In the wine business, a brand’s reputation is often tied to its history—which you can only create if you’re still in business in the years and decades to come. That means doing all you can today to make your business sustainable for the long term.

That point is especially relevant for the 96 percent of US wineries that produce fewer than 50,000 cases per year while contending with distributor consolidation, labor shortages, evolving consumer preferences, and the increasing scarcity of water and other critical resources. There’s a clear theme to how many wineries and vineyards are making themselves more efficient: technology.

MANAGING YOUR ENVIRONMENTAL IMPACT

US consumers are increasingly spending on sustainably produced products and the companies that make them. This movement continues to gain momentum, and its effect is compounded when you add the viral nature of product success today. But marketing aside, ecologically minded winery businesses also strive to conserve resources and be more cost-efficient on principle.

Water

Many wineries are performing water-use audits to analyze how many gallons they consume and where, then using the results to find new ways to reduce, reuse, and recycle the water. Some are installing catchment systems so rainwater can be recirculated, treated, and used; others are tapping treated wastewater from municipalities. Though not potable, this water can safely be used for vineyard and landscape irrigation and other uses, reducing potable water consumption.

Two other new technology solutions for water management and sanitization: the Tom Beard Company’s barrel-washing equipment and BlueMorph’s UVC technology.

The Tom Beard Company’s barrel-washing units are specially designed to recycle and reuse water in the last wash cycles. Using them, Jackson Family Wines in Sonoma County reduced its consumption of water for washing barrels by two-thirds and trimmed the amount of time required to wash barrels by about 40 percent.

Jackson Family and other wineries have also cut water use by more than 20 percent in the tank-cleaning process using BlueMorph’s technology, which sterilizes tank interiors with a specific wavelength of ultraviolet light instead of chemical sanitizers and water. Per Bluemorph, the savings can be over 80 percent if fully adopted and implemented. Trials have proven this technology is significantly more effective at sanitizing stainless steel tanks than traditional cleaning and sanitizing methods. In addition to eliminating microorganisms that spoil wine, the BlueMorph’s UV technology can also:

• Reduce wineries’ heating bills by approximately 70 percent
• Eliminate the need for chemicals in the sterilization process
• Remove the scalding hazard posed by steam and hot water to employees
• Reduce the time and labor required to wash a tank by about 75 percent (three minutes for a 3,000-gallon tank or 30 minutes for a 25,000-gallon tank)

Wineries are often surprised to learn that these technologies may not be cost-prohibitive. While the results depend on a winery’s size and winemaking processes, the savings in water, labor, time, chemicals, and energy can offset the cost of this equipment in as little as one year and generally less than three.

Pesticides

Another environmental issue is the use of pesticides. New technology is changing the story here too. One promising example is called thermal plant treatment (TPT) from AgroThermal Systems.

The initial idea was to blow hot air into the leaf canopy to control small insects and mildew with heat rather than with pesticides and fungicides. Trials in Oregon, New Zealand, and Napa, Sonoma, and Monterey Counties showed a significant decrease in the need for sprays but also multiple unexpected benefits among heat-treated blocks:

• A 23 percent higher yield than control blocks
• Repeatedly higher rankings in blind taste tests
• Healthier leaf canopies and a more uniform fruit set (especially in cooler areas)
• A 40 percent increase in the number of berries, a 40 percent increase in bunch weight, and one to two additional tons per acre in yield

How it works: Rather than applying a pesticide or fungicide spray every 10 to 14 days, a trailered TPT unit emits directed blasts of hot air (200 to 300 degrees Fahrenheit), raising the temperature under the leaf canopy by 12 to 25 degrees for about 15 seconds—enough to kill most small insects, insect eggs, and mildew. Growers can use TPT throughout the growing season to encourage more uniform bud break and control insects and disease. If the goal is a more uniform fruit set, growers can make two or three passes during bloom.

The resulting increase in tonnage can offset the cost of TPT equipment within one year. Though TPT requires less chemicals and water than pesticide, it does require burning propane to generate the heat, so there are some environmental trade-offs.

