W. H. Plant, Jr., and Doris D. Plant, Plaintiffs-appellants, v. United States of America, Defendant-appellee, 682 F.2d 914 (11th Cir. 1982)

In this tax refund suit the appellants seek a capital gain for proceeds received under the terms of a timber sale contract. The district court granted the government's motion for summary judgment, concluding that the decision in Crosby v. United States, 414 F.2d 822 (5th Cir. 1969) mandated such a result.¹  We agree with the district court and affirm.

In 1967, the appellants agreed to sell to Hammermill Paper Company (Hammermill) all the timber standing and growing on 2,394 acres of land for a period of twenty years.²  The agreement provides that Hammermill pay for the timber according to a base price per cord³  and obligates Hammermill to pay for at least 2,000 cords per year regardless of the actual annual harvest. If Hammermill cuts more than 2,000 cords in any one year, the compensation for the excess is payable at the end of the year. In the event less than the guaranteed minimum is severed, a "timber backlog" clause authorizes Hammermill to harvest the timber paid for in advance at any time prior to the expiration of the contract when the right to cut expires and the taxpayers retain as "liquidated damages" advance payments not credited against the timber yield.⁴ 

In 1973, 1974 and 1975, the Plants received a total of $47,391.38 in accordance with the terms of the contract and reported the income as capital gains pursuant to 26 U.S.C. § 631(b).⁵  When the Internal Revenue Service disallowed this relief, the taxpayers paid additional taxes and filed this suit for a refund.

Section 631(b) provides that income received under a timber sale contract may be regarded as capital gains from a sale of timber if timber which has been held more than twelve months is disposed of by the owner, who must retain an economic interest in the trees. 26 U.S.C. § 631(b).⁶  The sole issue in this appeal is whether the Plants retained an economic interest in the timber in light of the possibility that Hammermill will not harvest all of the trees paid for in advance before the expiration of the contract period, thus entitling the Plants to retain payments for timber not actually severed from the land.⁷  If the taxpayers did not retain an economic interest, section 631(b) does not control and the proceeds must be considered as ordinary income.⁸ 

The tax regulations provide that

(a)n economic interest is possessed in every case in which the taxpayer has acquired by investment any interest in ... standing timber and secures, by form of legal relationship, income derived from ... the severance of the timber, to which he must look for a return of his capital.

26 C.F.R. § 1.611-1.⁹  In Dyal v. United States, 342 F.2d 248 (5th Cir. 1965), the taxpayers sought to qualify for favorable treatment under § 631(b) where the contract specified the payment of fixed amounts annually without regard to the amount of timber cut. The court explained that for taxpayers to retain an economic interest, "(i)t is essential that the consideration for the transaction ... be contingent upon the severance of the timber, and payable to the owner solely out of the proceeds from the natural resource itself." Dyal, 342 F.2d at 252 (footnote omitted). The taxpayers retained no economic interest because

(t)hey were not required to look to the sale or severance of the timber for the annual payments, and the obligation of (the purchaser) to make the annual payments ... was in no way determined or affected by the amount of timber cut, or whether any timber was cut at all.

Dyal, 342 F.2d at 252.

In Crosby, 414 F.2d 822, the court elaborated on the Dyal rationale in a factual setting very comparable to this controversy. There, the purchaser was obligated to make minimum annual payments which entitled it to cut a prescribed number of cords each year. Timber so purchased but not severed went into a "timber backlog" which the purchaser could cut without making further payments. After reciting the definition of a retained economic interest enunciated in Dyal, the court went on to hold that there could be no retained interest unless all of the minimum annual payment is necessarily contingent upon the severance of the timber:

Significantly, even if these restrictions (on the right to cut the backlog) were met, the agreement does not obligate (the purchaser) to exercise its backlog privilege. Consequently it is possible for the taxpayers to receive their payments without a single tree ever being cut. This possibility clearly demonstrates that the payments are not contingent upon the severance of the timber. Finally, the contract provides that upon termination all timber not cut and removed remains the property of the taxpayers even if (the purchaser) had previously made advance payments for the timber.

Crosby, 414 F.2d at 825. The court took note of Title 26 C.F.R. § 1.631-2(d),¹⁰  which extends capital gains treatment of advance payments if the taxpayer retains an economic interest, but rejected its relevance where there is "simply no guarantee that the timber will ever be cut." Crosby, 414 F.2d at 825.¹¹ 

We find no real difference between this contract and the one before the Crosby court.¹²  It is true that the Crosby contract contained more significant restrictions on the purchaser's ability to cut its timber backlog. The Crosby court made it clear, though, that the mere possibility that the backlog would not be cut was the bedrock of its decision. While such a likelihood may be more remote here, it is plainly a part of the contract. The Plants also call attention to the fact that their contract, unlike the Crosby agreement, anticipates that the backlog might not be harvested before the expiration of the contract, and thus enables them to retain the prior payments as "liquidated damages for (Hammermill's) failure to cut the timber." Record at 34. The use of these words of art does not alter the fact that both the Crosby contract and the Plant agreement permit the landowners to retain the consideration previously paid thereunder at the end of the contract term without obligating them to make a refund for the uncut timber. In reality, it is a guaranteed annual income for the Plants for the life of the contract, precisely the type of arrangement foreclosed by Crosby.

For the foregoing reasons, the judgment of the district court is

AFFIRMED.

MERRITT, Circuit Judge, dissenting:

It seems to me that 26 C.F.R. § 1.631-2(d), quoted in footnote 10 of the Court's opinion, is applicable to the timber contract in question here. Thus, the "amounts received (by the taxpayer) prior to cutting" under subsection 2(d) (1) should be treated as capital gains subject to recomputation as ordinary income under subsection 2(d) (2) if the contract ends "before the timber which has been paid for is cut." The Crosby case relied upon by the court did not specifically consider and analyze subsection 2(d) (2), and I would distinguish it on the ground that the taxpayer in Crosby did not bring to the court's attention the recomputation feature of the regulation, a feature that clearly contemplates that all the timber paid for may not be cut. The court in Crosby was, therefore, led to believe that the statute and regulation in question contemplate as a decisive test of capital gains treatment the cutting of all the timber. Subsection 2(d) (2) cannot be reconciled with such an interpretation. The Crosby court did not reach a considered decision based on an analysis of all the law applicable to the facts, namely subsection 2(d) (2). The Crosby case should be distinguished because the court there did not consider the main argument concerning the applicability of subsection 2(d) (2) presented by the taxpayer here.