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Frequent ("frequent" remains undefined by the IRS)
sellers of standing timber are considered to be in an "active
trade or business" by the IRS and are therefore declared
"dealers" of timber. If deemed a "dealer,"
landowners must comply with special rules in Section 631(b) of the
Code in order to realize capital gains treatment once they have met
the holding period requirement.
Under 631(b), landowners are required to "retain an economic
interest" in their standing timber until it is harvested. Under
these circumstances, a hardship is created for landowners who sell
timber under a contract that provides that the seller bear all the
risk of loss of the timber until it is harvested. Even when buyers default on
contractual obligations to complete the harvest of specified timber,
the seller is prohibited from collecting the full value of the
contracted sale, and can only impose a penalty amounting to a
fraction of the value of the contract.
Although the timber buyer may be a large forest products company,
631(b) requires the landowner to take all the risk for harm to the
timber, i.e., storms, insects, disease, fire, etc.
Sales structured to meet 631(b) requirements, known as
"pay-as-cut" sales, favor the buyer -- not the timber
grower. When selling timber, landowners must currently choose
between the most advantageous method of measuring their timber or
the most favorable tax treatment.
How was this illogical and unfair provision ever added to the
Internal Revenue Code in the first place? The explanation lies in
the evolution of the tax code over many decades. Earlier in this
century, outright ("lump-sum") timber sales were
associated with a "cut and run" mentality that did not
promote good forest management. At that time, "pay-as-cut"
sales were equated with enlightened resource management. So, in
1943, Congress passed legislation that allowed capital gains
treatment for pay-as-cut sales, in an effort to provide an incentive
for improved forest management.
Pay-as-cut sales are no longer associated with proper timber
management. Instead we have learned that such sales are likely to
encourage fraud and abuse by unscrupulous timber buyers. Under the
pay-as-cut method, since the seller is paid for only the timber that
is harvested, there is an incentive for unscrupulous buyers to waste
timber during the harvest, which disrupts management plans for
sustainable forests.
Also, there is an incentive for unscrupulous buyers to
under-measure timber, to falsify measurements, or remove timber
without measuring (scaling) it. Because of cases of fraud, the USDA
Forest Service is changing to the lump-sum method.
Lindy Paull, Chief of Staff of the Congressional Joint Committee
on Taxation, has said that a correcting-change in 631(b) will have a
negligible effect on federal revenue. The JCT calculations resulted
in a "score" of zero. The scoring process was not
undertaken once, but twice.
A change in Section 631(b) has been supported or suggested by a
number of groups for tax simplification purposes, including the
Internal Revenue Service.
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