With around 1,000 operational or in progress craft distilleries, (mostly all who have opened in the last five to ten years) the craft spirits industry is following the similar past trends of craft beer and wine. This rapid growth often leaves owners and investors focused on how to get their next bottle out the door and they miss out on the incentives available to reduce their tax liability or free up cash flow.
The following are some of the most useful incentives to help maximize your return on investment with examples that are directly applicable to the craft spirits industry.
As you know, this is a very capital intense industry, what you might not know is that cost segregation is one of the best ways to free up cash flow for other expenditures. Typically, if you own a building, or improvements to a building, it is depreciated over thirty-nine years. Cost segregation is a recognized federal and state tax deferral strategy that identifies certain components of a building that can be depreciated over five, seven, and fifteen years. In a distillery, or any manufacturing facility, this can be significant because the IRS has allowed both individual pieces of equipment and many of the built-in connections that service the equipment to qualify. This means, a lot of those expensive electrical, plumbing and HVAC components could be reclassified into five and seven year depreciable property. Through the analysis of an engineering based cost segregation study, you can maximize this benefit and allowing you to defer taxes by front end loading depreciation deductions, putting more cash in your pocket today.
Tangible Property Regulations (TPR) Incentives
While you were expanding your tasting room or manufacturing facility last year, the IRS released the final tangible property regulations (TPR) guidance. This provides you the opportunity to examine the same building and improvement assets discussed in cost segregation, for potential write-offs and losses as they relate to repair and maintenance expense vs. capitalization. A further opportunity exists for those whom have extended their 2014 returns because this is the only year you are allowed a look-back opportunity for past years to claim these write-offs and losses.
The TPR offer benefits to any building owner who routinely maintains their properties. Going forward, you could be able to fully expense certain repairs and maintenance items that had previously been treated as a capital expense. However, the IRS is requesting a unit of property breakout for the facility to establish a baseline for the repair and maintenance costs to be analyzed. To comply with this, a “two-sided” cost segregation study that engineers the entire building (not just the qualifying property) is able to identify these units of property to help determine the correct application of TPR going forward.
In addition to your bond, state and federal production taxes there are also property taxes. Property tax is often taken at face value; however, if the insurance’s assessed value is greater than the fair market value, you can challenge and possibly mitigate your assessment. By knowing your actual real and personal property, what it is comprised of, and what it’s fair market value is, you can potentially reduce your property tax liability. This information can also be obtained by a “two-sided” cost segregation study with an included property insurance analysis.
Research & Development (R&D) Tax Credit
Yes, research and development; at some point from the grain to bottle processing, research and development is being performed. This credit can be very lucrative, especially to craft spirits, beer, and wine manufactures because of the inherent uncertainty of their processes.
This often overlooked tax credit is intended to incentivize manufacturing (and other) companies with a dollar for dollar reduction of income tax owed. It is more beneficial than the straight deductions generated with other incentives. This credit may also be claimed up to three years after the tax return was filed or two years from any tax payment made for the year the R&D occurred, whichever is later.
You are performing research and development if you partake in any of the following:
- Making a new product for the first time;
- Producing a product using new equipment or processes;
- Hired an engineer or consultant to assist in producing a new product or improving an existing product or process;
- Experimenting with a new product or process;
- Investigating or implementing a new process or significant improvements to existing processes for manufacturing, testing, or quality control;
- Developing new products or making substantial improvements to existing ones;
- Endeavoring to solve technical problems related to new customer orders or changes in product application.
There are many costs associated with these activities that are obvious and some others that are not so evident, such as an employee's time spent on a project and their related wages. The R&D credit requires an expert who can identify, document, and prepare all the qualifying costs to maximize the benefit. The federal credit is 20% of qualified R&D expenditures and many states offer a state tax incentive as well.
In conclusion, if you are building, improving, expanding or purchasing a facility in this craft spirit renaissance, a cost segregation study can offer cash benefit through tax deferral. If you’re making routine repairs and maintenance to a facility you own, the TPR incentives can reduce your tax liability, property tax mitigation can reduce overpayment of property taxes, and the R&D tax credit can reduce your taxable income, possibly significantly.
Engineered Tax Services (ETS) offers a Next Generation cost segregation study that includes a unit of property breakout and property tax analysis. ETS also routinely consults on TPR repair and maintenance incentives and prepares R&D tax credits.
[box]Please contact Aaron Roy Coffeen, Senior Consultant, or your Engineered Tax Services director for more information or questions. Aaron has been an American Distilling Institute member since January 2014 and specializes in full service tax incentives for the spirits, beer, and wine industries.