Hidden Deductions for Wineries and Growers
Wine accounting experts outline savings available despite pending tax increases
He adds that his firm sees untaken deductions all the time. “One (larger) company was able to recover $26 million over the prior allowed three years of changes to returns just by careful attention.”
Management at another ag company learned they could deduct the six-figure amount spent for a fish ladder required for a creek on their property, something that had never occurred to them.
Scott noted, “Ag has the most-favored-nation status of taxes.”
Many of these deductions result from intense lobbying by big ag businesses, and most grapegrowers are just collateral beneficiaries, while other provisions represent the vagaries of growing crops.
In addition, many special financial incentives passed to stimulate the economy after 9/11 still apply, but they are about to end.
This week PwC hosted a seminar to go over some of these tax provisions and recent changes to tax laws for local wine businesses. The intense, comprehensive and fast-paced session only scratched the surface, and it’s clear that any wine company should have an accountant very familiar with its special tax needs.
Scott, for example, has 30 years of experience in the area, and he initiated the ability to depreciate AVAs among other boons to wineries and growers. With that move, he inspired the IRS to recognize that being in an AVA is an intangible asset eligible for amortization over 15 years.
In addition, accountants should segregate many other depreciable assets often “buried” in land costs such as fences, roads and wells.
Most companies are now required to use accrual accounts, not cash, but nurseries can continue to use the cash method to get tax basis to zero.
Expenses encountered for soil and water conservation required by government agencies—as well as to protect endangered species—can also be deducted, not capitalized. Likewise, conservation easements can reduce taxes, but also reduce basis.
While most businesses can only claim a two-year net operating loss (NOL) carryback, ag businesses can carry losses back five years.
Also, many growers who can’t use the cash method can deduct post-harvest/pre-bud break costs. These can be big numbers for larger growers.
Accounting for inventory offers many possibilities for savings: The costs of the whole term of production applies for wines that are aged, not just the current year. Likewise, the value of the wine aged and different packaging costs matter.
There are differences between the way grape costs are handled in generally accepted accounting principles and for tax purposes, too.
One of the recent upheavals to hit wineries is being forced to adopt more specific item definition for LIFO (last in, first out) accounting for inventory. Each different wine produced—variety, appellation, self-grown vs. bought, multiple vintages in the same stage of production, blends, selections from a lot regarded as reserve, packaging—should be treated as separate items, not just lumped together by variety.
States are getting very aggressive in trying to raise money through audits, and one way to avoid large penalties is to file a voluntary disclosure agreement with the tax agency regarding claims that might be unusual.
States also try to get companies to pay taxes if they do business there, but the federal government has ruled that just soliciting sales doesn’t create a legal presence (nexus.) This is only true in states levying income taxes, however; it doesn’t apply in other states.
California has generally outlawed net operating low carryover for 2008-11 except for small businesses (less than $300,000 in taxable income in 2010 and 2011.) However, for 2013, a two-year NOL carryback is being phased in. A taxpayer may carry back 50% of the loss for 2013, 75% for 2014 and 100% for NOL incurred after.
The PwC speakers expect this to change as the state seeks to balance its budget, however.
Ag equipment is allowed a sales tax exemption, and solar panels that help power a farm are exempt (previously they weren’t if they were tied into the power grid.) Trellis parts—but not labor—are eligible for the sales tax exemption, too.
Oddly, food-processing machines used to turn large carrots into “miniature carrots” get a tax deduction, other processing equipment like crushers, destemmers and presses do not. Large wineries are looking into addressing this inequity.
Other exemptions include seeds, plants and fertilizer, packaging materials, promotional/advertising materials, oak barrels. However, use tax is due on packaging costs for wine used in promotions.
One little-known provision of the IRS code can provide significant savings for exporters: It’s the Interest Charge Domestic International Sales Corporation (IC-DISC), a tax-exempt domestic corporation set up as a brother/sister of a C or an S corporation or partnership. It offers two opportunities: To convert ordinary income into dividend income (now taxed at 15%), or to allow a shareholder to defer tax on part of export-related income. It can defer tax on commissions up to $10 million.
The IRS regulations related to repairs on equipment have been a bit murky, and the agency is attempting to clarify them—but the result is a massive amount of complexity and paperwork. This is definitely territory for an expert.
The code also allows a tax deduction of up to 9% for domestic producers, and the rules allow storage, handling and processing to qualify as well as growing or winemaking. It even appl ies if the product is grown outside the U.S., as long as the taxpayer’s business is here. One caveat is that if a company separates its activities into different companies, the impact may be reduced. Including tasting room revenue in a business that produces wine would help shelter that revenue, for example.
One short-term benefit for all companies is the ability to take a special deduction for assets placed in service during recent years, as long as the total expenditures are under $2 million in 2010 or 2011, $500,000 this year and $200,000 in 2013 and beyond. The maximum deduction ranges from $500,000 in 2010 or 2011, to $125,000 this year, but only $25,000 starting in 2013.
Many tax reductions have just expired, and others are about to—most of them leftovers from recent tax incentives to spur business after 9/11 and due to the recession.
Several expired during 2011: alternate minimum tax relief for 2012, 100% bonus depreciation, R&D credit, CFC look-through, active financing exemption and 15-year leasehold amortization.
A number are now scheduled to expire this year but may be maintained by Congressional action. Some, however, may not be settled until after the national election:
• Extension of 2001-03 individual tax cuts and deduction limitations.
• Estate and gift tax at 35% top rate and $5 million exemption
• Lowered capital gains and dividend tax rates
• 50% bonus depreciation
• Payroll tax and unemployment relief
• Highway trust fund taxes
• Medicare physician reimbursement
In addition, the federal debt should hit its ceiling of $16.394 trillion in late 2012 or early 2013, and $1.2 trillion in across-the-board discretionary spending cuts will occur Jan. 3, 2013, unless Congress and the president reach an agreement to change this.
Health care changes
Major changes and increased expenses will hit almost everyone as the health care act goes into effect—but it should also result in improved coverage for many Americans.
Costs include an additional 0.9% tax on wages more than $200,000 (individual)/$250,000 (couple), plus 3.8% tax on investment (non-wage) income.
Corporations will also have to start reporting on their coverage.
Scariest of all for most people, the top federal tax rate will rise 6.7% to 43.15% on wages (1.45% more for the self-employed), grow from 15% to 25% on capital gains and from 15% to 44.6% on dividends—that’s assuming Congress doesn’t act.
California proposed to raise taxes for those earning more than $300,000 (single) and $600,000 (joint) from 9.3% to 10.3%; for incomes greater than $500,000 (single) and $1 million (joint) taxes will rise to 11.3%. An extra 1% surcharge assessed to those earning more than $1 million is separate from this increase.
That equates to a total potential tax of more than 53.3% for high-wage earners.
Of course, rates for those earning less will be much less.
Finally, individuals have $5 million exempt for gift taxes and estates during for 2011-12. Next year, that drops to $1 million.
In somewhat good news, however, few of the proposed major changes in financial reporting have been adopted.
All the changes—plus the many obscure provisions that benefit farmers—make it imperative that wineries and growers have good advice from knowledgeable accountants now more than ever.
And one caveat: Many of these dire tax changes may be avoided if Congress and the president act.