REDUCING COSTS THROUGH BIG DATA

Pinpointing where resources are needed is an important part of efficient, sustainable business. In addition to neutron probes and other devices that measure the presence of available water in the soil, newer technologies are helping farmers gauge the health and resource requirements of their plants on a practically molecular level.

For water management, technology by Fruition Sciences enables growers to measure the water demands of individual vines, while technology developed by Oregon-based Tule Technologies provides evapotranspiration data on acres of plantings at once. Vineyards today can use GPS-enabled technology to generate maps containing layer upon layer of data aggregating soil type, mineral content, drainage patterns, sun angle, and other factors. This helps them manage resources as well as design new, more drought-tolerant vineyards that produce higher-quality grapes and better yields.

Mobile farm management and farm data record applications such as the cloud-based iCropTrak are making it easier for growers to document and monitor all aspects of their farming operations. Many vineyards are also establishing weather monitoring stations with expanded capabilities to record minute-to-minute data on temperature, humidity, wind direction, and speed. These stations provide data directly back to scouts and field managers through smartphones and other wireless technology to announce frost warnings, system failures, and required adjustments. The data reveals important year-to-year trends, the effects of variation in soil and climate on the timing of key phenological stages, such as bud break, bloom, and harvest.

Aerial technology (drones included) provide growers with a bird’s-eye view of their vineyards. These show uniformity of growth, detect areas under stress from disease, and help assess when a picking crew might have the next load of grapes ready to send to the winery. Colorful NDVI (normalized difference vegetation index) maps, which show areas of high and low vegetation density, provide visual cues on how to improve uniformity of growth within a vineyard and how to harvest vineyard areas for optimal grape quality.

Some of these technologies even collect multiple types of data in a single pass through a field, which cuts costs, reduces wear on equipment, and lessens soil compaction.

SAVINGS THROUGH AUTOMATION

Automating work can help mitigate the effects of labor shortages. Used in vineyards and wineries, optical sorting equipment at harvest can remove material other than grapes (MOG) and reject unripe, sunburned, and overripe grapes based on color sensitivity criteria you can calibrate.

Typically, this technology (which starts around $75,000) can sort five to 10 tons an hour compared with a team of 10–12 workers, who can sort about a ton per hour. Winemakers report that the quality of the sorted fruit is often more uniform—and because this technology allows wineries to get more work done in a day, they can react more quickly to sudden changes in the weather and get the fruit safely “into the barn.” As a second benefit, employees can go home at a more reasonable time, so they’re more rested, less prone to injuries and mistakes, and better at making decisions. The ultimate result: a better-quality wine.

Marketing and sales functions are another focal point for automation. Now that direct-to-customer sales are a serious option in 43 states, wineries are upgrading their IT systems and other technologies. As they transition from a paper-based to a digital world, wineries are capturing orders, interacting with customers, and monitoring real-time inventory levels with the data streaming from mobile technologies. This brings greater efficiencies by reducing the time and cost of materials required to place and process orders and eliminating many of the manual steps winery employees used to do by hand. Better still, electronic orders may reduce the customer wait time between order and delivery, freeing up employees to perform more fulfilling, customer-facing work.

Last, new business intelligence software, such as Adaptive Insights, is shedding light on wineries’ year-to-year trends and allowing them to quickly reforecast projections. This can be invaluable when wineries are faced with a sudden change in the economy, a strike, or an unexpected weather event affecting the crop. By uploading current, budgeted, and historic data into the platform, the visual representations of the data can help winegrowers and managers make faster, better, more informed decisions.

STAY AHEAD OF THE CURVE

The technology wineries are using today can seem like science fiction to an outsider. But more and more, our climate—both business and environmental—is making it such that the wineries using this futuristic technology today are indeed the wineries that will thrive long into the future.

Disclaimer: This article does not constitute an endorsement of Moss Adams LLP by the companies referenced herein, or an endorsement of such companies by Moss Adams LLP.  Companies and products are described based on publicly available information and other user information.

