Utilizing IC-DISCs is a savvy strategy for U.S. wineries aiming to expand internationally, offering significant tax benefits, and supporting cash flow management.
Successful international expansion requires understanding and navigating local regulations and choosing the appropriate business structure or appropriate method of entering a foreign market that will sustain company growth and provide necessary flexibility.
Advanced technologies and innovative practices can help wineries enhance production efficiency, market analysis, and intellectual property management.
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You have invested time, energy, and meticulous care into crafting your wine. As a result, you have steadily increased your brand recognition and revenue. With a solid domestic footprint in place, you start the process of building your international presence.
That’s when you run into some new challenges: Cost. Compliance. Taxes. Understanding the complexities of structuring your business and strategic tax planning are crucial as your winery expands its reach to a larger global and more diverse audience.
To get the most from your winery’s international expansion, here are four key strategies to keep in mind:
1. Decreasing Your Tax Burden on International Sales
One of the primary considerations for wineries expanding internationally is the strategic formation of an IC-DISC (Interest Charge Domestic International Sales Corporation). This tax vehicle can significantly benefit U.S. exporters by reducing tax burdens on export income. By establishing an IC-DISC, your winery can enjoy deferred tax payments and lower rates on dividend distributions, which are vital for managing cash flow and reinvesting in growth.
Wineries with substantial international sales should consider an IC-DISC strategy. While the setup involves initial costs and compliance, the long-term tax savings make it an attractive option. Careful planning and advice from tax professionals with specific knowledge of the wine industry can help you maximize the benefits.
2. Navigating International Compliance and Business Structuring
Expanding into international markets requires more than just tax planning — it demands a comprehensive understanding of the local compliance and business environments. Your winery must adhere to various regulations, from local business laws to specific wine industry standards, which can differ significantly by country.
Choosing the appropriate business structure or method of entering a foreign market is pivotal. Whether establishing a direct presence through subsidiaries or leveraging partnerships, your winery must assess its operational scale and strategic goals. For smaller wineries, direct export might be feasible. Larger operations might benefit from a more established local presence, which can facilitate deeper market penetration and brand recognition.
3. Leveraging Technology and Innovation
Incorporating technology and innovation has become an increasingly important competitive advantage in the wine industry. From production techniques to supply chain management, technology can streamline your operations and enhance quality control across borders.
Advancements such as artificial intelligence (AI) offer new ways to analyze market trends and consumer preferences, enabling wineries to adapt strategies dynamically. For instance, AI is transforming the way sommeliers select and pair wines. Additionally, AI-powered systems can examine the chemical and sensory attributes of wines, recommending ideal conditions and components to achieve a specific flavor profile. This leads to time savings, minimizes waste, and provides winemakers the flexibility to explore novel mixtures and styles.
The use of AI and Generative AI (GAI) in wine inventory, selection, and pairings is growing increasingly popular. Companies that consider how to capture these business processes — and do so tax efficiently — may reap the rewards of increased profitability.
4. Building a Responsive and Agile Business Model
For wineries operating internationally, quickly adapting to new opportunities and challenges is critical. This includes being responsive to market demands, regulatory changes, and competitive pressures. Developing an agile business model allows for rapid adaptation and decision-making, enabling you to take advantage of emerging trends and mitigate potential risks.
Tax and accounting firms can assist wineries in building responsive models that quickly adapt to market demands and regulatory changes. In addition, helping wineries know when and how to upscale from one operating model to another is often critical. Strategic advisory services can help your winery anticipate shifts in the international landscape and adjust your strategy effectively, reducing risks and capitalizing on new opportunities.
Taking Your Winery to the World Stage
For wineries looking to expand internationally, a strategic approach to tax planning, compliance, and business structuring is essential. By leveraging tax strategies like IC-DISCs, ensuring compliance with local regulations, adopting innovative technologies, and developing an agile business model, you can enhance your competitiveness and position your wine for growth in the global marketplace.
How MGO Can Help
MGO can provide your winery with guidance on setting up an IC-DISC. Our tax professionals are well-versed in the complexities of international tax law, helping you enhance tax savings and manage compliance risks. Our team can also advise you on optimal business structures, market entry strategies like importing or licensing, and adherence to international standards.
With our global reach and local knowledge, MGO equips your winery with the insights needed to establish and maintain a compliant international presence. Reach out to our team today to learn more.
Businesses must now capitalize Research & Experimental (R&E) expenditures and amortize them over 5 or 15 years, significantly impacting cash flow and project viability for innovation-driven enterprises.
The gradual phase-out of bonus depreciation rates necessitates a reevaluation of capital expenditure strategies and their tax implications.
Mergers, acquisitions, and international transactions can come with complex tax consequences. Proactively engage with your accountant to navigate compliance, optimize tax positions, and leverage strategic planning opportunities.
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You turn to your tax advisor to learn how the latest tax law changes will impact your organization. But does your advisor reach out proactively to discuss how upcoming changes might impact your business and its tax liabilities?
As we progress through 2024, several significant tax developments may impact how you make business decisions and manage your tax obligations. Is your accountant aware of these changes and, more importantly, actively discussing the implications and opportunities with you?
