North Carolina, like many states, teems with breweries -- as well as brewpubs, distilleries, and other manufacturers. It’s a booming industry nationwide and one that got a bit of boost with tax reform. If this is your business, you’ll want to listen up.
The Tax Cuts and Jobs Act (TCJA) affords craft breweries and others a wealth of opportunities to positively impact their bottom line, including:
Cash basis method of accounting and accounting for inventories
Under the previous rules, companies were generally allowed to use this method if their average annual gross receipts did not exceed certain levels (usually $10 million max). The new rules increase that gross receipts test to $25 million, allowing more small brewers to use the cash basis method of accounting. In addition, taxpayers who meet the $25 million gross receipts test do not have to account for inventory under IRS Code §471, General Rule for Inventories, and typically can treat inventories either as non-incidental materials and supplies or conform to the inventory method used for financial statement purposes.
In plain English? That’s way easier and leaves more money in your pocket.
Also impacted by the increased $25 million gross receipts test are the uniform capitalization (UNICAP) rules for inventory. Both producers and resellers meeting the $25 million gross receipts test are now exempt from the UNICAP rules.
These provisions are effective for tax years beginning after Dec. 31, 2017.
Deducting the cost of new equipment
Craft brew equipment is expensive, so the following tax savings are very welcome and may allow some brewers to expand their operations.
Under the new law, businesses may take:
- 100% bonus depreciation on new or used tangible personal property with a recovery period of 20 years or less that is both acquired and placed into service after Sept. 27, 2017, and before Jan. 1, 2023.
- 50% bonus depreciation on property acquired before Sept. 28, 2017, and placed in service after Sept. 28, 2017.
- 20% bonus depreciation property acquired and placed in service after Dec. 31, 2022, and before Jan. 1, 2027.
Another benefit is Section 179 expensing, which allows businesses to deduct the cost of qualifying equipment and software placed in service during the tax year. The new law increases the expense limitation to $1 million and the phase-out amount to $2.5 million for property placed in service in taxable years beginning after Dec. 31, 2017.
New limits on deducting business interest
Under the new TCJA rules, most companies would not be allowed an interest expense deduction for amounts exceeding 30% of their adjusted taxable income.
Adjusted taxable income for years beginning before Jan. 1, 2022 is defined as taxable income calculated without regard to depreciation, amortization, business interest expense/income, net operating losses, items of income or loss not allocable to the trade or business and deductions for certain pass-through income.
For tax years beginning on or after Jan. 1, 2022, the definition of adjusted taxable income is the same as previously described other than the adjustment for depreciation and amortization.
Note to small brewers: This rule generally doesn’t apply to taxpayers who have less than $25 million of average annual gross receipts for the previous three years (our “small” brewers). So, for the new brewers in our region still building their gross receipts, this limit on deducting business interest wouldn’t really have an effect.
Now, for our larger brewing clients, those with average annual gross receipts exceeding $25 million, we can help reduce the impact of the interest limitation by utilizing other tax-saving strategies -- adding new equity investors rather than acquiring debt, for example. Talk with your BGW teammate for more info.
R&D tax credit opportunities
We always say the R&D is one of the most underutilized tax saving strategies. Why? Because companies don’t think they research and develop anything! Nothing could be further from the truth. Craft brewers develop and test new beer recipes all the time, experiment with new ingredients, improve bottling and packaging concepts and processes, just to name a few. And, yes, that’s R&D. Brewers of all sizes are very likely eligible for this credit.
In addition, certain start-up breweries may also be eligible for the R&D credit payroll offset that was enacted as part of the Protecting Americans from Tax Hikes (PATH) Act of 2015. The R&D credit payroll offset allows eligible small businesses that have little or no income tax liability to offset the R&D credit against payroll taxes instead of income taxes. To qualify, a business must have gross receipts of less than $5 million for the current taxable year and no gross receipts for any taxable year preceding the five-taxable-year period ending with the current taxable year. For example, to be eligible for the R&D credit payroll offset in 2017, a company must have had less than $5 million of gross receipts in 2017 and no gross receipts prior to 2013.
The election to claim the payroll tax credit must be made on a timely filed original tax return (including extensions). Up to $250,000 of annual federal R&D credits can be allocated against payroll tax liability, beginning in the first quarter after the filing of the income tax return.
Excise tax rate decrease
Both large and small craft breweries also have the potential to see a reduction in their per-barrel excise rates. Small brewers producing less than 2 million barrels per year could see their rate go down from $7 per barrel to $3.50 per barrel for the first 60,000 barrels. The general excise tax rate will go from $18 per barrel to $16 per barrel on the first 6 million barrels, and the rate is $18 per barrel for barrels brewed or imported in excess of 6 million barrels. The new rates go into effect for beer removed after Dec. 31, 2017, and before Jan. 1, 2020.
20% deduction for certain pass-through income
The TCJA includes a rule allowing individuals, estates, and trusts to claim a deduction equal to 20% of the domestic qualified business income from a partnership, S corporation, or sole proprietorship. The deduction is generally subject to a limit based on either wages paid or wages paid plus a capital element.
This is not the most straight-forward deduction in the world. In fact, it’s incredibly tricky, and we’re still waiting on a lot of clarification from the federal government. Consult your BGW teammate for help here.
Converting to a C corp
This, too, is a complicated question with many variables to consider. But, when it’s right, it’s right. The highest marginal rate for individuals is 37% under the new law, while C corporations are taxed at a flat rate of 21%.
What factors do you need to consider before making the switch? Start here. Ultimately, however, switching entity types is a very individual decision based on multiple factors. Make the switch only after discussing it with your tax advisor.