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IRS Taxpayer Compliance Program Yields Results

Tree Farmer Magazine: January/February 1999 - Volume 18, No. 1

I believe that Tree Farmers by and large make every effort to file correct and complete Federal Income Tax returns. But not all timber owners manage their affairs with adequate attention to detail.

The IRS is aware of numerous opportunities for timberland owners and firms in the timber industry to take advantage of our self-compliance income tax systems. To estimate the extent of compliance in the hardwood segment of the industry the IRS conducted a tax compliance study focusing on but not limited to taxpayers in West Virginia from 1989 through 1992.

This was part of the Market Segment Specialization Program. Under this program market segments of special concern are identified and studied. The results are used to provide guidance to auditors about what to look for in examinations and to identify needs for taxpayer education programs.

The study focused on the hardwood industry specifically. This industry is very fragmented with many small firms. Many small logging and sawmill firms do not follow the business and accounting practices typical in other industries, making it harder to clearly identify the correct tax liability.

Non-Compliance Very High

The study concluded that for that three-year study period, 40 percent of identified timber industry entities failed to file an income tax return. Of the 30 percent that did file, over 30 percent appeared to report less than their total gross income. Keep in mind that this is mostly loggers and sawmills.

But the IRS also concluded that many sellers of standing timber do not report the income on their tax returns. This may be because they were either paid in cash or didn't receive a Form 1099 from the buyer. Under current IRS rules timber buyers aren't required to file 1099's unless the payments are classified as royalties. Royalties result from selling timber under a lease or pay-as-cut contract.

The report advises agents that timber sellers' income can be identified by examining courthouse records of timber deeds, real property and related tax receipts, logger or broker tax receipts, timber cruiser job orders, and Federal or State forest service records.

Recording- Keeping Biggest Problem

The biggest problem identified in the study was lack of adequate recording keeping. The check book accounting system was found to be common in the industry. Even if all transactions were deposited in or written from a checkbook, it's necessary to have supporting documents associated with each entry to properly identify the nature of expenses and sources of funds. The study also noted large number of returns being prepared by professional tax preparers with little, if any, understanding of the timber industry. And, as we've discussed here, many returns claiming timber transactions were filed without the required Form T.

Comprehensive Compliance Program Implemented

The purpose of the study was to improve compliance. The IRS quickly realized that it was neither appropriate nor possible to invade West Virginia with IRS agents out to get taxpayers not in compliance.

Instead a comprehensive compliance program was put in place. The study indicated that in many cases compliance was low because taxpayers lack information. Thus, an education program was developed. Mass media was used to make the public aware of the program. Posters and flyers were distributed to IRS, state tax offices, forestry department offices and over 500 sawmills and concentration yards. Workshops were conducted at state and federal agencies, timber associations, and tax practitioner and CPA chapter meetings. Sawmills and concentration yards were sent letters requiring operators to keep files recording the name, address, identification number, and legible signature for all purchases of timber or logs. These and other outreach activities led to many non-filers filing returns and in some cases amend incorrect returns.

IRS Report Available On-Line

The IRS report on the study is useful because it provides a summary of the tax treatment of all the basic timber transactions. The basic points included in these summaries are the ones agents focus on in audits. It would also be useful to refer an agent to this report if they don't regularly audit returns with timber transactions. The sample contracts for stumpage sales and pay-as-cut disposals are included in an appendix.

You can read or download the report on the Timber Tax Website at http://www.timbertax.org. The title is Market Segment Specialization Program: Hardwood Timber Industry, April 1996.

The following article has been reproduced here from the "Tree Farmer" magazine with the permission of the American Forest Foundation, 1111 19th Street, N.W., Suite 780, Washington, D.C. 20036. (Telephone 202.463.2462)