1. Research and Experimental Expenditures
Internal Revenue Code (IRC) Section 174 was one of the most radical components of the Tax Cuts and Jobs Act (TCJA) of 2017 and continues to create questions for corporate tax departments today. It requires your company to capitalize and amortize Research and Experimental (R&E) expenditures over five years (15 years for the research performed outside of the U.S.) instead of deducting them in the year incurred.
Losing the ability to deduct R&E expenditures can significantly increase your taxable income, impacting cash flow and project viability.
Your accountant should guide you through the implications of this change, helping you maintain records linking expenses to qualified research activities and maximizing your R&D tax credits.
2. Accelerated/Bonus Depreciation Phaseouts
Another significant change from the TCJA that might catch you off guard is the phaseout of accelerated and bonus depreciation.
As a reminder, the bonus depreciation rate was 100% in 2022 but dropped to 80% in 2023. It will continue to drop by 20% each year until bonus depreciation is unavailable in 2027 (assuming Congress doesn’t enact new tax law changes).
This gradual reduction impacts your ability to deduct the cost of capital expenditures, affecting your tax liability and financial planning strategies.
Despite the phaseout, there are still planning opportunities for companies to consider. For example, you might accelerate planned equipment purchases before year-end, use a cost segregation study to accurately categorize building components into asset classes with shorter recovery periods, and continue to take advantage of Section 179 expensing rules.
Your accountant should proactively discuss these changes with you to help you make informed decisions about capital investments.
3. Foreign Sales – FDII Deduction
The Foreign-Derived Intangible Income (FDII) deduction represents a significant tax-saving opportunity if your company has foreign sales.
FDII is income from the use of intellectual property — legally protected, non-physical assets in the United States used to create an export.
You can deduct 37.5% of your FDII against taxable income, effectively reducing the tax rate on each dollar of FDII to just 13.125%. However, the FDII deduction will be reduced after 2025, at which point the effective tax rate will rise to 16.4% under current law.
Your accountant should actively inquire about foreign sales activities and advise on the potential benefits of the FDII deduction, so you do not overlook valuable tax savings.
4. M&A and Cross-Border Transactions
Mergers and acquisitions (M&A) and cross-border transactions present a complex array of tax considerations.
Cross-border transactions can include any transaction outside of the U.S., including receiving interest or royalties from a foreign entity or making sales in a foreign country (whether to an unrelated third party or a related entity). These transactions can come with transfer pricing considerations, foreign tax consequences, and reporting requirements in foreign jurisdictions.
In the mergers and acquisitions space, your accounting firm can help with various issues, including buy- or sell-side due diligence, risk mitigation, structuring the transaction as a stock sale or an asset sale, analyzing transaction costs, and determining whether you can deduct or capitalize those costs.
Whether you’re contemplating a transaction or have recently completed one, your tax advisor can provide support in navigating the tax implications, ensuring compliance, and optimizing your tax position through strategic planning and structuring.
Unlock the Power of Proactive Advice
The tax landscape in 2024 includes significant changes and opportunities. From how businesses account for R&E expenditures to the strategic implications of FDII deductions, and the potential tax benefits, these developments require careful consideration and strategic planning.
To navigate these changes effectively, engage with a team of advisors who are aware of these developments and prepared to discuss their implications for your business. Reach out to an MGO advisor today.
Sales and use tax rates and regulations change often, and the rules vary widely from state to state. As a result, many businesses find themselves “over-complying” with sales tax rules and neglecting potential savings. For taxes that have already been paid (and that are still within the statute of limitations), you can submit a claim for refund — through a process that is often referred to as a “reverse audit.” In this video, we explore how collaborating with our State and Local Tax team can help you perform a reverse audit to improve your bottom line.
The world of wineries and vineyards is a harmonious blend of tradition, innovation, and meticulous craftmanship. As California grapes transform into wines that delight consumers across the globe, another transformation process is unfolding behind the scenes: one that involves intricate tax considerations like transition planning, international exporting, and proactive tax planning strategies.
In this overview, our International Tax and Private Client Services teams “uncork” the complexities of tax issues that permeate the winery and vineyard industry so you can seamlessly confront tax challenges and seize tax opportunities. As financial landscapes continue to evolve, understanding these challenges becomes essential for vineyard owners, winemakers, and investors alike in their pursuit of crafting both exquisite wines and sustainable financial success. And as some new seasons start, others come to an end. When the time comes to transition the business, you will likely want a seasoned professional to guide you through.
The wine-making cycle
Generally, a vineyard or winery has a business cycle that may take various courses but the course we see most commonly goes as follows:
Organization / Creation / Purchase
The creation of the organization generally entails the creation of an appropriate legal entity. Whether this act should be taxable or not will depend on the tax attributes of the potential owners and should be reviewed to position the organization optimally for taxing purposes.
The purchase of an existing winery or vineyard should be structured in a tax efficient manner such that future depreciation and deductions are maximized for the purchaser. Typically, the maximization of deductions will be at odds with what a seller would desire, so the final decision will stem from negotiations between both the buyer(s) and seller(s). Ultimately, a good due diligence exercise is always warranted in these situations.
Operations
Both metaphorically and physically, the seasons always present themselves with a new beginning for the industry.
