Brewing a Lower Tax Bill

As any brewery owner can attest, taxes are one of the most expensive ingredients in beer.

In fact, according to a study cited by the Beer Institute, taxes make up a whopping 40% of the average beer’s retail price. Fortunately, there may be some relief. On December 22, 2017 the Tax Cuts and Jobs Act (TCJA) was signed into law, and among other things, lowered tax rates for both corporations and individual taxpayers, reduced tax rates for certain businesses organized as a passthrough, and modified or added deductions that are critical for capital intensive businesses. This article will explore how brewery owners can use today’s tax code to grow their business, improve after-tax cash flow, and take some of the bitterness out of this expensive ingredient.

More Incentives to Buy Equipment

In general, the costs of fixed asset acquisitions are capitalized and written-off for tax purposes over the asset’s useful life, meaning any tax deduction to reduce the business’ tax bill is often misaligned with the timing of any cash outlay for large capital expenditures. This mismatch can put a crimp on the cash flow of any small business, but can especially hamstring breweries, due to their large capital expenditure needs. The Internal Revenue Code (Code) includes some longstanding incentives designed to ameliorate this problem, including Sec. 179, which prior to the TCJA allowed small businesses to deduct the full cost of qualifying equipment in the year of purchase, up to $500,000 per year. The TCJA doubled this threshold to $1 million. This increase is a major consideration for brewers starting out, or existing breweries contemplating large capital expenditures as it could reduce federal taxes by up to $185,000. Timing is critical, however, to make sure capital expenditures are made in a year when the taxable income offset will yield a benefit at the highest tax rate.

More Incentives to Expand

Once a business takes its Sec. 179 deduction, it can often also benefit from bonus depreciation, another Congressional incentive, for capital expenditures in excess of the Sec. 179 threshold. Prior to the TCJA, the bonus depreciation rules permitted businesses to deduct 50% of the cost of qualifying new property in the year in which the property was placed in service. For example, under prior law, if a business spent $2 million on qualified property, it could deduct $500,000 under Sec. 179 and claim bonus depreciation on an additional $750,000 (50% of the remaining $1.5 million cost basis), leaving $750,000 of cost basis to depreciate over the remaining useful life of the property.

Bonus depreciation was set to expire in 2020, but the TCJA extended the provision until 2026 (with phase-out beginning in 2023) and increased the deduction amount from 50% of cost to 100%. This increase is known as full expensing. Recalculating the example above using the new rules, a $2 million purchase of qualifying property in 2018 will be 100% deductible in 2018 ($1 million deduction under Sec. 179 and $1 million in bonus depreciation).

While there are limitations and nuances to bonus depreciation beyond the scope of this article, in general breweries can buy qualifying property and equipment and deduct 100% of the cost from taxable income in the year of purchase beginning in 2018. In addition to equipment, certain leasehold improvements may now qualify as well, which can help a brewer repurpose an old warehouse or garage for the needs of his or her brewery. Additionally, bonus depreciation previously applied only to purchases of new property but can now also apply to purchases of used property as long as the property is being used by the taxpayer for the first time. For an entrepreneur just starting out or an existing brewery looking to expand, these new rules offer tremendous opportunity to lower the cost of capital.

Bonus depreciation is elective, meaning that a business can opt to capitalize expenses and deduct over time rather than taking full expensing in the year property is placed in service. While counterintuitive, a business might want to take the deduction over time if its taxable income is relatively low today but will be higher in the future and potentially subject to higher marginal tax rates, meaning the deductions could be more valuable down the road. Further, the TCJA could be repealed or altered depending on the outcome of future elections, meaning today’s relatively lower tax rates could be temporary. Accordingly, the next 18 months are an ideal time for growing breweries to consider their options and model the after-tax cost of their capital expenditures. The general principles are straightforward, but the devil is in the details, which is why it is important to contact an expert for help.

