C. ss.613A(c)(6). The term "marginal production" includes natural gas and
oil produced from a domestic stripper well property, which is defined as any
property which produces a daily average of 15 or less equivalent barrels of oil,
which is 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
KUNZMAN & BOLLINGER, INC.
Atlas Resources, Inc.
September 3, 2003
Page 16
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 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;
KUNZMAN & BOLLINGER, INC.
Atlas Resources, Inc.
September 3, 2003
Page 17
(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 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.)
"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."
KUNZMAN & BOLLINGER, INC.
Atlas Resources, Inc.
September 3, 2003
Page 18
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.)
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.)
KUNZMAN & BOLLINGER, INC.
Atlas Resources, Inc.
September 3, 2003
Page 19
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 regardless
of how long the Participant has owned his Units. (See " - Sale of the
Properties," above.) If the Units are held for 12 months or less, the gain or
loss generally will be short-term gain or loss. Also, a Participant's pro rata
share of 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
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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. 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 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, for 2003 and 2004, married persons filing separately must increase
their alternative minimum taxable income by the lesser of: (i) 25% of the excess
of alternative minimum taxable income over $191,000; or (ii) $29,000. 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.
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The repeal of the excess Intangible Drilling Costs preference, however, under
current law may not result in more than a 40% reduction in the amount of the
taxpayer's alternative minimum taxable income computed as if the excess
Intangible Drilling Costs preference had not been repealed. I.R.C.
ss.57(a)(2)(E). Under the prior rules, the amount of Intangible Drilling Costs
which is not deductible for alternative minimum tax purposes is the excess of
the "excess intangible drilling costs" over 65% of net income from natural gas
and oil properties. Net natural gas and oil income is determined for this
purpose without subtracting excess Intangible Drilling Costs. Excess Intangible
Drilling Costs is the regular Intangible Drilling Costs deduction minus the
amount that would have been deducted under 120-month straight-line amortization,
or, at the taxpayer's election, under the cost depletion method. There is no
preference item for costs of nonproductive wells.
Also, each Participant may elect 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;
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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 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 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;
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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 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
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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 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.
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 Offering Costs
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 under the Partnership
Agreement 100% to the Managing General Partner as Organization and Offering
Costs, 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:
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o paid or incurred in connection with:
o investigating the creation or acquisition of an active trade or
business;
o creating an active trade or business; or
o any activity engaged in for profit and for the production of
income before the day on which the active trade or business
begins, in anticipation of the activity becoming an active trade
or business; and
o which would be allowed as a deduction if paid or incurred in
connection with the expansion of an existing business.
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 the Partnerships will possess the requisite profit motive. This
opinion assumes that each Participant has an objective to carry on the business
of the Partnership in which he invests for profit, and 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 representations that each Partnership will be operated as described
in the Prospectus and 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 for Atlas America Public #12-2003 Limited Partnership
included in Appendix A to the Prospectus).
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.
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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;
exceeds 2 to 1. In this regard, the Managing General Partner has determined that
none of the Partnerships has a tax shelter ratio greater than 2 to 1.
Accordingly, the Managing General Partner does not intend to register any of 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, in our opinion none of the Partnerships is required to register with
the IRS as a tax shelter. This opinion is based in part on the Managing General
Partner's representations that none of the Partnerships has a tax shelter ratio
greater than 2 to 1 and each Partnership will be operated as described in the
Prospectus.
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
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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.775. 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.
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:
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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.
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;
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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.
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 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 assumes that each Participant has an
objective to carry on the business of the Partnership in which he invests for
profit, and 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 representations that each
Partnership will be operated as described in the Prospectus and 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 for
Atlas America Public #12-2003 Limited Partnership included in Appendix A to the
Prospectus).
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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 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
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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.
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.