There are many ways to operate a winery or vineyard. You may start with raw land—and then have vines, or not. Rocky soil and warm temperatures provide an excellent environment for grapes to make Cabernet Sauvignon, for example. Cooler microclimates and sandier soil offer great growing conditions for Sauvignon Blanc. A vineyard manager may want to “test” some of the grounds and only plant a smaller portion of the plot.
When planting a new crop, it can sometimes take up to three years before a vine produces viable grapes. Veraison is that magical moment when those hard, green grapes transform into plump, juicy clusters. In white grapes, such as those used for Sauvignon Blanc and Chardonnay, the clusters turn from bright green to a more mellow, golden green.
Once your grapes are ready, one may harvest and then crush, press, and start the primary fermentation process. Then the aging and malolactic fermentation sets in. Towards the end of the aging process, winemakers will frequently taste the wine to ensure the flavors are just right. They do this with a “wine thief,” or a special tool that extracts a small amount of wine from the container it is aging in. This is commonly referred to as racking and bottling. Once the process is complete, then one obtains the finished bottle.
Having an appropriate cost accounting system is crucial to tracking the costs that are attributed to each step in the process — and will be the cornerstone to any tax planning you will want to implement.
Having an appropriate cost accounting system should help track the costs that are attributed at each step of the way.
Some of the tax implications that should be considered are provided below.
Qualifying for R&D tax credits
Archaeological records insinuate that wine was first produced in China around 7000 B.C., with the oldest winery in the world in Armenia. So, it’s no secret that wine making has been around for a long time. However, this doesn’t mean winery owners can’t and don’t implement new technologies or approaches to making their cultivation and fermentation methods more innovatively efficient.
And many in the industry do not claim the Research and Development (R&D) tax credit, failing to realize their research activities actually fall into the qualifying research activity (QRA) category. In fact, many daily activities you may already conduct — as well as wages paid to your employees involved in these activities — can qualify.
R&D tax credits enable your business to apply for a dollar-for-dollar reduction of your tax applied to any qualified research and development expenditures you may have. In some circumstances, these credits can be applied against payroll taxes as well. These can provide significant value to your organization, as it provides reduced tax liability and cash back so you can reinvest or apply to other needs. Companies of all sizes are eligible — and the tax definition of “qualified research” is broader than you might think, covering more than research that takes place in a lab. If you develop new or improved products, processes, and/or software to use in your operations, you could be eligible for technologically advancing the industry.
Whether it’s making unique improvements to products already available on the market or inventing something completely new, if you demonstrate you’ve experimented to resolve technological uncertainties and tackle challenges that are new to you, you could qualify. This includes new or improved beverages. The best part? You don’t have to actually achieve your goals in order to qualify.
Examples of qualifying activities
Improving or creating bottling and packaging processes.
This includes bottle labeling or equipment, corks, and methods to improve filtration and shelf life. This could include new packaging designs to improve shelf life.
Optimizing vineyard plots.
This can mean evaluating soil, water availability, and ground slopes for optimal grape cultivation; soil and rootstock process improvement; plant irrigation system development; and trellis improvements.
Augmenting your production mix.
This can include evaluating conditions that affect winemaking like humidity, lighting, and ventilation in your barrels; developing product formulations; experimenting with new combinations for unique flavors; creating new aroma/flavor profiles and ingredient mixing methodologies; experimenting with prototype batches and preservative chemicals; developing new fermenting techniques; developing or refining press-fraction, press-yield or other crush or press trials; etc.
Recycling efforts and techniques related to waste management along with sustainable energy technologies.
Fixed assets — i.e., property, plant, and equipment involved in your winemaking — can prove a powerful tax savings tool if you manage them correctly as well as increase your cash flow, so you can reinvest the savings or hold onto them to endure an uneven or less fruitful year.
Some of the tax opportunities you can capitalize on in the wine industry include:
Reducing your current-year tax liabilities,
Increasing your current-year cash flow, and
Deferring your tax liabilities to later years.
Depreciated assets are one area you might overlook. Because wine production requires a significant amount of equipment you might not think about initially (like infrastructure and process-related electrical and plumbing hookups in your facility), you can count them in the total share of your property’s acquisition or constructed cost. The higher the percentage in assets available for shorter recovery periods, the more tax deferral opportunities you may have. Careful categorizing of assets between personal property v. real property can mean a substantial difference in tax benefit including amount and timing in a given year.
If you have implemented ways to make your winery more environmentally friendly, you may also capitalize on energy efficiency incentives. With an intensifying focus on environmental, social, and governance (ESG) permeating more industries, you can take advantage of available credits and deductions, which are measured against your facility’s ability to utilize alternative power systems (like solar energy) or the installation of energy efficient heating, ventilation, air condition, and lighting.
American viticulture areas
When you first purchase a vineyard, you have the option of acquiring an American Viticulture Area (AVA) intangible asset, whose value is recovered over 15 years through amortization. This provides annual deductions that lower your taxable income — a beneficial opportunity as it shifts the value out of the land that is normally not able to be depreciated.
Didn’t measure an AVA intangible when you bought your vineyard? That’s okay. An AVCA valuation can be performed — and any missed amortization deductions will be taken out from your application year.
Once the domestic tax planning is well oiled, some wineries and vineyards decide to expand.