Many California wineries are ramping up their production volumes to near prerecession levels. As a result, they may be unknowingly increasing their tax liabilities—but lucky enough, California now provides a partial sales and use tax exemption that could help offset the increase.

The partial exemption is available to businesses engaged in R&D or qualified manufacturing activities. That may not sound quite like your winery, but on a closer look it applies to many of the activities wineries regularly engage in.

The partial exemption became effective July 1, 2014, and applies to the purchase or lease of qualified property primarily used in these qualified activities by a qualified person. Although the applicable laws are somewhat more complex, qualified property is generally defined as tangible personal property used in a qualified activity that has a useful life of greater than one year.

In regards to the actual benefit, the partial exemption reduces the tax rate on these qualified expenditures by approximately 55 percent, with a rate reduction of a little under 4.2 percent. Since the current statewide tax rate is 7.5 percent, the partial exemption reduces the sales tax on qualifying property sold to a qualified person to a rate of just over 3.3 percent, plus any applicable district taxes. Simply put, $1 million in qualified expenditures would result in an immediate $42,000 of above-the-line savings.

WHAT ACTIVITIES AND PURCHASES QUALIFY?

Most wineries will find that their production falls into California’s definition of manufacturing. Moreover, if you’re building a new winery production facility, many of the construction costs may also qualify to generate tax savings.

If your winery does qualify for the incentive, you’ll need to complete an exemption certificate specific to this program and provide it to your construction vendor for a reduced tax rate.

Purchases of the following items likely qualify for the partial exemption:

• Crushers
• Stainless steel fermentation tanks
• Bottle washers
• Laboratory testing equipment

The construction of barrel buildings and other special purpose buildings also potentially qualify for the partial exemption. The following three categories of property, on the other hand, are ineligible for the partial exemption:

• Consumables with a useful life of less than one year. This would include chemicals, such as gelatin, bentonite, and sulfur dioxite, which are used as manufacturing aids.
• Furniture and equipment used to store completed wine. This would include forklifts or dollies used to move finished wine from storage to the loading docks.
• Administrative and general management or marketing property. This would include tasting room furnishings, computers used in your accounting office, and display racks.

BENEFITS AND CHALLENGES

Odds are you aren’t purchasing wine production equipment solely for the pleasure of claiming the partial exemption. You’re growing, improving your products, and becoming more sophisticated as a business, which means every dollar you can save on taxes is a dollar you can reinvest toward your long-term goals.

Though the partial exemption isn’t intended to be difficult to claim, there are a few areas where wineries can get snagged. Some of the issues that may come up as you pursue the exemption include:

• Difficulty recouping overpayments. Since the incentive was enacted, many wineries have continued to pay tax as if the incentive didn’t exist, meaning they’ve already overpaid tax on qualified expenditures. Most aren’t aware of how to recoup these overpayments.
• Pushback from vendors. Because many businesses aren’t aware of the incentive, wineries and other manufacturers attempting to purchase qualified property are encountering resistance from their vendors, which don’t necessarily know (or believe) that this partial exemption even exists.
• Rates passed down through contractors. When performing work for a qualified business, a construction contractor may purchase some materials at the reduced or partially exempt tax rate, passing that benefit on to the customer. The rules that govern construction contractors are complex, and as a result this issue has been hotly debated on a number of fronts.

NEXT STEPS

The first step in claiming the partial exemption is to document your qualification for it. Then, you’ll need to complete the Partial Exemption Certificate for Manufacturing, Research and Development Equipment (Form BOE-230-M or BOE-230-MC), and provide that certificate to your vendor.

If you purchase equipment from a non-California retailer that doesn’t collect California sales and use tax, report the purchase on your California sales and use tax return, where there’s a section specifically for partial exemptions.

You may create an exemption certificate for each specific purchase you plan to make, or you can choose to create a blanket certificate. If you’re purchasing from a vendor that provides both equipment and consumables, creating an exemption certificate for each individual purchase will help you make sure you’re taking the partial exemption only on qualified items.

