The IRS Form 1099 Conundrum
Updated on 11/29/07 to reflect REG-155669-04 , Information Reporting for Lump-Sum Timber Sales, 11/28/2007
There has been rampant confusion for many years about the filing by timber buyers and lessees of IRS Form 1099. Current Regulations under Internal Revenue Code (IRC) Sec. 6045 provide that filing is not required for the purchase of standing timber for a lump sum amount since such transactions come under the Uniform Commercial Code of most states and are not real estate transactions, IRC Reg. 1.6045-4(c)(2)(i). (See also Letter Rulings 9104012 and 9544005) Note, however, that this provision is based on the assumption that the timber is a capital asset under IRC Sec. 1221, not a business asset under IRC Sec. 1231. When timber is acquired under any form of so-called pay-as-cut contract the payments are considered to be royalty payments since they are tied to the severance of the timber. Royalties are generally reported on IRS Form 1099 Misc and are taxed as ordinary income. However, timber royalties are subject to capital gains treatment under IRC Sec. 631(b) and as such Form 1099S is to be used, not 1099 Misc., IRS Announcement 90-129 [90-129 I.R.B. 1990-48, 10, (Nov. 26, 1990)]. Timber royalties under IRC Sec. 631(b) are generally reported on Form 4797. Note that these provisions reflect current law. The issue is the reporting of lump sum sales under IRC Sec. 631(b). This became an issue when IRC Sec. 631(b) was amended by the American Jobs Creation Act of 2004 (P.L. 108-357, Sec. 315(a)). Capital gains treatment applies under IRC Sec. 631(b) to sales after 12-31-04 whether sold lump sum or with an economic interest retained. The IRS announced that they would address this issue under the Department of the Treasury, 2007-2008 Priority Guidance Plan. And, on November 28, 2007 they issued proposed changes to Reg. §1.6045-4 that would classify all lump-sum sales as real estate transactions under 1.6045-(4)(2). This would make these transactions subject to the same reporting requirements as other real estate transaction. The effective date would be when the amendments to the regulations are adopted. Reg. §1.6045-4 is posted here . The IRS will not announce how this change is to be implemented until the revised regulations are adopted.
Analysis : Even with the proposed requirement to require 1099's for all timber sales, the problem of a firm acquiring standing timber under a lump-sum contract not knowing if the timber in the hands of the owner, lessor, or sublessor is a capital asset or a business asset will remain. The IRS could rule that the acquiring firm is required to make this determination by communicating with the seller, requiring no doubt a form to be sent by the buyer to the seller and returned to the buyer. It would be simplier to designate a new Form 1099 to be used by buyers for all lump sum acquisitions. This form would include instructions to the seller to report the transaction on Schedule D, or Form 4797, depending on the determination by the seller as to the classification of the timber as a capital asset under IRC Sec. 1221, or a business asset under IRC Sec. 1231. But, in the case of timber that is a capital asset in the hands of the seller this would be inconsistent with the provisions of IRC Sec. 6045-4 and would require a legislative change.
Some firms acquiring standing timber cover their bets by filing a Form 1099 for all acquisitions. Form 1099S would be used without question for acquisitions under pay-as-cut contracts. Given the current litney of Form 1099's, Form 1099S is also the most appropriate to use for lump-sum acquisitions. If Form 1099Misc is used the IRS computers will look for a matching entry under ordinary income on the seller's tax return and generate an adjustment notice if not found. Firms filing Form 1099's for lump sum sales might win repeat business by including an insert with the 1099S's suggesting that the taxpayer consult their tax preparer concerning the proper way to report the revenue received. Suggested language for inserts is provided here for 1099-S and 1099-MISC