Market Segment Specialization Program (MSSP)
Placer Mining Industry
Table of Contents
Chapter 6 - Non-FilersThrough examination of DNR documentation and research of the information available through internal resources, the identity and filing status of an individual can be ascertained. Investigation of these records will allow for determination of compliance by this population.
Affidavits of Annual Labor on file with DNR are a good place to start. The documents will reveal the owner of a claim and the current address. It is the owner's responsibility that the Division of Mining have a current address. The Affidavit further reports the names and current addresses of the persons who actually performed the work.
When examining the DNR documents, the names and addresses of the individuals on the report should be noted and subsequently verified through IDRS for their filing status. If research reveals that an individual has failed to file a return, contact should be made and they should be encouraged to come into compliance.
An IRP document should be obtained and checked for information regarding wages or non-employee compensation. Employers can then be contacted for copies of documents or any other information concerning the individual which would be helpful in supporting an income issue. The DNR files can also be examined for activity regarding this individual. This includes any property transfers, production reports, etc.
The Affidavit of Annual Labor gives the names of individuals who actually worked the claim in any given year. It does not detail the capacity of the laborer, that is, as an employee or an independent contractor. If the SSN or the EIN can be ascertained for the owner, a PMFOLS (summary) can be run to determine if Forms W-2 or 1099 have been filed. If it is found that information documents have been filed, a PMFOLD (detail) can then be run to further define what has been filed.
If it is found that an individual laborer has not filed an income tax return but information reports were filed, the information should be obtained to properly document the file. Initially, this information should be sought from the individual who actually filed the form. If the documents are not obtainable, an explanation as to why and what procedures were taken to procure a copy should be included in the file.
Upon confirmation of an individual's non-filer status, an IRP document should be ordered. An IRP document will be considered evidence of income, as it is an internal IRS document whose source and authenticity is within the Service's ability to confirm. However, copies of actual documents are preferable over internal documentation.
The Bureau of Labor Statistics (BLS) for non-filers should be considered when a taxpayer can be located but is uncooperative. The BLS statistics can be used, if it appears that a taxpayer is gainfully employed or self-employed, based upon the individual's standard of living.
Chapter 7 - Employee versus Independent Contractor StatusIf individuals work a claim as employees or independent contractors, they are performing a service for the owner and not conducting exploration or development for themselves. Thus, they are not entitled to deduct expenses with regards to that claim.
However, an employee or independent contractor would be allowed to deduct unreimbursed expenses under IRC section 162. It is advisable to find out what the individual's status is in relationship to the owner or lessee of the claim. This information can be obtained through interviewing the individual, the claim owner, or from the information available at the Department of Natural Resources.
If the individual is working as an employee, there should be a Form W-4 filed with the employer and Forms W-2 & W-3 filed by the employer, as well as the appropriate employment tax returns. The documents should be examined for possible employment tax issues when completing the Required Filing Checks as part of an examination of the employer's income tax return. Employee returns should include Form 2106 to claim expenses in connection with the employment. Since the employee is working for the owner, no Schedule C should be filed.
If the individual is working as an independent contractor, a Form 1099 should be issued by the owner. The income and associated expenses of the contractor should be reported on Schedule C. In most cases, the independent contractor does not have an interest in the claim or mine. Thus, the contractor cannot deduct exploration or development expenses for the particular claim. If there are expenses, determine the type and if the taxpayer is deducting them under IRC section 162 as ordinary and necessary business expenses or as exploration or development expenses. In the case of the independent contractor, an IRC section 183 issue can be considered.
In either case, whether an employee or independent contractor, a determination of employment tax issues should be considered. Consult the employment tax coordinator if there are any questions or issues regarding the classification of workers or employment taxes.
