Freres Lumber Co. v. Commissioner

Decision Date13 December 1995
Docket NumberDocket No. 16062-93.
PartiesFreres Lumber Co., Inc. v. Commissioner.
CourtU.S. Tax Court

Philip N. Jones, Ore., Stephen J. Klarquist, and Richard W. Miller, for the petitioner. Brenda M. Fitzgerald, for the respondent.


COLVIN, Judge:

Respondent determined that petitioner had deficiencies in Federal income tax of $29,750 for 1988, $40,732 for 1989, and $51,119 for 1990. In an amended answer, respondent asserts that petitioner has deficiencies in Federal income tax of $43,787 for 1988, $64,689 for 1989, and $74,786 for 1990. After concessions, we must decide the following issues:

1. Whether the fair market value of three covenants not to compete on March 1, 1988, is $1,650,000 as petitioner contends, $403,000 as respondent contends, or some other amount. We hold that it is $930,000.

2. Whether the fair market value of certain land on March 1, 1988, is $145,000 as petitioner contends, $200,000 as respondent contends, or some other amount. We hold that it is $145,000.

3. Whether the fair market values of buildings and improvements, equipment, and rolling stock on March 1, 1988, are $283,000, $1.5 million, and $290,000, respectively, as petitioner contends; or $195,000, $1.1 million, and $225,000, respectively, as respondent contends and as petitioner reported on its return. We hold that they are $384,608 for buildings and improvements, $1.5 million for equipment, and $290,000 for rolling stock.

4. Whether the fair market value of goodwill on March 1, 1988, is zero as petitioner contends, $750,000 as respondent contends, or some other amount. We hold that it is zero.

Section references are to the Internal Revenue Code in effect for the years in issue. Rule references are to the Tax Court Rules of Practice and Procedure.


Some of the facts have been stipulated and are so found.

A. Petitioner

Petitioner is an Oregon corporation, the principal place of business of which is in Lyons, Oregon. Petitioner operated sawmills and wood veneer mills in North Santiam Canyon in western Oregon. The Freres family owned a controlling interest in petitioner. The common stock of petitioner was owned as follows: 40.90 percent by Robert T. Freres, 29.69 percent by Theodore F. Freres, and 29.41 percent by Doris Wipper (not otherwise identified). Robert T. Freres, Jr., son of Robert T. Freres, began to manage petitioner in 1979. He and petitioner's owners were officers of petitioner. Robert T. Freres, Jr., was the vice president of petitioner in 1988.

Robert T. Freres, Jr.'s grandfather established petitioner in 1922 to operate a sawmill. In the late 1950's, the Freres family dismantled the sawmill and began to manufacture veneer. They added a second veneer mill in 1963 and a stud mill in 1970. In 1985, they leased a plywood mill and a veneer plant. Before March 1, 1988, they operated a large log veneer mill, a small log veneer mill, and a stud mill. These mills were in Lyons, Oregon, about 5 miles from the Walker mills (see par. B-2, below). They own a trucking company to haul their products.

Before March 1, 1988, petitioner bought 95 to 98 percent of its lumber from public timber sales, primarily from the U.S. Forest Service (Forest Service) and the Bureau of Land Management (BLM). Petitioner also bought timber from the State of Oregon. Before March 1, 1988, petitioner had 10 major competitors for public timber. Petitioner's primary competitors were the Walkers (see par. B, below) and Young & Morgan.

B. The Walker Family and the Walker Business

Until 1988, the Walker family owned and operated two forest product companies in the North Santiam Canyon in Oregon.

1. The Walker Family

References to the Walker family are to Donald Clayton Walker (D.C. Walker), his wife, Mary Walker, and their daughter, Donna Lee Bebout (Bebout). The Walker family competed with the Freres family in the forest products business in North Santiam Canyon. On March 1, 1988, D.C. Walker was 62, Mary Walker was 65, and Bebout was 37. Each member of the Walker family was in good health on March 1, 1988.

a. D.C. Walker

D.C. Walker was born in 1925. He graduated from high school, but had no further formal education. He ran his family's business and made all of the important business decisions. He worked at least 60 hours per week on his family businesses.

In 1959, D.C. Walker and two other people bought a sawmill, moved it to Lyons, Oregon, and formed Cedar Lumber, Inc. (Cedar Lumber). D.C. Walker Enterprises, Inc., an S corporation, bought Cedar Lumber in 1985. D.C. Walker started the Lyons Veneer partnership in 1981. D.C. Walker had good relationships with suppliers and customers. We discuss D.C. Walker Enterprises, Inc., and Lyons Veneer, further at par. B-2, below.