WE'RE HERE TO HELP

It’s nice to finally see California provide a real cash incentive that isn’t tied to an income tax return. Our state and local tax professionals have helped clients resolve many of the challenges associated with claiming this new partial exemption, and we’ve also helped them pursue other planning opportunities related to this incentive. Contact your Moss Adams tax professional for more information on whether your operations may qualify and for help claiming the exemption.

Buy-sell agreements are one of the most important elements in the planning for any business’s long-term success. But for family-owned businesses—common in agribusiness, food, wine, and forest products—they play an even more critical role in the successful transition of the business from one generation to the next.

WHY CREATE A BUY-SELL AGREEMENT?

Buy-sell agreements control the ownership of a business when a triggering event occurs. This may be an owner’s death, retirement, or departure from the company, but death is the most common, particularly for family businesses, whose owners are unlikely to leave otherwise. This being the case, buy-sell agreements play a critical role in estate and succession planning.

Whoever inherits a business owner’s estate—be it a spouse, heir, or other potential beneficiary—may also inherit the deceased’s ownership interests. For many businesses, that’s not the desired outcome. A survivor who inherits a business may have no desire to be involved; meanwhile, the remaining owners may find themselves with a new and potentially unwanted business partner. This is where giving careful attention to your buy-sell agreement and related documents becomes an important tool for following through on your business and personal wishes.

FUNDING YOUR BUY-SELL AGREEMENT

It’s all well and good to create a buy-sell agreement that details how ownership should change upon an owner’s departure or death, but unless that buy-sell agreement is funded, it’s unlikely it’ll be executed successfully. A farming operation owned by two brothers may have a buy-sell agreement stating that if one dies, ownership goes to the other, but how will the surviving brother buy out the deceased brother’s shares? This is a common trouble spot in buy-sell agreements.

There are a number of ways to fund a buy-sell agreement, each with its own pros and cons:

• Create a sinking fund. A business diverts a portion of its revenue into a savings account so liquid assets are available to buy the shares of an owner who leaves the business or passes away. This provides liquidity when it’s needed, but it diverts a substantial amount of revenue away from the business’s operations, potentially hampering growth.
• Promissory note. Ownership interests pass into the deceased’s estate, and the business or surviving owner purchases the deceased owner’s share from the estate through installment payments, which should include interest. It’s easier to manage financially, but the business must record a liability on its books, and the estate must wait a long time to be paid in full. Furthermore, there’s no clean break between the business and the deceased’s estate.
• Use life insurance. If death is the triggering event, life insurance provides the cash to fund a buyout when it’s needed. However, the feasibility of this funding mechanism is dependent on the insurability of the owners. Using life insurance to fund a buy-sell agreement is a simple and elegant solution, but it may not be right for every business or owner.

Each owner should take the time to do a careful analysis to determine the appropriate funding method for his or her business.

FUNDING A BUY-SELL WITH LIFE INSURANCE

Type

There are different types of life insurance, and one size doesn’t fit all. Owners and businesses must look to their desired goals in determining what type of insurance is most appropriate for them.

Will the owners retire, or will be the business be sold to a third party in the future? If either of these situations is a possibility, then term insurance may be the best option. There’s a specified period during which the need for insurance to fund a buyout exists. However, if the owner plans on participating in the business indefinitely—with no intention of ever retiring—then a permanent policy may be more appropriate. In this scenario, there’s no specific time frame, so the insurance need may continue until death.

Structure

When using life insurance to fund a buy-sell agreement, the two common arrangements are cross-purchase and entity-owned arrangements. Each arrangement defines how the life insurance will be owned and how the buyout will occur.

In cross-purchase arrangements, every owner personally owns a life insurance policy on each other owner and is the beneficiary of that policy. To return to our example, take a farming operation owned by two brothers (A and B). In a cross-purchase arrangement, A purchases a policy on B and B purchases a policy on A. This works well with two owners, but what happens when A brings his daughter, C, into the business? Now we have three owners, and if we continue in the same mode, A must own policies on both B and C, B must own policies on both A and C, and C must own policies on both A and B. That’s a total of six policies. As you can see, the number of policies increases rapidly as more owners are added.

