This article was updated April 22, 2021. A version was published in the Protea Financial Blog in March 2020.
R&D is often associated with technology and life science companies from Silicon Valley and San Francisco; but if you head less than 100 miles north into wine country, or any other appellation across the United States, you’ll find the same trend toward innovation being applied to the ancient practices of grape growing and winemaking.
However, many in the wine industry fail to utilize R&D tax incentives offered by federal and state governments. For wineries and grape growers, including those impacted by smoke, the potential tax savings opportunities could be significant.
R&D Tax Credit Overview
The R&D tax credit is available to companies developing new or improved products or processes, including software, that result in increased performance, functionality, efficiency, reliability, or quality.
It’s a dollar-for-dollar tax savings that directly reduces a company’s regular tax liability. There’s no limitation on the amount of expenses and credit that can be claimed each year. If the R&D credit can’t be used immediately or completely, any unused credit can be carried back one year or carried forward for up to 20 years—or indefinitely for California tax returns.
In addition, previously filed tax returns can typically be amended for up to three or four years to claim the R&D credit retrospectively, providing an avenue to recoup previously paid taxes.
FAQs About R&D Tax Credits
To help break down this complex topic, we’ll address the following common questions vineyards and wineries have about the R&D credit.
- How much can a vineyard or winery save with R&D tax credits?
- What’s qualified R&D?
- What vineyard and winery activities qualify for the R&D credit?
- Does smoke exposure research qualify for the R&D credit?
- What types of expenses can be included?
- What’s the next step to apply for the R&D credit?
- What documentation is necessary?
1. How much can a vineyard or winery save with R&D tax credits?
In general, companies can receive a credit refund of approximately 10% of their qualified expenses, depending on several factors. Generally, the more a company spends on qualified R&D, the higher the credit they’ll receive, with taxpayers receiving a larger credit if they increase R&D spending year over year.
2. What’s qualified R&D?
Qualified R&D ultimately depends on whether the activity meets each element of the four-part test established in the tax code. These criteria include:
- Qualified purpose. The activity relates to a new or improved function, performance, reliability, or quality of a product or process.
- Elimination of uncertaintyThe activity is undertaken to discover information intended to eliminate uncertainty about the capability, method, or design of a new or improved product or process.
- Process of experimentation. The activity involves one or more alternatives intended to eliminate that uncertainty and conduct that leads to evaluating the alternatives through modeling, simulation, or a systematic trial and error methodology.
- Technological in nature. The process of experimentation must rely on hard sciences, such as engineering, physics, chemistry, biology, or computer science.
3. What vineyard and winery activities qualify for the R&D credit?
Vineyards and wineries often aren’t aware that many of the activities they perform—potentially at each stage of the winemaking and grape-growing process—could meet this qualification.
Following are some specific examples of R&D activities that may qualify for the credit.
Qualifying Vineyard and Winery Research
- Evaluation of geological plot characteristics, including soil, water, and climate conditions
- Evaluation of rootstocks, varietals, and clones for optimal cultivation in vineyard
- Techniques related to vine and soil nutrient, pest, disease, or irrigation management
- Design and development of trellising systems for desired canopy
- Pruning and training techniques for optimal production
- Methods to treat harvested grapes prior to sorting and destemming
- Automated sorting and crushing processes or equipment
- Development of new methods or systems to manage wastewater
- Methods related to fermentation, clarification, fining, or filtration
- Product formulations for desired flavor or aroma profiles
- Development of new or improved aging, bottling, and packaging methods or processes
4. Does smoke exposure research qualify for the R&D credit?
Yes. In 2020, many wineries and vineyards were forced to develop innovative methods and techniques as they attempted to produce a 2020 vintage from smoke-exposed grapes. The wildfires that ravaged the western United States brought the immediate threat of fire to those in close proximity as well as the more widespread threat of smoke exposure to grapes across the region.
Smoke exposure is characterized by overwhelming smoke and ash traits in a wine due to an increase in volatile phenols such as guaiacol and 4-methylguaiacol. Significant uncertainty still exists regarding smoke exposure, its effects, and its treatments, causing companies across the industry to invest significant resources in research and experimentation.
These innovative methods can often qualify for R&D tax credit. Qualifying smoke-related R&D activities include the following:
- Crush or press trials. For example, press-fraction or press-yield trials
- Fermentation methods or techniques. Such as yeast strain tests, skin-contact trials, and fermentation temperature trials
- Clarification methods or techniques. Including improvements to fining and filtration processes—for example, activated carbon, reverse osmosis, or solid phase extraction
- Product formulations for desired flavor or aroma profiles. For example, dilution or blend trials
- Aging methods. Such as barrel and toast trials
To learn more, please see our article, R&D Tax Credit for Vineyards and Wineries Affected by Smoke Exposure.
5. What types of expenses can be included?
If a company determines the work it’s conducting likely qualifies, the next consideration is identifying related expenses.
Most expenses fall into three categories: wages, supplies, and contractor expenses.
Qualifying employee wages can include Form W-2, Box 1 or pass-through income subject to self-employment tax. This would include individuals performing qualified research, such as winemakers or vineyard managers, as well as those who directly support or supervise the research, such as cellar workers. The rules specify that if an employee is 80% qualified, 100% of their wage can be included to calculate the credit.
Qualifying equipment and materials related to the research process can include the following:
- Some large-scale prototypes and pilot models
- Tangible property—other than land or depreciable property—that is used in qualified research, including grapes, yeast, fining agents, corks, bottles, barrels, barrel staves, testing supplies, and batches of wine used in experimental blends
Payments to contractors, including those made to consulting winemakers, outside labs, or temporary labor, can be eligible contingent on specific rules.
6. What’s the next step to apply for the R&D credit?
Each company’s goals, values, and resources are unique, which makes it important to develop a customized project plan to identify, calculate, and support your company’s R&D credits and activities.
If you think your company may qualify for the R&D credit, the first step is to collect preliminary information about your company’s potential qualified activities and expenses. That information is used to develop an estimate of the credit benefit your company could receive as well as identify other R&D-related tax planning opportunities so you can make an informed decision about whether an R&D credit analysis is worthwhile for your company.
7. What documentation is necessary?
Like many other aspects of tax compliance, documentation is important. There are two primary categories of documentation your company should compile for R&D purposes—quantitative support and qualitative support.
Taxpayers will want to clearly track costs spent on the R&D projects in their financials—ideally through specific general ledger accounts or tagged memo entries. Taxpayers should also maintain employee wage information, specifically Form W-2 data.
Taxpayers will need to retain all documentation—formal or informal—developed over the course of the R&D project, such as:
- Project descriptions or plans
- Trial designs
- Test logs and reports
- Sensory and organoleptic evaluations
- Chemical analysis
- Notes, presentations, and emails
We’re Here to Help
With recent increased IRS scrutiny around R&D credits, it’s also crucial to understand what’s necessary to substantiate a credit claim. To learn more about R&D tax credits, see Five Misconceptions about R&D Tax Credits—and if You Qualify, or request a credit benefit estimate to see how much your company could save.