The following is a guest post written by Sara Schorske, founder of Compliance Service of America (CSA). Sara is one of the original compliance specialists in the alcoholic beverage industry. She has advised and assisted clients with compliance matters, trained many winery personnel and compliance professionals, and written numerous articles on compliance for industry publications since she founded CSA in 1983. She is known in the industry for her clear, down-to-earth explanations of complex regulatory matters. CSA is a leading provider of regulatory consulting and licensing services for the alcoholic beverage industry, nationwide.
Late last Friday afternoon (March 2) TTB released further guidance on the recently enacted Craft Beverage Modernization and Tax Reform Act. The new guidance finally answered some large and pressing questions about how the law will be implemented, and revealed some very troubling consequences. While the Act created new tax credits that were meant to benefit all wineries large and small, it’s now clear that it falls short of its promise due to its poor drafting and hasty implementation.
Not all of your wine is eligible
In three FAQs added last week to TTB’s website the agency confirmed that, because of the way the law was written, only wine produced by the taxpayer who removes the wine is eligible for the new credits. This means that any wine received in bond is not eligible for the new credits — unless the removing winery has performed an operation on it that increases its volume, such as sweetening, the addition of wine spirits, amelioration (where legal), or the production of formula wines which was “undertaken in the ordinary course of production and not solely for the purpose of qualifying for the credit” (emphasis added). (This means that wineries are not allowed to add concentrate or perform other production activities on wine only for the purpose of qualifying for lost tax credits.) In effect, wineries were told that their common industry practice of custom crushing, which allows wineries to use their excess production capacity to help other wineries who are short on fermentation space, and the thriving business of buying and selling wine in the bulk market, so central to the health of the industry, have suddenly inherited heavy, unexpected tax consequences, putting wineries that rely on them at a competitive disadvantage.
Transfer of credits has been suspended
TTB’s guidance also announced that the provision allowing wineries to use their tax credits on wine stored in bond at independent bonded wine cellars (BWCs) is now suspended, because it was allowed in connection with the currently suspended Small Producer Credit. Under the transfer-of-credit provision, small producers were formerly allowed to transfer their tax credits on wine they produced to other taxpayers – an important privilege since most smaller wineries (and many larger ones) simply do not have the warehouse space to store all of their own case goods. Therefore, it is common for wineries to ship their case goods in bond to BWC warehouses that offer storage, consolidation, and shipping services. The BWCs have been removing the wine and paying tax on their winery clients’ behalf, at each winery’s tax rate.
When the new Act suspended the Small Producer Credit, it neglected to extend the transfer provisions. Wineries that could have shipped credit-eligible wine to a BWC in bond without losing their tax credits last year must pay their taxes at the winery before shipment in order to take their tax credit this year – or, if the wine is already stored at a third-party BWC as hundreds of thousands of cases are, the winery must return it to the winery for removal from bond.
Recognizing the cost and impracticality of returning wine physically to the winery from the BWC, TTB created an alternate procedure of operation that will partly make up for the problems, but only for several months. And TTB has not addressed how they will treat wine that has already been removed from BWCs during the first two months of 2018, and whether the alternate procedure can be used retroactively.
The newly announced alternate procedure allows wineries to return wine to the winery, remove and taxpay the wine at their own premises, and send it back to third-party storage through a series of paperwork transfers without physically moving the wine. This solution will be available only until June 30, 2018. I will describe in detail how to use the alternate procedure later in this article.
Other implications to consider
What does this mean to your winery? There are many operational implications to these changes. I will describe four of them below. Please read the following discussion carefully to see what parts of it apply to you.
First, part or all of the products sold by your winery may be ineligible for the new tax credits, because they were not produced at the winery. The new Act changed what wines would be eligible for the new credits in a very significant way. In the past a small producer could purchase and bottle bulk wine made by another winery, and as long as it removed the purchased wine from its winery, it could claim the credit on that wine. The new credits can only be taken on wine the winery both produced and removed. Wine received from another winery in bond and merely bottled by the winery that removes it does not qualify for the new credits.
The guidance published last week did not address whether the new credits would apply to any of your products that are blends of wines produced by your winery with wines from another winery. After querying TTB directly about the issue we’ve been told that when a winery removes from its bonded premises wine of its own production that has been blended with wine produced by another winery, the winery may claim the credit only for the portion of the wine that it produced. It may not take the credit for the portion of the wine that it did not produce. TTB intends to post official guidance on this question to its website very soon.
Beyond the reductions in tax credit eligibility for blending with purchased wine, you may also inadvertently sacrifice some of the tax credits you could otherwise take on wine produced at your winery if ineligible wines are removed from bond earlier in the year. Because the tax credit is allowed on wine in chronological order of removal (the first 30,000 gallons, next 100,000 gallons, and next 620,000 gallons removed) any non-qualifying wine removed before all the credit is used up reduces the total gallonage eligible for tax credits in the calendar year. For example, if half of the first 30,000 gallons of wine removed happens to be ineligible for the tax credit, the winery will only be entitled to take the highest rate of credit on the remaining 15,000 gallons of wine.