The alternative is to have the business be the owner and beneficiary of life insurance policies on each owner. This reduces the number of policies to three: one each on A, B, and C. When one owner dies, the business receives the death benefit, funding the purchase of the deceased’s shares and distributing the interests across the remaining owners. In addition to reducing the number of policies, this means there’s only one transaction to structure when an owner dies, since remaining owners don’t personally have to buy their portion from the deceased’s estate.

How you choose to structure your life insurance policies carries tax implications as well. In a cross-purchase arrangement, the business generally distributes money to owners to cover premiums. Owners usually recognize these distributions as additional income. In other words, it’s more money that can be taxed—and that may be especially undesirable if premiums vary substantially between owners.

Say owner B is elderly and in poor health. Owners A and C will have to recognize a larger amount of income to cover their policy premiums on B, potentially bumping up their tax rate. On the other hand, if the business owns the life insurance policies, the business pays the premiums directly to the insurance company. There’s no individual liability for the premiums, and the disparity of premium amounts is equally borne by the owners.

PUTTING IT ALL TOGETHER: SUCCESSION PLANNING

Now that you’ve got a handle on how life insurance funds a buy-sell agreement, let’s look at an example of how it can be used to put a succession plan into action.

Using our original example, brothers A and B own a dairy farm valued at $10 million. Both have children who are involved in the business and own small minority interests, but neither of their spouses is part of the business. Unless they’ve planned otherwise, at either’s death, their share of the business will fall to their respective spouses. Now assume that A passes. His wife is now an equal owner of the dairy with B. Unless B created some kind of funding mechanism to buy out A’s wife, he must now continue to operate the business with someone who has no knowledge of farming.

Instead, let’s say that brothers A and B set up a buy-sell agreement so the dairy owns insurance on all owners. At A’s death, the dairy receives the death benefit proceeds (generally free from income tax). The dairy uses those proceeds to purchase A’s interests from A’s wife. Consequently, A’s shares are now proportionally distributed among the remaining owners. A’s wife now has liquid assets to maintain her lifestyle, and B is no longer equal partners with someone who is uninvolved in the dairy business.

Naturally, how you structure your buy-sell agreement and insurance policies should depend on your long-term goals for your business. But with careful planning, an understanding of your options, and a bit of teamwork on behalf of your business and personal advisors, you’ll be able to execute a strategy that aligns with your goals.

REVIEW YOUR PLAN REGULARLY

Even the best-laid succession plans, buy-sell arrangements, and insurance policies can fail if they’re not revisited regularly.

As your business grows, ownership interests evolve, long-term goals shift, and the value of your business continues to increase. The business value you’ve based your buy-sell funding on can become outdated quickly, and with it, the amount you’ll need to buy out a departing owner. In addition, it’s important to consistently review your insurance. Life insurance should be handled like any other investment: The timing of premium payments, term periods, and policy performance can all have an effect on the success of your strategy.

This brings us to another piece of the puzzle: valuations. Unless you know the value of your business, you can’t know how much it’ll cost to buy out a deceased owner’s share. There are many ways to value a business, so be explicit in your buy-sell agreement. Having a clear, definitive, and independent valuation method that is appropriate to your business will help reduce conflicts and keep the buyout process moving forward.

To keep your business valuation, buy-sell agreement, life insurance policies, and estate planning documents working in harmony, review them:

• At least every five years, though insurance should be reviewed annually
• When there’s a relevant regulatory change
• When there’s a life-changing event, such as a marriage, children, divorce, or change of ownership
• When there’s a significant change in the value of your business

Most important, work with all of your advisors—together—to create and review your buy-sell agreement, estate plan, and other related documents. Without a view into what each advisor is doing, it’s unlikely they’ll all align toward your ultimate goals. As a best practice, always review your buy-sell agreement, life insurance, and estate plan in tandem.