Before March 1, 1988, D.C. Walker had a friendly but competitive relationship with the Freres family. He did not have a social or business relationship with the Freres family after March 1, 1988.

b. Mary Walker

Mary Walker was born in 1922. She went to business school. She first worked as a secretary and bookkeeper. She did estimating for a Ford automobile agency and the U.S. Government. She later did office work for a lumber mill and retail lumber yard. In 1959, she and her family founded Cedar Lumber. She did the office work, including the inventory, payroll, and books for Cedar Lumber. Mary Walker never bid for timber or sold products. She did not routinely work for Lyons Veneer. When she did, she helped with log inventories. By 1985, she had stopped working full time because of her age. She did not do much with her family's businesses after 1985. Mary Walker was not employed in 1994.

c. Donna Lee Bebout

Bebout was born in 1951. She worked for Cedar Lumber during the summers when she was in high school. Before 1978, she worked as a secretary for the owner of Ruble Forest Products in Eugene, Oregon. She worked part time in the forest products industry when her son Kyle was born. She began to work for Lyons Veneer in September 1980. During the 5 years before March 1, 1988, Bebout did the bookkeeping for Lyons Veneer in her home. She had Lyons Veneer's checkbook. She did some management or supervisory work for Lyons Veneer. Lyons Veneer paid her about $3,500 to $4,500 per month.

Bebout was a vice president of D.C. Walker Enterprises, Inc., and was on the board of directors in 1988. When her father was out of town, Bebout sometimes answered questions about D.C. Walker Enterprises, Inc., and signed papers for the corporation. She also did some clerical work for D.C. Walker Enterprises, Inc.

Bebout had no plans to compete against petitioner even if she had not signed a covenant not to compete. To compete with petitioner, Bebout would need the help of someone more knowledgeable about the forest products business than she is.

d. Brent Walker

Brent Walker is the son of D.C. and Mary Walker. He was estranged from his parents in the 1980's. Brent Walker operated a company called Thomas Creek Lumber & Logging Co. He previously had an interest in the Lyons Veneer partnership (described in par. B-2-b, below) owned by the Walker family. There was litigation between Brent Walker and his parents and sister. A court (not specified in the record) decided that Brent Walker's interest in the Lyons Veneer partnership had terminated in September 1983.

Thomas Creek Lumber & Logging Co. bid on public timber sales but did not own a mill. Brent Walker bought timber and paid subcontractors to harvest it. He sold some logs. He also leased manufacturing time at a veneer plant. He milled lumber at the Brazier Lumber Co. in Molalla, Oregon, into metric sizes for export to Japan.

2. The Walker Entities

Before March 1, 1988, the Walker family owned and operated D.C. Walker Enterprises, Inc., and Lyons Veneer, a partnership, in North Santiam Canyon. We refer to D.C. Walker Enterprises, Inc., and Lyons Veneer as the Walker entities. The Walker entities were in the business of logging, manufacturing veneer and lumber, and related activities. They bought and performed timber contracts. The Walker entities were smaller than the companies with which they competed.

a. D.C. Walker Enterprises, Inc.

D.C. Walker formed D.C. Walker Enterprises, Inc., in 1985. D.C. Walker Enterprises, Inc., bought Cedar Lumber in 1985. On March 1, 1988, D.C. Walker, Mary Walker, and Bebout each owned one-third of the stock of D.C. Walker Enterprises, Inc.

Before March 1, 1988, D.C. Walker Enterprises, Inc., manufactured forest products. It sold mostly soft white woods to customers in the Orient. It did not sell products in competition with petitioner. Customers from the Orient wanted high-quality lumber cut to precise metric measurements. Petitioner did not have that capability.

b. Lyons Veneer

D.C. Walker started Lyons Veneer in 1981. On March 1, 1988, Bebout owned 50 percent of Lyons Veneer, and D.C. and Mary Walker owned the other 50 percent. Lyons Veneer competed against petitioner, Willamette Industries, and many others before March 1, 1988. Petitioner, the Walker entities, Young & Morgan, and Frank Lumber were the primary competitors. Before March 1, 1988, Lyons Veneer sold almost all of its finished product to Alpine Veneer. Lyons Veneer did not process soft white woods.

c. Sources of Timber for the Walker Entities

The Walker entities obtained logs from the Forest Service, BLM, the State of Oregon, and private sources. Most of its logs came from the Forest Service. Lyle Sanders and D.C. Walker managed timber procurement for the Walker entities.

d. The Walker Entities' Employees

D.C. Walker Enterprises, Inc., employed about 40 people before March 1, 1988. Lyons Veneer employed 25 to 40 people before March 1, 1988. There was no union representation at the Walker entities before March 1, 1988.

C. Sale of Public Timber in the North Santiam Canyon Area in the Mid to Late 1980's

Generally, sales of public...

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