Expanding operations
Many owners tend to expand their domestic operations, or some even venture overseas. Going offshore presents its own diverse challenges, some of which are described below.
International tax challenges
Exporting your wine abroad is a huge step — and one that can yield significant brand recognition and financial gain. Navigating the challenges associated with crossing borders and marketing in foreign markets coupled with international tax can prove extremely complex for wineries and vineyards because tax regulations vary from country to country, significantly impacting your operations and profitability. The taxes one may need to contend will be beverage taxes, customs and duties, tariffs and income tax, to name a few.
First and foremost, it’s critical that you work directly with experienced tax professionals who are knowledgeable not only about the area where your vineyard is located but also about the laws in the countries where you are exporting to. They can help you remain compliant amid the many seemingly convoluted challenges you face.
Because many countries have double taxation agreements (DTAs) to prevent the same income from being taxed twice, you should understand how these work between your home country and the countries you do business in. You certainly don’t want to be taxed twice!
Another way to successfully traverse these challenges is ensuring your transfer pricing practices are aligned with international guidelines. You’ll want your pricing transactions to remain fair between related entities to avoid tax evasion or an excessive tax burden in specific jurisdictions.
In general, it’s important to ensure you’re well versed in the tax laws of the countries you’re exporting to or operating in. That’s why a tax professional can come in handy. Different countries have different rules about importing, excise taxes, value-added taxes (VAT), and other forms of taxation that can majorly affect your business if you’re not complying.
This brings us to compliance with your reporting. Reporting all your international transactions and income is critical to avoiding penalties or legal issues. You’ll also need to consider any customs duties and tariffs, which may impact how successfully your wine competes in international markets. International tax regulations can change frequently at the hands of political, legal, or economic factors. Stay up to date on changes that could impact your business operations—or tax liabilities.
And just like the U.S. provides tax incentives, some countries do as well to encourage foreign investment and exportation. Your winery or vineyard could take advantage of these if they are available.
International tax compliance when exporting your wine can be complex. It also involves risk. Because every situation is different, you must tailor your approach based on the specific circumstances of your winery with advice from a professional knowledgeable in international tax. They can ensure you are adhering to the most updated regulations as well as maximizing your tax efficiency while remaining compliant.
From simply exporting abroad to setting up local in-country distribution operations we may assist by tailoring a strategy that best meshes with your company. A strategy many exporters use is an IC-DISC. The IC-DISC (Interest Charge-Domestic International Sales Corporation) is a federal income tax incentive for U.S. companies that may export their California wines outside of the United States. Domestic U.S. entities and sole proprietorships are eligible to receive this federal income tax savings. Our team may guide you as to whether an IC-DISC or other strategies are more suitable for you and your winery or vineyard.
Transition and succession planning
Whether you’re passing the business to the next generation or selling to a new owner, transition planning is crucial for taxes in the winery business, as it helps to ensure a smooth and successful transfer of ownership and management. However, transitioning a winery business involves complex financial transactions like asset transfers and potential restructuring. Tax efficiency is key to minimizing potential tax liabilities that could arise from poorly executed transfers. Here are some things to consider.
Minimizing your capital gains tax
Depending on if your winery has appreciated in value since its inception, transferring ownership can trigger capital gains tax. Strategizing the timing and structure of the transfer can potentially minimize these taxes through options like installment sales, gifting, or estate planning techniques. In fact, if the winery has been owned by a corporation, you might be able to sell your stock in that corporation with no taxable gains at all and/or rollover the gain into a new business, income tax free.
Navigating estate and gift tax considerations
Many wineries or vineyards are family affairs. If this is the case, you might face estate and gift tax implications. Taking advantage of exemptions and deductions can help you reduce the impact of estate and gift taxes.
Creating a smooth succession plan
Whether or not you’ve seen the popular show Succession, you know that sometimes, passing something as large as a corporation down to the next generation can cause some drama. That’s why succession planning is critical — it smooths the handover of management and ownership, which will help maintain your business’s stability and profitability. This can include a phased transition, training and development of successors, and establishing clear roles and responsibilities.
Optimizing your business structure
Different business structures have different tax implications. Knowing how to take advantage of your current structure’s tax efficiency and being open to changing it if that could prove advantageous before a transition occurs can pay dividends.
Assessing your value
Knowing the accurate value of your winery business is essential for tax purposes to calculate estate taxes or establish a fair selling price. Conducting a professional appraisal can ensure your business’s value is appropriately assessed.
Determining if you qualify for tax breaks
Some areas offer tax incentives for qualified business transfers, including reduced rates for capital gains taxes or other tax breaks. If you conduct transition planning, you can understand and leverage these applicable incentives.
Complying with tax laws and regulations.
Because tax laws and regulations can vary widely depending on where your winery or vineyard is located — not to mention they change over time — transition planning helps you stay aware of relevant tax regulations over the course of the transfer process, so you don’t incur penalties or legal issues.
Transition planning is a strategic process that analyzes the various tax implications that could affect a seamless and financially sound transition of ownership and management in your business. Tax professionals with experience in the wine industry can help you develop a transition plan tailored to your exact circumstances.
