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Should Wineries Rush to Adopt the Cash Method of Accounting in 2018?

Under the “Tax Cuts and Jobs Act”, signed into Law in December of 2017, certain taxpayers who have annual average gross receipts of less than $25 million for three prior taxable years can elect to use the cash basis of accounting. 

This sounds like a huge tax savings opportunity for wineries who meet this test, doesn’t it?

As a winery, it sounds like you can finally stop dealing with those pesky accountants who won’t let you expense the costs you incur (like grape purchases, cellar and production, and bottling) this year in producing wine that won’t be sold for three or more years in the future.  Your life will be so simple and you will never have to pay taxes again, right? And who needs a bookkeeper anymore?  

Not so fast.

While it is true that qualified wineries can elect to use the cash method of accounting for tax purposes, there are some other requirements:

  1. You must either
  • Treat inventory as “non-incidental” materials

or

  • Use the same method of accounting in your “applicable financial statements” purposes (i.e. prepared on a GAAP basis of accounting, which means you are back to using the Accrual Basis of Accounting.)

So, if you don’t want to keep your tax records according to GAAP, you are left with the option of treating inventory as non-incidental materials for tax purposes.

Under this method, the cost of inventoriable goods, like bottled wine, is deductible in the year sold, or in the year in which the goods are paid for, whichever is later. 

Here’s a comparison of the current tax-based inventory costing versus the non-incidental materials method: 

Accounting Decision

Tax Filing

Accrual Basis

Tax Filing

Cash Basis (new law)

Non-incidental materials method

LIFO method of costing inventory

Applies most recent costs to items as they are removed - provides tax savings in inflationary times

Not applicable

Inventory on Hand

Must be tracked

Must be tracked

263A Uniform Capitalization Rules

Requires additional indirect costs to be allocated to the wine inventory costs. 

Not applicable – Direct Costs Only

When costs are deductible

When item is sold

When item is “consumed” in taxpayer’s operations [1]  or paid for by the taxpayer, whichever is later.  For inventoriable items, “consumption” happens at the time of a sale to a customer. 

 

Depending on your facts and circumstances, a switch to the cash method of accounting may have a positive or negative impact on your inventory costing for tax purposes.  You need to carefully look at both options. 

Other Costs of Changing

There are filing and computational requirements needed for making this change.

A change in accounting method requires the filing of IRS form 3115 with the IRS and requires the taxpayer to calculate the impact of the change in method (called a §481 adjustment). If the change increases income, it must be added to income over the next 4 years. Any negative adjustments are taken in a single year.

Multiple Sets of Books

And don’t forget, the accrual method of accounting will still be required for most other purposes (and for managing your business effectively.)

Other implications – Revenues and Expenses

If you move to the Cash Basis for tax purposes, you will exclude uncollected customer receivables (Accounts Receivable or AR balance) at the end of the year from income, but you must also ignore any unpaid vendor and supplier invoices (Accounts Payable or AP balance). The change to Cash Basis can have a positive or negative impact on your taxable income, depending on the relationship between these two balance sheet accounts at the end of any given year.  For those qualified wineries with a significant portion of revenue coming from wholesale sales and a resulting significant AR balance at the end of the year, this provision may offer tax savings.  (Any differences here will also be considered in the §481 adjustment mentioned previously.)

The Bottom Line?

As with almost every other tax situation, the answer is, it depends.  You need to carefully consider the unique facts and circumstances of your winery.

 

[1] Reg § 1.162-3