As the season for year-end tax planning approaches, the possibility of tax reform means it’s essential for individuals and business owners to consider a wide variety of tax strategies to best position themselves for the future.
The plan, which aims to simplify the tax code, lower the business tax rate, and grow the economy, could significantly impact taxpayers if adopted. That said, sound tax planning—especially in the face of such unpredictability—is essential to effective wealth management for those who work, own, or do business in the wine industry.
If tax reform passes, the value of normal tax deferral and acceleration strategies could become increasingly valuable and result in lower future tax rates. For example, if corporate rates are reduced to 20%, it would create a one-time 15% permanent rate difference on what otherwise would be a temporary timing difference.
Entity Structure Planning
Good structuring is critical—not only from a tax perspective, but from a legal and business perspective too. Do you plan to transition your wine business to a second or third generation? Or do you plan to grow it and sell it in a few years?
Estate planning may be simpler with an LLC, but another entity type may be better suited to an outside sale or the transfer of an existing license. Considering entity structure well in advance of formation can help you find the structure that works best for your long-range plans and tax exposure. It’s also a good idea to reevaluate your structure periodically, especially in years with significant tax law changes.
In addition to entity structure, the most fundamental level of tax planning includes selecting your overall accounting method—cash or accrual. The cash and accrual methods each have their benefits, depending on your long-term goals. If you’ve examined your overall accounting method and determined the one you aren’t currently using would be more advantageous, you aren’t out of luck. You can choose to change your accounting method by filing Form 3115, Application for Change in Accounting Method, with the IRS.
Various requirements will apply, depending on the type of change, so it’s important to determine whether the change is feasible and what you need to do to execute it.
Farm Income Averaging
Qualifying taxpayers may elect to have either part or all of their current-year farming income spread evenly over the prior three tax years. This can mitigate the tax impact of higher-earning years, ideally keeping taxpayers out of the top tax bracket in the current year.
This is especially helpful because top federal individual tax rates are higher than they’ve been in the past. Some of this benefit may be lost if tax rates go down in the future, but it’s still something to consider.
Farm income averaging can be more involved for taxpayers with multiple activities—a combined winery and vineyard operation, for example. To take advantage of this strategy, you need to be able to determine the exact amount of income that’s attributable to farming and therefore eligible for averaging.
Some states, such as Oregon, have farm income-averaging provisions in addition to federal provisions, which may impact your tax strategy.
Many wineries have expanded their sales overseas as the international markets for US-produced wines continue to grow. If you export your products, you may benefit from forming an interest-charge domestic international sales corporation, more commonly referred to as an IC-DISC.
IC-DISCs aren’t taxed at the federal level. They are organizations that don’t have employees or offices and instead exist solely to collect a sales commission from an exporting business. Once they’ve collected this commission on the exporter’s international sales, they distribute the income to their shareholders—generally the same individuals or entities that own the exporter—in the form of qualified dividends.
Because qualified dividends are taxed at a lower rate than ordinary income, IC-DISCs yield a federal tax rate reduction of approximately 16% at the top bracket. Some states also provide for favorable taxation of IC-DISCs too.
Forming and maintaining an IC-DISC involves additional recordkeeping and the involvement of attorneys and other advisors, making advance planning integral to the successful implementation of this strategy.
State Tax Considerations
To plan properly for state taxes, you can benefit from understanding which activities may be taxable in each state where you have operations—especially if your tax liability could tip the balance one way or another.
Partial Sales-and-Use-Tax Exemption
At the state level, California offers a partial sales-and-use-tax exemption on the purchase of equipment used in manufacturing, including wineries’ crushers, fermentation tanks, bottle washers, and laboratory testing equipment. The exemption reduces the tax rate on these purchases to approximately 3.3% compared with the state’s standard 7.5% rate.
California Competes Tax Credit
Another state tax planning opportunity in California is the California Competes Tax Credit (CCTC), which is a negotiated credit that offsets California state income or franchise tax. Designed to help businesses continue or expand operations in California, the credit is available to companies of all sizes and across industries, with no boundary restrictions anywhere within California.
The CCTC Committee has up to $200 million to award to California businesses for each fiscal year through the 2017–2018 fiscal year. For more information, read our Insight.
Solicitation of Sales
Some states have become increasingly aggressive—and creative—with how they tax wine businesses. Solicitation of sales, for example, is generally shielded from state income tax under Public Law 86-272, but states have created franchise, margin, and gross receipts taxes that work around this law.
R&D Tax Credit
At over $12 billion annually, the R&D tax credit is one of the largest tax incentives available to businesses. For wineries and grape growers, the potential tax savings could be significant—yet many wineries and growers are missing out. This is because some businesses are unaware of the credit’s existence, while others simply aren’t taking full advantage of it.
Activities that occur during each stage of the winemaking and grape-growing process have the potential to qualify for the credit, and the amount that wineries and growers can claim depends on many factors. Understanding the tax code definition of qualified research and the four-part test is the starting point for any company looking to claim the credit.
Companies that haven’t previously taken advantage of the credits can look back at all open tax years—typically three to four years, depending on the taxing jurisdiction—to claim missed opportunities for savings.
Explore other tax considers for 2017 in our complete guide. We cover personal income tax, credits and deductions, wealth management, and some business-related topics. Read the complete guide or print the PDF.
We’re Here to Help
Start planning early so you can adequately account for any changes you want to make or opportunities you want to take advantage of. While the opportunities outlined above are limited to wineries or vineyards, integrated winery-and-vineyard operations are often in a position to take advantage of both. Contact firstname.lastname@example.org for more information.