WE'RE HERE TO HELP

To learn more about buy-sell arrangements, life insurance, and how they can work in your estate and succession plan, contact your Moss Adams insurance specialist or accounting professional. We can help you gain perspective on your long-term goals and align your plans, putting you on track to achieve them smoothly and effectively.

As we begin wrapping up the year, it’s time to think about year-end financial considerations. For many of us—whether it’s for philanthropic reasons or tax planning reasons (and it’s likely both)—one of those is charitable giving.

CHOOSING A GIFTING VEHICLE

If you tend to simply write checks at the end of the year, there may be a more financially efficient way for you to give. Let’s look at a few of the most common.

Gifting Stock

Gifts of appreciated stock are an easy way to avoid the capital gains tax you’d pay on an appreciated asset upon its sale while receiving a charitable deduction for the full value of the stock. Most charities do accept securities, and you can also use a donor-advised fund to give to those that aren’t able to accept stock.

Another strategy is to first sell stock that has decreased in value—generating a tax loss you can use to offset capital gains income—then gift the sale proceeds, which further results in a charitable deduction.

Donor-Advised Funds

A donor-advised fund can be useful if you’re looking to generate a charitable deduction in 2015 but aren’t sure where you want your money to go. These funds allow you to gift cash, appreciated securities, and other appreciated assets to the charitable organization that runs the donor-advised fund—such as Schwab Charitable or Fidelity Charitable—which in turn gifts the value of the assets to the charitable organization of your choice. You can also give through a community foundation that acts as a donor-advised fund. Once you’ve had time to think about where you want the funds to go, you can direct the money to the recipient you choose.

Choosing to gift through a donor-advised fund doesn’t mean you need to forgo the convenience of checkbook giving, especially if you rely on checks to give to your child’s school, auctions and gala dinners, or other events. For these kinds of gifts, you can direct that checks be sent from your donor-advised fund. Note, however, that you can’t use a donor-advised fund to pay off a previous pledge.

Donor-advised funds can also be a way to involve your children or other family members in charitable giving, since multiple authorized users are permitted to direct where gifts go. Additionally, they can offer anonymity in your gifting if you’d like to keep your giving information private.

Charitable Trusts

It’s getting late in the year to consider more complex gifting vehicles such as charitable trusts, but the current low interest rate environment will continue to be beneficial for charitable lead trusts into 2016.

Charitable lead trusts allow you to transfer assets that either produce income or are expected to experience strong growth to your heirs while providing a gift to a charity in the form of income during the term of the trust. You get a tax deduction for the value of the income stream going to charity—so the lower the discount rate, the greater your tax deduction. The assets remaining in the trust can be left to your heirs. The value of your gift to your heirs is the fair market value less the gift to charity, which means the charitable gift completely offsets the gift going to your heirs, making it effectively $0 for estate and gift tax purposes. 

Charitable remainder trusts are the reverse of charitable lead trusts. The income beneficiary can be you or someone else, and whatever remains in the trust at the end of the trust term goes to charity. These trusts aren’t as attractive in low interest rate environments, but they may be worth considering for the future depending on your charitable goals and your income needs.

Even if you aren’t able to create a charitable trust to meet your giving needs in 2015, you may want to begin the process now if you’re interested in having one for future tax years.

ADDITIONAL RESOURCES

Our 2015 year-end tax planning guide provides a wealth of information on charitable giving strategies, including how they may impact your estate and retirement planning, alternative minimum tax liability, and lifetime gift exclusion. It also provides key information on other ways you can reduce your tax liability in 2015 and beyond. See our related tax planning infographic for a few of the most important topics individuals should consider.

As the year winds down, take some time to read through the opportunities in the 2015 tax guide and talk with your advisor about options that may be a good fit for you, your family, and your business.

LOOKING AHEAD

While you may be focused on finalizing your charitable gifts for 2015, remember that it’s not too early to start thinking about how you can make your 2016 giving as efficient and effective as possible. As you make your final 2015 gifts, take advantage of the opportunity to review your giving methods, habits, and goals, since these will provide insight you can apply toward your 2016 giving strategy.