Potential Rate Reductions for Partnerships and S Corporations

In addition to the benefits listed above, breweries organized as sole proprietorships, partnerships or S corporations may also qualify for a new 20% deduction enacted under the TCJA that reduces the tax rate imposed by the federal government. Provided certain thresholds are met based on the amount of wages paid and fixed assets placed in service, the effective tax rate imposed on taxable income could drop from 37% down to 29.6%.

In concept, this rate reduction is usually available to businesses engaged in producing a tangible product, but often not to those providing a service. It is important to know what parts of the business qualify for this provision, as each brewery may have certain activities that qualify and others that do not. For instance, if the brewery has an associated tap room or restaurant, that part of the business likely would not qualify for the deduction. In such circumstance, it may be possible to split these activities to take advantage of this new rule. The government has included substantial anti-abuse provisions to penalize aggressive taxpayers, but an expert can help navigate these new rules.

Fewer Excise Taxes

The most targeted change for breweries came via the Craft Beverage Modernization and Tax Reform Act of 2017 (CBMTRA), which cut the federal excise tax on beer. The lobbyists behind the CBMTRA sought to lower the tax burden on small to midsize breweries, especially those that brewed just over 60,000 barrels annually but were paying tax at the same rate as the beer conglomerates producing hundreds of millions of barrels a year.

The CBMTRA did not close the gap entirely, but it did halve the excise tax from $7.00/barrel to $3.50/barrel, which applies to the first 60,000 barrels produced by domestic breweries that produce less than 2 million barrels per year. For all other breweries and beer importers that exceed these barrelage amounts, the first 6 million barrels are taxed at $16.00/barrel, and any barrelage exceeding 6 million remains subject to the old $18.00/barrel rate.

To provide some context, there are approximately 150 breweries in Massachusetts and only one (Samuel Adams, the flagship brewery of the Boston Beer Company) produces more than two million barrels per year, so most of these breweries will qualify for the $3.50/barrel tax rate. However, the CBMTRA is set to expire in 2020, so this rate reduction might not last forever.

More Collaborations

The CBMTRA also eliminated tax on the transfer of beer between bonded facilities. This permits breweries to begin production in one facility and finish in another. Prior to the CBMTRA, a brewery could only receive and store beer produced by another brewery if the taxes were already paid and the beer was already packaged. Beer collaborations have become increasingly popular in the past decade, seen as a way to reach new audiences and also learn from fellow brewers. Now, breweries no longer need to host the production at a single site but can instead ship unfinished beer back and forth. However, this benefit all comes with one caveat – state laws. The CBMTRA is a federal law and there are still state and local regulations on intrastate beer transportation of which breweries need to beware.

Other Items to Consider

It is easy to overlook old tax incentives when there is new tax legislation enacted. With that in mind, here are a few additional tax issues to keep on the radar that may not be new, but may be material:

• Tip Credits – Many breweries open a tap room as a way to get people drinking their beer. Tap rooms collecting and reporting tips on poured beers may be entitled to tax credits on social security payments paid to the government. These tip credits can add up to tens of thousands of dollars per year.
• Sales Taxes for Multi-State Operations – As a brewery grows, so does its regional footprint. State taxes may be a burden, but compliance is crucial to ensure the brewery does not end up paying state sales or use taxes, which should be paid by customers.
• Research & Development (R&D) Credits – Breweries today are innovating with new styles of beer and doing business in ways the industry has not seen before. Breweries creating new canning processes or developing new techniques to improve efficiency may be entitled to tax credits for research and development (R&D) expenditures on these innovative endeavors. The R&D credit rules are complex, but the credits can yield real dollar-for-dollar tax savings at both the federal and, potentially, state levels.

The Takeaway

Both the new and preexisting tax law contain many provisions that can impact breweries. Since many breweries are organized as flow-through entities, that impact is felt directly by the individual owners. It is important to seek advisors that can work with the businesses and the individual owners simultaneously to proactively implement tax saving strategies and structural planning.