Regulations may Benefit Innovators
Research and experimentation expenses, which would normally be capitalized, can be deducted for tax purposes in the year in which they are paid or incurred.
This deduction can be a source of significant tax savings for wineries who incur these costs since qualifying expenses do not get included in the cost of wine inventory and are instead deducted in the year incurred.
Previously, the IRS definition of eligible expenses was unclear. New regulations have expanded the definition of deductible costs and clarified some of the provisions. Under the regulations, certain costs of developing new processes, testing equipment modifications, or investigating new vineyard practices may be deductible as they are paid (for cash basis taxpayers) or incurred (for accrual basis tax filers).
According to the regulations, research or experimental expenditures "must be incurred in connection with the taxpayer's trade or business" and represent "research and development costs in the experimental or laboratory sense".
Included in the regulations are:
- costs incident to the development or improvement of a product
- costs of obtaining a patent, such as attorneys' fees expended in making and perfecting a patent application
- expenditures for activities intended to discover information that would eliminate uncertainty concerning the development or improvement of a product. "Uncertainty exists if the information available to the taxpayer does not establish the capability or method for developing or improving the product or the appropriate design of the product"
Eligible winery activities might include:
- Development of new or improved fermentation processes
- Development of new or improved bottling and packaging processes
- Development and testing of new or improved corks
- Development of new or improved ingredient processing techniques
- Development of filtration methodologies
- Development of new or improved water recycling or waste management processes
- Development of new or improved fermentation or bottling equipment
- Development of new or improved product formulations
- Development of ingredient mixing methodologies
- Development of new or improved product prototype batches
- Development of flavor or aroma profiles
- Development of new or improved preservative chemicals
- Testing of new or improved products to ensure consistency
- Testing of new or improved products to ensure shelf life
- Testing of product ingredient mixtures for desired flavor or aroma profiles
- Development of new or improved qualify assurance testing processes
When winery activities qualify, the following types of expenditures should be considered:
- Salaries and wages
- Lab analysis costs
- Rental or lease costs of computers
- Contract research expenses
- Engineering costs
The term research or experimental expenditures does not include expenditures for—
- The ordinary testing or inspection of materials or products for quality control (quality control testing)
- Efficiency surveys
- Management studies
- Consumer surveys
- Advertising or promotions
- The acquisition of another's patent, model, production or process
- Research in connection with literary, historical, or similar projects
The regulations provide the following wine industry example:
"Z is a wine producer. Z is researching and developing a new wine production process that involves the use of a different method of crushing the wine grapes. In order to test the effectiveness of the new method of crushing wine grapes, Z incurs $2,000 in labor and materials to conduct the test on this part of the new manufacturing process. The $2,000 of costs represents research and development costs in the experimental or laboratory sense. Therefore, the $2,000 incurred qualifies as research or experimental expenditures under section 174 because it is a cost incident to the development or improvement of a component of a process."
Please contact us for help applying these rules to your winery.