Contact us to learn more about how you make the most of your charitable giving and which solutions may work best for your personal financial situation and goals.

As the tax rates on top earners continue to rise, many winery and vineyard owners are looking for new ways to reduce what they’re required to pay in taxes.

The good news is there are many tax planning opportunities for wine businesses at the state and federal levels, and if you’re willing to invest some time into researching and implementing them, you can significantly reduce your overall exposure. Let’s look at a few of the ways wineries and vineyards can reduce what they owe, both early on and as they continue to grow.

ENTITY STRUCTURE PLANNING

Good structuring is critical whether you’re starting a wine business from scratch or purchasing an existing business—not only from a tax perspective but also from a legal and business perspective. The entity type you choose depends heavily on your long-term goals for the business, and each comes with pros and cons.

On the tax side, C corporation structures are less common due to the double taxation that occurs. Limited liability companies (LLCs) have traditionally been the most popular vehicle, but S corporations are gaining ground as a result of the Affordable Care Act. Unlike an LLC, the flow-through income from an S corporation to an active shareholder isn’t considered self-employment income; as a result, it isn’t subject to self-employment tax or the additional 0.9 percent Medicare tax that went into effect in 2013.

On the other hand, LLCs can provide more flexibility to allocate losses to those members that funded the business, allowing them to use those allocated losses to offset their other taxable income. This can be a great planning tool at the inception of a vineyard or winery business, since in its first five years it may generate only losses as its vineyards come into production and its wine is aged.

As an example, take a winery owned by two partners, and say partner A has contributed 100 percent of the capital. If the winery is an LLC and the operating agreement is structured accordingly, all its losses can be allocated to partner A. Alternatively, if the winery is an S corporation, its losses are allocated according to the number of shares owned by each shareholder, regardless of who funded the business. So if the two are equal owners, shareholder B will be allocated 50 percent of the losses, and those losses would be deductible only to the extent the shareholder has basis.

Above all, consider your end goals: 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. Spend time with your attorney and CPA well in advance of formation to determine which structure works best for your long-range plans and tax exposure.

ACCOUNTING METHODS

At the most fundamental level of tax planning, your overall accounting method—cash or accrual—is important.

Vineyards, as farming operations, are generally permitted to use the cash method regardless of size if the activity is held by a sole proprietor or through a flow-through entity. This assumes the vineyard activity doesn’t meet the tax shelter rules defined in Internal Revenue Code Section 448. The most common situation that would prohibit a vineyard from using the cash method is when more than 35 percent of the losses from the activity are allocated to “limited partners” or “limited entrepreneurs.” Additionally, if a vineyard is held within a C corporation, certain revenue thresholds could preclude the vineyard from using the cash method. The standard threshold for C corporations is $1 million; a higher $25 million threshold applies if the entity qualifies as a family corporation.

Wineries generally must use the accrual method due to the creation of inventory, although there’s a small-taxpayer exception that allows some to use the cash method. To meet this requirement, the winery’s average annual gross receipts for the prior three tax years must be less than $1 million. If a winery can meet the small-taxpayer exception, it may want to consider using the cash method as well as accounting for inventories in accordance with Revenue Procedure 2001-10. This allows a winery to treat as inventory only raw materials (grapes, glass, corks, purchased bulk wine, etc.). All other costs, such as labor and custom crush fees, are expensed as they’re paid.

The cash and accrual methods each have their benefits (depending again on your long-term goals), but cash is generally favored. From a vineyard perspective, your ability to use the cash method provides you the option to either capitalize or expense preproductive costs on your vineyard. These are the costs incurred from the time you plant a new vine until you’re able to harvest a commercially viable crop (typically three crop years). The cash method allows these costs to be deducted in the year they’re paid, reducing your taxable income right away. One downside is that you’re required to use slower depreciation methods and longer recovery periods under the alternative depreciation system. Second, once you’ve elected to expense your preproductive costs, the election applies to all future vineyard and permanent crop development activities in which you incur preproductive costs, regardless of the entity that holds it. Under the accrual method, these costs must be capitalized (similar to generally accepted accounting principles), which provides no immediate benefit but permits faster depreciation methods and shorter recovery periods.