How we can help
Making and selling great wine is your top priority — which is why we’re here to help you navigate the tax challenges and seize the opportunities that can accompany following that passion. Our Private Client Services and International Tax teams are rooted in California, one of the most wine-centric regions in the world. We understand the nuances of your work while providing an external, holistic eye to help you grow and succeed. Contact us today.
Now that a recession seems imminent, it’s important to prepare by adopting state and local tax planning techniques now.
These techniques include performing a nexus analysis to lower your effective tax rate; getting ahead of sales tax collection so that you’re not left holding the bag; coming clean on your own to avoid penalties; and being ready to win in case you “win” the audit lottery.
Right now, you should be taking proactive measures to avoid overexposure and capitalize on opportunities that limit your overall tax burden.
Despite a seemingly robust economic recovery from the COVID-19 downturn, we are now looking down the barrel of another recession. When polled for a Wall Street Journal survey, more than three in five economists predicted a recession will occur over the next year due to a variety of reasons: inflation has hit a 40-year record high, the Fed has raised interest rates to the highest levels in more than 15 years, and several Fortune 500 companies have implemented mass layoffs. In addition, market volatility prompted by the implosion of Silicon Valley Bank and Credit Suisse has sent regulators around the globe into damage control.
While no one can predict the future — and if the COVID-19 pandemic has taught us anything, it is that the economy won’t follow the course of even the most prescient prognosticators. To prepare for the proverbial rainy day, in the following our State and Local Tax team details state and local tax planning techniques you can adopt now.
Technique #1: Perform a nexus analysis to lower your effective tax rate
Typically, a nexus analysis is performed “defensively” when you’re under the threat of an audit or to identify potential tax exposure … and that usually means an increase in state tax. But you should also consider performing a nexus analysis “offensively” as a method for lowering your effective tax rate – either by capturing net operating losses (NOLs) in states where you haven’t previously filed or by lowering apportionment in high-tax jurisdictions.
This first idea rests on the principle that you can’t claim NOL deductions on returns you never filed. If your company historically operated at a loss (for tax purposes), a nexus analysis might not have been on your radar; or maybe you had a nexus analysis done, but then decided not to file returns where there wasn’t a material exposure. But if in 2022 or later years, you were or expect to be profitable and you’ve been doing business online or in multiple states, identifying potential prior year state income or franchise tax filings may allow you to claim the benefits of the federal NOLs on your state returns by carrying the losses forward to offset current or future taxes.
Note, current federal rules allow you to carry NOLs forward indefinitely until the loss is fully recovered, but they are limited to 80% of the taxable income in any one tax period. States do not always follow these rules, and moreover, state apportionment rules will affect how much of the NOL is allocated to a given state. Therefore, you’re not likely to see a “one-to-one” application, and you may still owe some taxes, but under the right circumstances, this technique will go a long way towards mitigating exposure for state income taxes that you may owe in the future.
Another way that increasing your state tax filings may decrease your state tax liability is by taking advantage of “economic nexus” developments to “spread out” your state tax liability across jurisdictions where rates may be lower (i.e., reducing your “effective tax rate”). Many states impose “throw-back” rules that require you to treat sales to states where you don’t pay taxes as if those sales should be sourced to your home state. But if, under economic nexus, you should or could be paying tax in those jurisdictions, you may be able to reduce the payment in your home state. Similarly, differences can arise between state’s rules for sourcing sales of services or intangibles that may be particularly helpful when considering how to treat a large item of gain from a sale of a business asset (e.g., stock in a subsidiary, or a valuable piece of intellectual property).
A few example scenarios illustrate these techniques:
SoftDev Corp. started developing a SaaS product in 2019 and then testing its prototype apps online. They have employees that work remotely from home offices in five states. While SoftDev had potential nexus due to the economic activity in several states and payroll in the other five states, they only filed in their state of corporate domicile because sales were not significant, they had losses on their federal return, and the cost to prepare the other returns exceeded their compliance budget. In 2022, SoftDev expanded its product offering and began seeing significant sales in all 50 states. For federal tax purposes, they have accrued a large NOL that will reduce taxable income for the year (and probably several years to come). It would be wise to perform a nexus analysis at this point to identify whether SoftDev can capture any NOLs in other states – the key qualification being whether there is significant apportionment in the prior years as this will drive the amount of NOL available.
Cal Widget Co. sells widgets (tangible personal property) it manufactures in California to customers all along the west coast and all its operations, including its one warehouse, are in California. Historically, Cal Widget only files a return in California, where it has 100% apportionment because of the throwback rule, and thus pays 8.84% on all its taxable income. However, by filing in additional states, the throwback rule would not apply to those sales, and thus they wouldn’t be “thrown back” to the California numerator of the apportionment formula. Even without paying tax to the other state, if Cal Widget could show that they would have owed tax under California’s rules, but for the fact that the state does not apply tax under those circumstances, the sales could still be removed from the California numerator. For example, if 50% of sales were to California customers, 25% went to customers in Oregon (average rate = 7%), and the remaining 25% went to Washington (no corporate income tax), using this method, Cal Widget could reduce its effective state income tax rate from 8.84% to 6.17%.
