While everyone is ready to forget about 2020 and move on, doing so will not be so easy for California wine producers. It is not just the unprecedented destruction to iconic Wine Country institutions; even those producers lucky enough to have escaped direct damage to this year’s crop by wildfires are far from in the clear. That is because a wine vintage is, among other things, a sort time capsule, and unfortunately the specter of smoke taint present in many of this harvest’s grapes will likely serve as an unfortunate reminder of all the strife that 2020 has wrought.
Where There Is Fire, There Is Smoke
Despite all that, wine producers, more than anyone, are accustomed to dealing with whatever fortune nature brings them. They are resilient. Smoke taint is a challenge, yes, but one to be overcome through the art and science that is modern winemaking.
With the 2020 harvest coming to a close, grape growers have already had to make tough decisions, including whether to scrap this year’s harvest. Many, however, have invested significant resources into combatting the effects of smoke taint in their wines. Some are applying cutting-edge science to salvage smoke-tainted grapes. Others are, for instance, creating novel products.
Credit Where Credit Is Due
There may be a silver lining for these winemakers who have spent money on exploring or realizing new products or processes in response to wine taint in their grapes: a credit on their 2020 tax return.
Many winemakers will already be familiar with the R&D credit, but for those not, here is a quick run-down. The R&D Tax Credit is a federal tax incentive program that provides a dollar-for-dollar reduction of a taxpayer’s tax burden on qualifying research and development expenses. To reiterate: It is not a tax deduction (although Section 174 of the U.S. Tax Code does, separately, allow taxpayers to utilize deductions on many of the same expenses instead of taking the credit). For every dollar spent on qualifying R&D expenses, the taxpayer can receive an equivalent reduction to their tax burden.
Moreover, it does not have to be used immediately. If a business cannot use the deduction because their tax liability is already zero, they may carry it forward and apply it on to tax returns up 20 years in the future.
How do you know if your investments in combatting smoke-taint qualify for the R&D Credit? The IRS applies a four-part test to determine if a given expense qualifies:
- The Technological in Nature Test. Fundamentally, the nature of the activities must rely on the principals of engineering, computer science, biology, chemistry, physics, etc.
- The Business Component Test. The purpose of the effort must be intended to develop or improve a new or existing business component. A business component can be “any product, process, computer software, technique, formula, or invention, which is to be held for sale, lease, license, or used in a trade or business of the taxpayer.”
- The Technical Uncertainty Test. Activities meant to develop or improve a business component must showcase an attempt to overcome or eliminate technical uncertainties or obstacles. For example, attempting to overcome uncertainties related to capabilities, methodologies, or discovering the most appropriate design would satisfy this test.
- The Process of Experimentation Test. In an attempt to overcome technical uncertainties, there must evidence of a “process of experimentation” to evaluate alternative solutions. This can be done through performing modeling and testing efforts, systematic testing, trial and error-based testing, or refining and discarding hypotheses thorough an iterative process.
As you might have guessed, a good many activities directed towards fixing smoke taint would likely pass these four tests. Examples of activities likely to qualify include:
- Evaluating new techniques to minimize smoke exposure
- Employing new methods for salvaging fermentations
- Exploring new product developments or alternatives
- Lab testing
- Bringing on new equipment or tools
- Evaluating clarification methods
- Evaluating aging methods
Of course, individual circumstances vary. Determining whether a given activity can reasonably be said to qualify for the R&D credit is a highly specialized area of tax expertise. To minimize the possibility of potentially costly audits, consult a reputable R&D tax expert before making any important decisions about your crop.
For Thorough Answers to Your Business’s R&D Credit Questions, Contact BPM
The harvest is coming to a close and winemakers are having to make tough decisions about what to do with their grapes. Addressing wine taint can be expensive, and the possibility of applying the R&D Credit to those expenses may be a factor in winemakers’ decisions regarding what to do with their 2020 vintage.
For swift, thorough answers to your R&D Credit questions, you can trust the professionals in BPM’s R&D Tax Credit team. Our R&D experts have deep domain expertise in this specialized area of the tax code and provide grape growers and other wine industry businesses with sophisticated business consultations to help you determine the best use of your credit. Coupled with our strong ties and robust client base in the wine industry, BPM is the superior choice to handle all your wine business’s R&D Credit needs.
To learn more about how BPM can help during these challenging times, contact Andre Shevchuck, partner and leader of BPM’s Tax Credit Consulting Practice, at AShevchuck@bpmcpa.com.