Since it is March, your winery may have already removed wine from bond in 2018, so it may be too late to avoid the loss of some or all of your eligibility for the highest rate(s) of credit.
Second, many wineries have significant quantities of wine in bond stored off-site at third-party commercial warehouses. If this wine was not produced by your winery, just leave it there: you face no loss of tax credits when the BWC removes that wine at the full tax rate. However, if the wine was totally or partly produced by your winery and therefore is eligible for tax credits, you will be able to take the tax credit only if you return the wine to your winery and taxably remove it at your own bonded premises. In recognition of the logistical difficulties and expense of this requirement to both the wineries and the BWC’s, and the fact that wineries and BWCs had no advance notice of this change giving them the opportunity to taxably remove the wine at the BWC before the law went into effect, TTB has instituted for a limited time an easier alternate procedure for wineries to tax determine and taxpay wine stored in bond at bonded wine cellars, described in detail in TTB Industry Circular 2018-1. This procedure may be used any time through June 30, 2018.
Under the alternate procedure, wineries may return wine to their own bonded premises for removal and tax payment through paper documentation and reporting, without any physical movement of the wine — in other words, using a paper-only transfer — under the following conditions:
- The transfer documents used must clearly refer to the alternate procedure in Industry Circular 2018-1.
- All of the documented transfers must be completed so that the removals from bond occur on or before June 30, 2018.
- All “movements” must be reported on the winery’s and BWC’s Forms 5120.17, Report of Wine Premises Operations. The wine must be reported as transferred in bond from the BWC, received in bond at the winery, and taxpaid at the winery. Bills of ladings or invoices showing taxpaid wine returned to the BWC and received by it for taxpaid storage should also be prepared.
- The taxes due must be paid by the due date for the wine producer’s next tax return following the removal. For annual reporters, the bills of lading and/or invoices showing taxpaid wine returned to the BWC must be dated on or before June 30, 2018, but the wineries may report the transfers and pay the taxes on the annual 5120.17 and annual Federal Excise Tax Return due next January.
- No TTB approval is needed before using the alternate procedure.
- BWCs need not establish enlarged taxpaid areas to accommodate the additional taxpaid storage created by use of the alternate procedure. Any taxpaid wine stored outside of the BWC’s already established taxpaid area(s) must simply have markings on the outermost packaging of the taxpaid wine so that its taxpaid status is readily identifiable.
It is good that TTB devised the alternate procedure to permit wineries to take the tax credit, but having to do so will certainly create financial hardships. In order to take advantage of the tax credits on wine stored at third-party BWCs, many wineries will now be compelled to make large tax payments months or even years in advance of sale, due to limitations of storage space at the winery’s own premises. In addition to the expense of generating the needed paperwork, the unplanned cost of having to pay all those taxes will obviously put a financial burden on those wineries.
Third, wineries eligible for tax credits that remove more than 30,000 gallons of wine a year will need to implement additional recordkeeping procedures in order to remove wine at the proper tax rate throughout the year, and be aware of the point at which the tax rate changes. Wineries that sell and remove some wine that qualifies for the credit and other wine that does not qualify will have the additional burden of making sure each case is taxpaid at the correct rate, depending on how much wine has previously been removed this year, and how much of the removed wine was not produced by your winery. But remember, when you remove wine that doesn’t qualify for the tax credit, you must still include it in your cumulative total of gallons removed to date, in order to know what tax rate the winery currently qualifies for.
Because the law requires wineries to use the credits chronologically on the first gallons removed each year, wineries that have both eligible and ineligible wine will want to avoid if possible removing ineligible wine from bond in the first 30,000 gallons removed, and potentially also within the first 130,000 gallons removed, if they have enough eligible wine to take full advantage of both of those tax rates. That is, a winery that will remove over 30,000 gallons of wine of its own production during the year will want to make sure that the first 30,000 gallons removed will all qualify for the tax credit. The same is true for a winery that will remove over 130,000 gallons of wine of its own production during the year: it will want to make sure that the first 130,000 gallons removed will all qualify for the tax credit. A simple way to accomplish this would be to send your non-qualifying wine in bond for storage at a BWC who will later remove it at the time of sale and pay the taxes on behalf of the winery.
Fourth, small wineries that previously qualified for the Small Producer Credit but do not produce 100% of their wine will now owe tax at the full $1.07/gallon rate — a huge tax increase they had no way to anticipate. As I said earlier, wine received in bond and bottled by the small producer under its own label formerly qualified for the Small Producer Credit if removed at the small producer’s winery. The 2018 tax law has made such wine ineligible for any credit, requiring the small producers to pay taxes at the highest rate. This was certainly not the intention of the legislature or the administration in enacting this law and accelerating its effective date.
Hopefully, wine industry lobbyists will be able to prevail on Congress to enact emergency corrective legislation before the end of the year to reverse or mitigate some or all of these impacts. However, until corrective legislation is actually passed and confirmed to correct the problems, it is prudent for wineries to consider how the various implications of the new law impact their operations, and protect their interests as best they can.
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