Big Apple Co. has found a buyer for its signature logo and is anticipating a major gain event in 2023, and they realize that based on prior years, they’ll be paying New York State and City tax on the entire amount of gain because it’s the only state in which they’ve ever filed state income tax returns. If they are proactive, though, they can identify multiple states in which they have received revenue and can justify filing based on “economic nexus” and “market-based” sourcing principles – this won’t change New York’s tax rate, but it will provide a reason to apportion more of the income to source outside of the state and could save significantly on their tax bill.
Oftentimes, businesses are reluctant to really dig deep into nexus issues because they’re afraid of what they might find. And they end up waiting to take action until after they receive notices or their auditors (or worse, potential buyers) start asking about uncertain tax positions and accruals. But a slow-down in business due to the recession may offer you the opportunity to catch up on these nexus issues proactively.
Technique #2: Get ahead of sales tax collection so that you’re not left holding the bag
In a perfect world, when a company is properly accounting for, collecting, and remitting sales tax, there should be no (or at least very little) effect on revenue. Sales tax shouldn’t cost the business anything – instead, the business’ customers should be economically liable for the cost, while the business itself is only responsible for reporting and remitting the tax to the appropriate tax authority.
Problems arise when the business fails to account for sales tax and then only discovers the liability after the transactions have occurred and when it is no longer feasible to collect the individual sales tax amounts from customers. Then a cost that you could have passed through to your customers becomes your cost.
If you’re not currently collecting sales tax, you might consider a few of the “red flags” below:
Your business generates revenue online through a website, Software-as-a-Service, or another cloud-based product.
Many states treat SaaS (and similar cloud-based products) as they would other types of software, which are generally taxable.
What’s more, since you’re selling online, you may be subject to “economic nexus” without ever creating a physical presence in the location.
2. Your business processes payments online on behalf of other businesses making retail sales.
Since you are the party processing the transaction, you may be required to collect sales tax as a “marketplace facilitator,” even though you’re really just a company providing services to other businesses.
3. Your business provides services, so you haven’t really been concerned about sales tax in the past because you know it generally only applies to tangible personal property (TPP) … but consider whether:
You make some related sales of TPP when you are providing services (e.g., you design custom web infrastructure and occasionally sell specialized hardware to meet your client’s specifications);
The services you sell are computer programming and the end-product is typically custom software;
One division of your business is leasing goods from another division; or
Your services are taxable because they are dependent on, or related to, sales of TPP (e.g., third party software maintenance).
You can avoid this pitfall and ultimately save money by being proactive about identifying potential sales tax requirements and implementing systems to ensure you are properly collecting the tax.
Technique #3: Come clean on your own and avoid paying penalties
If your business sells products or services in multiple states, you could face unexpected tax liabilities for failing to comply with each state’s various income, franchise, gross receipts, sales and use, property, or other taxes. You may already be aware of the issue, and maybe you even have an accrual for the liability. And compounding any such liability are the interest and penalties that could be asserted if the state eventually discovers the business activity. But you don’t have to wait for the state to come after you, and if you’re proactive, you’ll probably be able to mitigate or remove all the penalties.
Virtually every state has a Voluntary Disclosure Program, under which you can execute a voluntary disclosure agreement (VDA) between your business and the tax authority to limit your liability for back-taxes. One benefit is that the VDA will limit the “lookback” period (otherwise a state can look back as far as the business had activity); this will often reduce the potential tax liability itself. Another benefit of a VDA is that any penalties that might have applied for late filing or payment are waived (though interest usually still applies). Finally, by going through the VDA process you are put in contact with a tax authority representative who can help you to determine precisely what rules apply to the business – they won’t exactly be a “tax adviser” but sometimes simply getting a hold of someone who will address your questions is challenge. And the certainty you will get from the process will give you comfort that your tax compliance process going forward is correct.
On top of state VDA programs, many states will offer amnesty programs. They usually are only available for a brief period (e.g., six months), have similar terms to a VDA, but are more relaxed in terms of eligibility. Let’s say you’ve been filing for five years, and you stop doing business in a certain state. You receive penalties and notices, and you ignore them — you aren’t doing business there anymore. But during the recession, you need to expand back into that state for additional customers. If you want to resume your business there, an active amnesty program may allow you to set up shop without having to pay penalties on the missed filings.
With the country entering a recession, business profits are likely to decrease, and so too will state revenues; under these circumstances, state governments are more likely to offer these amnesty programs as they seek to expand the tax rolls. Be on the lookout if a VDA isn’t an option for you.
Technique #4: Be ready in case you “win” the audit lottery
Not only do state governments seek out delinquent taxpayers through amnesty and VDA programs during a recession, but they may also seek out additional tax revenue through audits. For state income taxes, we’re likely to see a surge in audits surrounding online work and remote workers because of increased popularity in remote work over the last few years. In addition, states perennially test a business’ “unitary” status (i.e., whether a given item of income should be apportioned between several states or allocated to the corporate domicile) and therefore any significant sales of business assets in the last couple of years may make you a target.
Ultimately, this is the time to be more introspective: look back on your last few years and figure out if you had any gaps in recording. If there are opportunities to capture NOLs or other additional savings, bookmark those too. It’s best to be prepared, because while there’s no guarantee you’ll be met with an audit, there’s no question that state governments increase their audit activity during a recession.