If you have a combined vineyard and winery operation in a single entity and the vineyard is eligible to use the cash method, then you have some additional tax planning opportunities to consider. The first is the ability to deduct all estate-farming costs in the year paid rather than capitalizing them as a component of inventory. Estate-farming expenses aren’t deducted until the inventory is ultimately sold. Depending on the time frame in which a taxpayer ages and ultimately sells its inventory, deducting these costs up front could accelerate the deduction by one to four or more years.

If you’ve examined your overall accounting method and determined the other would be more advantageous, you aren’t out of luck: You can choose to change your accounting method by filing Form 3115 with the IRS. Various requirements apply depending on the type of change, so work with your CPA to determine whether a change is feasible and what you need to do to execute it.

FARM INCOME AVERAGING

Qualifying taxpayers may elect to have their current-year farming income (in whole or in part) 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 now that top individual tax rates are higher than they’ve been in the past.

Farm income averaging can be challenging for taxpayers with multiple activities—for example, a combined winery and vineyard operation. 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.

IC-DISCS

As the international markets for US-produced wines continue to grow, many wineries have expanded their sales overseas. If you export your products, you may benefit from forming an IC-DISC—that is, an interest-charge domestic international sales corporation—which yields permanent tax savings on export income.

IC-DISCs are paper organizations that aren’t taxed at the federal level. They have neither employees nor offices; rather, they exist solely to collect a sales commission from the exporting business. Once they’ve collected this commission on the exporter’s international sales, they distribute the income back 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 tax rate reduction of approximately 16 percent at the top bracket.

Forming and maintaining an IC-DISC does involve additional paperwork and the involvement of attorneys and other advisors, so you’ll need to put some advance planning into this strategy if you think your business could benefit from it.

STATE TAX CONSIDERATIONS

At the state level, there are still more tax planning opportunities available to wineries and vineyards that know where to look.

California offers a partial sales and use tax exemption on the purchase of equipment used in manufacturing, which includes wineries’ crushers, fermentation tanks, bottle washers, laboratory testing equipment, and more. It reduces the tax rate on these purchases to approximately 3.3 percent compared with the state’s standard 7.5 percent rate. So if you spend $200,000 on qualified equipment, you’ll see a tax savings of $8,400 using the partial exemption. California also permits faster depreciation (five years instead of 10) on vines replaced due to Phylloxera (after 1991) or Pierce’s disease (after 1996).

On the other side of the coin, states have become increasingly aggressive—and creative—about 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 taxes, margin taxes, and gross receipts taxes that work around this law.

To plan properly for these state taxes, you need to understand what activities may be taxable in each state where you have operations, then work with a CPA to reduce what you owe. On the planning side, understand what you’re getting into from a tax perspective before you commence operations in a new state, especially if your tax liability could tip the balance one way or another. Note that filing in another state isn’t necessarily a negative because California is such a high-taxing jurisdiction. In some situations, it may make sense to create a filing obligation in another state, pulling the income out of California and potentially reducing your overall tax liability.

WE'RE HERE TO HELP

The most important takeaway is to start planning early so you can adequately account for any changes you want to make or opportunities you want to take advantage of. While many of the opportunities outlined above are limited to either wineries or vineyards, integrated winery-and-vineyard operations are often in a position to take advantage of both. Entity structure and choice of accounting method are fundamental options that will impact your tax exposure, so invest time up front on those decisions, particularly in advance of a transaction or the formation of a new business entity.

Evaluating your tax strategy now is important, but just as important is reevaluating it occasionally. If you’d like to understand how these tax opportunities could affect your business, contact your Moss Adams professional. We can help develop a strategy, implement it properly, and prepare for tax law changes and new opportunities.