Chapter 7 - Other Considerations - Hardwood Timber Industry
REFORESTATION TAX INCENTIVES
Up to $10,000 of the costs which must be capitalized to the deferred reforestation account may be recovered as an adjustment to gross income over an 84-month period, and may qualify for the 10% investment tax credit. The costs included are those for tree planting or seeding, and the other activities required to reestablish timber stands after a harvest (reforestation), or to establish timber stands on land previously devoted to nontimber uses (afforestation). This favorable treatment is provided by IRC sections 194 and 48(b). The following example demonstrates the procedure used.
Example:
Mr. Myles owns a 35-acre tract of timberland which he manages for the commercial production of timber as an investment. The timber was cut a few years ago. However, a new crop of trees has not developed because of the competing vegetation that grew after the timber harvest. Therefore, Mr. Myles contracted a forester to prepare the site and to plant seedlings in year number 1. The cost was $150 per acre, making the total expenditure $5,250.
Mr. Myles determined that the facts in his particular case qualified his reforestation expenditure for the investment tax credit and amortization. He calculated the tax credit by multiplying the total cost ($5,250) by 10% (.10). This amount ($525) would be allowed as a reduction in tax in year #1. Mr. Myles' recoverable basis must be reduced by half of this tax credit, or by $626.50, (IRC 50(c)(3)(A)). He computes the amortization deduction as follows:
Reforestation Costs $5,250.00
Less:
1/2 of credit ($ 262.50) ($525/2)
Amortization Amount $4,987.50
Using 84 months and the half-year convention, Mr. Myles' amortization schedule is shown below:
Year Applicable Percentage Deduction #1 .071 $354.12 #2 .143 $713.21 #3 .143 $713.21 #4 .143 $713.21 #5 .143 $713.21 #6 .143 $713.21 #7 .143 $713.21 #8 .071 $354.12 Totals 1.00 $4987.50
OTHER FORESTRY INCENTIVES
The Forestry Incentives Program (FIP), Agricultural Conservation Program (ACP), and Stewardship Incentive Program (SIP) are programs established by the Federal Government to share the cost of tree planting and timber stand improvement with private landowners. The Federal share of these costs depends upon the cost-share rate set in a particular state and county. The maximum cost-share payment that a taxpayer can earn annually is normally $I0,000. Landowners who receive these cost-share payments may be able to exclude them from gross income for Federal Income Tax purposes per IRC Section 126(a).
USE OF SPECIALTY GROUPS
Examiners need to recognize the need for specialized services of the IRS as early as possible so as to allow the specialized agent as much time as possible to avoid holding up the closure of the case. Some of the most common specialized services needed in the hardwood timber industry are discussed below:
Engineering
Form 5202, Request for Engineering Services, should be used to request services when any complex or significant issue is noted on the return. Engineering services can be very useful in timber valuation cases.
Computer Audit Specialist (CAS)
If a large volume of records exist and a statistical sample is deemed useful, the agent should contact his/her CAS after consultation with his/her group manager. For example, the Parkersburg District used a CAS to select a "stat sample" in relationship to a third party data base.
International Examiner
If the examiner can ascertain that the taxpayer under audit is engaged in a business outside the United States through related affiliates, a request for International assistance should be made on Form 2962 per IRM 42(10)4. Increasing amounts of hardwood logs are being exported outside the United States.
Employment Tax Specialists
If unusual problems occur in the employment tax area, a referral should be made through the agent's group manager.
PENALTIES
During and at the conclusion of every examination, it is the examiners' responsibility to consider the application of penalties to be assessed if the circumstances so dictate. The following penalties should be considered and Planned for during the examination:
Fraud Penalty IRC 6663
Accuracy Penalty IRC 6662
Information Return Penalties IRC 6721-6723
Failure to File/Pay Penalty IRC 6651
Preparer Penalties IRC 6694-6696
COORDINATED ISSUES
Coordinated issues should be considered as part of every examination. Below is a listing of coordinated issues for all industries in general and the Forest Products Industry in particular.
All Industries:
1. Amortization of assembled workforce
2. Covenants not to compete
3. Customer based intangibles
4. Employment contracts
5. Amortization of market based intangibles
6. Amortization of order backlog (inventory)
7. Meal Allowances
Forest Products Industry:
1. Depreciation on Logging Roads
Only logging roads with a determinable useful life are fully depreciable. See Rev. Rul. 88-99, 1988-2 C.B. 33. For roads with an indefinite useful life, the cost of clearing, grubbing, rough cut, and fill is a part of the cost base of the land and is non-depreciable.
2. Timber Losses Following Tree Mortality Brought On By Insects
The loss of timber following an epidemic attack of southern pine beetles does not qualify as a casualty loss. See Rev. Rul. 87-59, 1987-2 C.B. 59. However, a section 165(a) non-casualty loss may be allowable. Also, Section 1033 treatment is allowable on gains from salvage of the affected timber but not the healthy trees cut to isolate the beetle infestation.
3. Computation of Timber Casualty Losses
When timber is damaged or destroyed in a qualifying casualty loss, the "single identifiable property,, damaged or destroyed, for purposes of computing the basis limitation under regulation section 1.165-7(b)(2)(1), is the marketable units of affected timber and not the entire block.
4. Paper Machine Structure - Depreciation and ITC
The typical structure containing a paper machine is a building rather than "other tangible property.,' Thus it does not qualify for the investment tax credit and its applicable recovery period is the period prescribed for nonresidential real property. Certain costs relating to the craneway support columns and foundations, however, do qualify as other tangible property and thus can qualify for the investment tax credit and shorter recovery periods. Rev. Rul. 79-181, 1979-1 C.B. 41; Rev. Rul. 79-182, 1979-1 C.B. 42; Rev. Rul 79-183; 1979-1 C.B. 44.