How MGO can help
A recession affects everyone, and state and local governments are no exception — which, in turn, affects you and your business. These techniques can help you prepare for whatever’s coming, ensuring you’re ready for potential audits and losses along the way. MGO’s State and Local Tax team provides experienced guidance to help you avoid overexposure and capitalize on opportunities that limit your overall tax burden.
The California Franchise Tax Board (FTB) recently announced a one-time penalty abatement program for California resident and non-resident individual taxpayers.
Here’s what you need to know to claim it:
It’s a one-time abatement of any “timeliness” penalties incurred on individual income tax returns (Form 540, Form 540NR, Form 540 2EZ) for tax years beginning on or after January 1, 2022.
It’s only available to individual taxpayers subject to personal income tax law (so estates, trusts, and fiduciaries aren’t eligible).
It can be requested verbally or in writing starting on April 17, 2023.
For California taxpayers who qualify for an extended 2022 income tax return due date because of the California Winter Storms (i.e., most California taxpayers), the “timeliness” penalties that would be abated through this program should not start being imposed until after the new extended due date for that tax year – October 16, 2023.
Which penalties are eligible?
Both the Failure to File Penalty (i.e., you did not file your tax return by the due date nor did you pay by the due date of your tax return) and the Failure to Pay Penalty (i.e., you did not pay the entire amount due by your payment due date) on California individual income tax returns for tax years beginning on or after January 1, 2022 are eligible for the one-time penalty abatement.
How do I qualify?
How do I request a one-time penalty abatement?
You can mail in a completed Form FTB 2918 or call the FTB at +1 (800) 689-4776 to request penalty abatement.
What if I can provide that I had reasonable cause for late filing or late payment?
If you can demonstrate that you exercised ordinary care and prudence and were nevertheless unable to file your return or pay your taxes on time, then you may qualify for penalty relief due to reasonable cause. Reasonable cause is determined on a case-by-case basis and considers all the facts of your situation.
You may request penalty abatement based on reasonable cause by mailing in a completed Form FTB 2917 or by filling out a reasonable cause request on your MyFTB online account. Penalty abatement based on reasonable cause may – depending on the circumstances – be preferable to using up your one-time penalty abatement request.
How we can help
If you need help with relief for your “timeliness” penalties or if you need help with any other state and local tax matters, please reach out to our experienced State and Local Tax team.
Thanks to maturing markets, limited access to capital, and disproportionate tax burdens, many companies in the cannabis industry are facing major challenges in managing their debt and creditors. Without ready access to federal bankruptcy protection, many companies with liquidity challenges are looking at their options. Without careful consideration of the tax consequences of these options, companies may be subject to significant tax traps. Here are several factors to consider to avoid these traps and stay solvent from Tax Partner Barbara Webb.
High cost of debt + high effective tax rate = cash crunch and tough decisions
How did cannabis companies arrive at this decision point? The current cash crunch in the industry has been building for years, precipitated in part by banking regulatory constraints and an abnormally high effective federal tax rate.
As the below chart illustrates, cannabis companies lack access to traditional banking and market rate loans and have turned to alternative, expensive sources of debt financing bearing effective interest rates as high as 20%. In addition, Internal Revenue Code Section 280E essentially taxes the industry on gross margins, such that even a company that would otherwise be in an overall tax loss position may still owe taxes.
Caught in this double bind, even an operationally successful cannabis company may face a difficult choice: service debt timely at the expense of keeping current with taxes, risking tax liens that threaten the license, or pay taxes when due at the price of defaulting on debt and risking the viability of the business overall.
The tax impact of debt restructuring
Restructuring debt is one route for cannabis companies in distress to remain operational, but debt modification carries potential tax traps for the unwary – both borrower and lender. Depending on the relative value of the debt exchanged, the borrower can realize cancellation of debt income. The insolvency exception to recognizing and paying current tax on this income may not be available to a cannabis company, as the fair value of its assets – including intangibles – may still exceed its liabilities. A lender may also experience a taxable event on the refinancing, either in the form of interest income, or gain due to the valuation of equity received in the exchange.
In any debt refinancing situation, both the borrower and the lender should anticipate and plan for complex tax calculations involving debt discounts (I.e., original issue discount, or OID) and the fair value of company equity in order to determine correct tax treatment. To avoid any last-minute surprises or deal delays, both the borrower and the lender should model the tax treatment on both sides.
Sales of distressed assets and the tax impact
Considerations for the borrower:
Are the assets to be sold in a different tax filing entity as the borrower?
Will the flow of cash between entities create a taxable event?
Considerations for the lender:
What is the borrower’s anticipated cash position after paying tax on the sale?
Can cannabis business assets be sold in the jurisdiction’s regulatory environment? Or is a sale restricted to equity?
Assignment of income receipt of equity
If the borrower and the lender agree on a debt workout based on assignment of income, or equity ownership, both parties should understand the borrower’s existing tax structure and the impact the restructuring will have on both sides.
The borrower should assess whether a “change in control” has occurred for tax purposes, as the use of tax attributes may be limited. If an assignment of income is structured as a fee, consider the tax treatment of the payment and deductibility under 280E.
A lender who becomes an owner or part of management should consider:
Depending on how the agreement is structured, the assignment of operating income and participation in management may turn the lender, or the lender’s entity, into a “trafficker” subject to 280E.