Chapter 8 - DepletionDepletion, like depreciation, is a form of cost recovery. Just as the owner of a business asset is allowed to recover the cost of an asset over its useful life, a miner is allowed to recover the cost of mineral property. Depletion is taken over the period of time that mineral is being extracted. Two forms of depletion are allowed: cost depletion and percentage depletion. The taxpayer is required to use the method which will result in the greatest deduction.
Cost DepletionThe general method used for the calculation of depletion is the cost method. The first step of this method is to determine the number of units which comprise the deposit. The units can be tons of ore, barrels of oil, board feet of timber, etc. The taxpayer must be consistent from year to year in the type of unit being calculated to insure uniformity. The second step takes the cost or adjusted basis of the property which pertains to the deposit and divides this basis by the total number of units to obtain the depletion cost per unit. Once the total number of units extracted is determined for the tax year, it is multiplied by the cost per unit to obtain the amount of depletion available.
It is possible that during the course of the operation or from examination, the estimate of the number of units which comprise the deposit may change. If this happens, the calculation can change. While the number of units can be recalculated, the basis cannot be adjusted. It is advisable to discuss with the taxpayer as early as possible how they estimated the number of units used in the depletion calculation. It is also helpful to determine if the taxpayer has adjusted this estimate over the course of production. Check to see if the taxpayer is being consistent with the measure of units and what method was used to develop the new estimate.
The following example covers depletion using constant estimates.
The taxpayer purchases a claim for $50,000, with known mineral reserves in mineable quantities. He states that he is in the production phase and is selling product. The taxpayer estimates that there is 100,000 tons of ore to be extracted. For purposes of the computation for depletion, the basis of the mine is $50,000. During the tax year, the taxpayer mines and sells 3,500 tons of ore. The first year depletion would be calculated as follows:
Rate of Depletion per ton ($50,000/100,000) $ .50 Depletion for year (3,500 x $.50) $ 1,750.00 Purchase price $ 50,000 First year depletion 1,750 -------- First year basis of the property $ 48,250
If estimates of the amount of reserves were never adjusted, the above calculation for depletion would remain constant. The basis would be reduced each year by the amount of depletion until it is totally consumed and the taxpayer has no basis left in the property. At this time, cost depletion is no longer allowed. While this scenario would certainly not be out of the ordinary, a revision in the estimate of reserves will affect the depletion calculation, and should be thoroughly examined. The following example covers depletion using revised estimates.
In tax year 2, the miner sells 7,000 tons. At the end of the year, the estimate of the ore changes to 130,000 tons. The calculation for depletion for year 2 would be as follows:
Revised estimate of unextracted ore 130,000 Ore sold during the year 7,000 ------- Total tonnage used to compute new rate 137,000 Remaining Adjusted Basis of property $48,250 Rate of Depletion per ton ($48,250 / 137,000) $ .35 Depletion for year 2 (7,000 x .35) $ 2,450 First year basis of the property $48,250 Second year depletion -2,450 ------- Second year basis of the property $45,800
Percentage DepletionUnder the percentage depletion method, a flat percentage of gross income from the activity is used to calculate the depletion allowance. The deduction for depletion cannot exceed 50 percent of the taxable income from the activity. This limitation is computed without regard to the depletion allowance. Depletion percentages are found in IRC section 613(b) and Treas. Reg. section 1.613-2. The amount of the deduction allowable under percentage depletion is not limited by the basis of the property. Thus, even though the basis of the property is reduced by the amount of depletion taken, if the basis becomes zero, the depletion based on the percentage of gross income may continue. However, if cost depletion will yield a higher deduction, it must be used to calculate the amount deducted.
In using percentage depletion the concepts of gross income, taxable income, and different percentages based on the type of material extracted all come into play in the computation. The Code and Regulations are specific regarding the percentages to be used for the various types of materials which can be mined. Particular attention should be paid to the type of arrangement the taxpayer is involved in, that is, is the property being leased, are there royalties involved, are there prepayments of any kind, etc. This information should be discussed in the initial interview in order to clearly establish the nature of the mining activity.