by David Natan
Breweries and distilleries often overlook the potential tax savings opportunities available with the R&D tax credit. As most breweries invest resources and time towards improving processes and developing new products, the R&D tax credit could provide your tasty venture dramatic tax savings. Recent legislation has made the credit permanent and enhanced its application by not limiting it to Alternative Minimum Tax (AMT) as well as providing a new potential payroll tax credit offset opportunity.
The R&D credit is a dollar-for-dollar benefit-against-tax designed to stimulate efforts aimed at the advancement of U.S. companies. While most of the credit savings may come on the federal tax side, there are certain states that offer their own version as well. Computation of R&D is complex and entails several different elections. The credit is primarily derived from an allocation of employee time, consultant expense, and related R&D supplies.
As of January 2016, eligible small businesses ($50 million or less in gross receipts) could claim the credit against AMT. This will benefit a significant number of closely held businesses and their shareholders who previously had to defer some or all use of their credit due to the AMT limitations. Due to the 2017 Tax Cuts and Jobs Act, as of 2018 only eligible small businesses and pass-through entities may be eligible to use the R&D credit to offset AMT (C corporations repealed AMT beginning in 2018). Additionally, certain small businesses ($5 million or less in gross receipts) will have the ability to offset the credit-against-payroll tax liability (capped at $250,000 for up to five years). There are many complexities to this law and how to apply it to your business.
The activities performed by brewers and distillers must meet the following to qualify for the R&D credit:
Technical in Nature: Though the R&D credit is not just for scientists, its application depends on the hard sciences. To qualify, research and development activity must rely on the principals of engineering, physics, biology, chemistry, or computer science.
Permitted Purpose: Contrary to popular belief, R&D does not exclusively pertain to new products. Taxpayers can only reap the benefits of R&D if they are working on projects undertaken for the development of a new or improved product or process. Increased performance, processes, functions, products, quality increases, reliability, and substantial cost reductions all fall under the umbrella of permitted purposes.
Process of Experimentation: Qualified research involves an element of trial and error. The venture’s process of experimentation must be designed to evaluate alternatives to achieve a result where the potential to achieve that result is initially uncertain. Measures that are taken to produce a hypothesis and test it are noted by the IRS when deciphering which research and development activities are entitled to the R&D credit.
Elimination of Uncertainty: You must demonstrate that you’ve attempted to eliminate uncertainty about the development or improvement of a product or process. For example, something that has been changed solely for aesthetic purposes would not qualify.
Some Examples of R&D Activities Within the Brewing and Distillery Industry Include:
- Adding new equipment pertaining to process improvement or new bottling/brewing equipment
- Developing new or improved hopping techniques or varieties of hops
- Developing new or improved yeast strains or fermentation processes
- Developing new or improved bottling and canning processes
- Developing new or improved bottle designs (including cans/crowns, etc.)
- Developing new or improved keg filling techniques, water recycling, or waste management
- Developing new or improved product formulations or improved ingredient mixing methods
- Developing new or improved prototype batches or improved preservatives
- Testing of new or improved designs to ensure shelf life or longevity
- Testing of product ingredient combinations relative to new flavors or enhancements
- Improving engineering process, new equipment, and production lines
- Production runs, proof of concept, etc.
A company that has not previously claimed the R&D tax credit but is eligible can look back to the prior three tax years to claim any missed R&D tax credit opportunities. Even if the company does not have taxable income and their credit is limited, the federal tax credit can be carried forward for 20 years. State credit carry forwards vary by each state.
To support qualified research, brewers and distillers must maintain documentation on paper or electronically. In addition to issuing logs and meeting minutes, taxpayers may utilize email communications, technical reports, and patent applications to warrant the R&D credit. Where there is indication of efforts to improve an existing process, research and development documentation is broad and takes many forms. Between information provided by taxpayers (or lack thereof) and the standards set by the IRS, distribution of the R&D credit can be challenging. This difficulty has shown up time and again in numerous court cases over the years. Keeping detailed records of R&D activities and consulting with a CPA firm that understands the credit can prevent future headaches and maximize your credit opportunity.