The lender should also be cognizant of the borrower’s standing with the taxing authorities and whether the operator can afford both paying down tax liabilities and payments under the terms of the workout. The retention of the cannabis or reseller license that the lender is depending on for cash flow is tied to staying current with state and local taxes. An IRS liability that has progressed to the lien stage unbeknownst to the lender could result in a “sudden” drain of cash from a bank account.
“Workouts” with taxing authorities
Given the current cash crunch in the industry, companies have been known to delay remittance of sales and excise taxes to state and local governments. Companies should be aware that non-payment of these “trustee” taxes can cause a loss of standing to operate legally and carries personal liability for officers and owners of the company. Taxing authorities may have limited sympathy for a distressed taxpayer who falls behind on these types of taxes and taxpayers should pay down any outstanding balances as soon as possible.
If income taxes are past due, it is important to continue to make payments toward the balance on a regular basis. A taxpayer cannot apply for a formal IRS payment plan until a revenue officer is assigned to the case. Also, a taxpayer must usually pay all outstanding taxes that are not overdue and remain “current” on all future taxes in order to establish and remain on an installment agreement. Federal and state revenue officers are generally willing to work with taxpayers in financial distress who act in good faith throughout the process. Engaging a professional representative who understands tax controversy practice and procedure and how to work with revenue officers can make all the difference between establishing a payment plan and facing a tax lien.
How MGO can help
A cannabis company navigating financial distress should engage a tax professional with both industry experience and a high level of tax technical skill to navigate the complex tax impact of a workout or restructuring. MGO’s Cannabis Tax team has both the industry experience and the technical knowledge to assist companies of all sizes during this challenging time.
Many people are excited about the pace of economic recovery, and it’s fair to say we are moving in the right direction. But as the excitement continues and life feels more like it is returning to normal after the pandemic, make sure you don’t forget to take advantage of some of the programs that were put in place to help us through the COVID-19 crisis.
Employee Retention Tax Credit
The Employee Retention Tax Credit (ERTC) is a refundable tax credit created by the Coronavirus Aid, Relief and Economic Security (CARES) Act, to encourage businesses to keep employees on their payroll. For 2020, the credit is 70% of up to $10,000 in wages paid by an employer whose business was fully or partially suspended because of COVID-19 or whose gross receipts declined by more than 50%
For 2021, an employer can receive 70 percent of the first $10,000 of qualified wages paid per employee in each qualifying quarter. The credit applies to wages paid from March 13, 2020, through December 31, 2021. And the cost of employer-paid health benefits can be considered part of employees’ qualified wages.
It’s an attractive credit if you qualify.
Eligible businesses
The credit applies to all employers regardless of size, including tax exempt organizations that had a full or partial shutdown because of a government order limiting commerce due to COVID-19 during 2020 or 2021. With the exceptions of state and local governments or small businesses that take Small Business Administration loans, this credit is available to almost everyone.
Of course, there is some fine print: • To qualify, gross receipts must have declined more than 50 percent during a 2020 or 2021 calendar quarter, when compared to the same quarter in the prior year. • For employers with 100 or fewer full-time employees, all employee wages qualify for the credit, whether the employer is open for business or shutdown. • For employers with more than 100 full-time employees, qualified wages are wages paid to employees when they are not providing services due to COVID-19-related circumstances.
One bright point about the ERTC is that employers can be immediately reimbursed for the credit by reducing the amount of payroll taxes they would usually have withheld from employees’ wages. That was a nice touch by the IRS.
Retroactive claims for the ERTC
Although it appears the IRS tried to make this as easy as possible, you may still need a tax professional to sort it out. For instance, if your business had a substantial decline in gross receipts but has now recovered, you can still claim the credit for the difficult period
Retroactive claims for refunds will probably be delayed because currently everything is delayed at the IRS. The credit can be claimed on amended payroll tax returns as long as the statute of limitations remains open, which is three years from the date of filing. So you have some time to claim the credit, but why wait?
Keep December 2021 in mind
The economy is in a state of change, and it is fair to say that we are once again in uncharted territory. On the positive side, there seems to be significant resources and support for businesses from both government and consumers. You and your tax professional should keep your eyes open for credits and benefits to make sure you don’t miss any opportunitie
The ERTC expires in December 2021. Though it may be difficult to think about year-end in the middle of the summer, you’ll want to figure out your position on this credit before December. A tax professional can help you understand the ERTC and help you decide on your next step.
About the author
Michael Silvio is a partner at MGO. He has more than 25 years of experience in public accounting and tax and has served a variety of public and private businesses in the manufacturing, distribution, pharmaceutical, and biotechnology sectors.
As the coronavirus (COVID-19) pandemic continues to have widespread economic impacts, small businesses, nonprofits, and similar organizations have been hit hard.
To help combat the economic fallout from the pandemic, the federal government has introduced sweeping legislation to provide emergency relief via loan and grant programs and tax breaks, credits and other incentives.
Millions of dollars of emergency relief is now available to qualifying organizations, some of which is eligible for 100% forgiveness. Unfortunately application processes are complex and time-sensitive, strict usage rules determine what can be forgiven, and changes to tax code are complex.
MGO has created the attached one-page summary to provide basic details on what your organization may be eligible for, and the levels of relief available.
