The spirits industry has a long history of closely guarded recipes, techniques, and methods, but, despite its traditions, the industry’s consumer preferences and market conditions are driving distillers toward innovation.
However, many in the spirits industry are unaware that developing new or improved products or processes can result in R&D tax incentives that can provide significant savings. This article outlines key information to help distillers benefit from this savings opportunity.
But first, what is the R&D tax credit?
The federal R&D tax credit is a dollar-for-dollar tax savings that directly reduces a company’s tax liability. Many states also offer R&D credits that resemble the federal credit. There’s no limitation on the amount of expenses and credit that can be claimed each year at the federal level. If the federal R&D credit can’t be used immediately or completely, then any unused credit is carried back one year or carried forward for up to 20 years. Each state may have a different set of carryover provisions.
In addition, previously filed tax returns at the federal level can typically be amended for up to three to claim the R&D credit retrospectively, providing an avenue to recoup previously paid taxes. Some states may allow you to look back even further to capture unclaimed credits.
For their first five years in business, startup companies may be eligible to claim an R&D tax credit that can offset their payroll taxes.
To help break down this complex topic, here’s a list of common questions spirits companies have about the R&D credit.
How much can a company in the spirits industry save with R&D tax credits?
There’s no limit to how much a company can claim for the R&D credit. However, there are several factors that can impact tax savings. The amount of tax credit available depends on how many qualified costs a company incurs during a specific tax year. See below for details on qualified costs.
In general, a company has the ability to save 7%–10% of annual R&D costs for federal purposes. The savings could be even greater if that company has an income tax filing obligation in a state that also offers an R&D credit.
Generally, the more a company spends on qualified R&D, the higher the credit generated.
What specific activities within the spirits industry qualify for the R&D credit?
Spirits companies often aren’t aware that many of the activities they perform on a regular basis could meet this qualification. Specific examples of R&D activities that might qualify for the spirits industry include new or improved:
- Product recipes for flavor, texture, and aroma profiles
- Product formulations, such as ready-to-drink or low alcohol by volume (ABV)
- Heating techniques and enzymes for mash
- Fermentation techniques and yeast strains
- Distillation processes and fraction optimization
- Distillation equipment and still design
- Filtration methods or techniques
- Aging processes or techniques, such as accelerated aging or container material trials
- Packaging processes or equipment
- Methods for shelf life extension and stability
- Sustainability techniques, such as water efficiency and waste management
- Software systems
What types of expenses are included in the R&D tax credit?
If a company determines the work it’s conducting likely qualifies, identifying related expenses is the next consideration. 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 as well as those that directly support or supervise the research. The rules specify if an employee is 80% qualified, 100% of their wage can be included to calculate the credit.
Qualified supplies include tangible property used in the qualified research, such as ingredients, enzymes, yeast, and lab equipment and supplies. Qualified supplies may also include small- or large-scale prototypes and pilot models.
Payments to contractors may also be eligible, but they’re subject to some restrictions. Qualified contractor expenses typically include consultants, temporary labor, outside testing, and other third-party services. What does the R&D credit apply to in the spirits industry?
Qualified Cost Examples
This often-underutilized opportunity could offer significant tax savings by reducing a company’s income tax burden. Those that participate in qualifying activities could include certain expenses directly connected to qualified research.
Qualifying costs could include taxable wages paid to employees for performing qualified R&D activities, including those who conduct R&D, first line supervisors, and personnel who directly support R&D projects and efforts. It could also include amounts paid to third parties who are performing research on a contract basis. Qualified departments typically include product development, lab, and quality assurance.
Specific examples could include:
- A head distiller who is driving new product or process development
- Engineers developing new equipment to improve efficiency or sustainability of distillation process
- Production staff distilling pilot recipes
- Lab or quality assurance technicians testing ABV or other characteristics of new products
- Welders and skilled fabricators constructing new equipment and processes
Contractor or third-party vendors performing qualified research on behalf of the company
Supplies and Raw Materials
These costs could include materials consumed or destroyed during qualified research, including the distillation of pilot recipes or aging of distilled spirits. The ultimate success or failure of a pilot doesn’t determine eligibility. For example, the distillation of a new recipe could qualify even if operational at the conclusion of the R&D.
To apply for these credits, what’s the next step?
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. 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.
We’re Here to Help
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.
With recent increased IRS scrutiny around R&D credits, it’s 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 Your Company Qualifies, or request a complimentary credit benefit estimate to see how much your company could save.