SELECTED FEDERAL TAX ISSUES
FACING VINEYARD AND WINERY OWNERS
Choice of Business Entity. The choice of the type of entity to own a winery or vineyard,
whether a corporation, partnership, or limited liability company (LLC), is one of the most
important considerations for any new or existing business. This involves issues regarding
transferability of ownership interests, personal liability for obligations of the entity, as well as a
variety of important tax considerations. This section will focus on some of the tax considerations
that a winery or vineyard owner should consider when determining the type of entity to own and
operate the business.
Entity Types. There are four primary types of business entities for federal income tax
purposes: C corporations, S corporations, partnerships, and disregarded entities. C corporations
are separate tax-paying entities. As a result, corporate income is generally subject to two levels
of tax: one at the corporate level and one at the shareholder level when distributions are made,
stock is sold, or the corporation is liquidated. S corporations are pass-through entities. The
corporation itself generally is not required to pay taxes but simply reports to each individual
shareholder his or her allocable portion of corporate income, gain, loss and deduction. To
qualify as an S corporation, a corporation generally must have no more than 100 shareholders,
have only one class of stock, and have only individuals or certain trusts, estates and charitable
organizations as shareholders. Partnerships are also pass-through entities that are generally not
subject to income tax; rather, income, gain, loss and deduction flow directly to the partners, who
report these amounts on their individual returns. LLCs with two or more members are generally
taxed as partnerships unless an election is made to be taxed as a corporation. Disregarded
entities are separate entities for state law purposes, but are disregarded for federal income tax
purposes. If an entity is disregarded for federal tax purposes, the entity is not required to file a
separate tax return, the entity’s assets are treated as assets of the owner of the entity, and
transactions consummated by the entity are treated as consummated by the owner of the entity.
Single-member LLCs are disregarded unless an election is made to be recognized and treated as
a corporation for federal tax purposes.
Equity for Services. Generally, whether an entity is taxed as a partnership or a
corporation, if the investor provides services in exchange for an ownership interest, the investor
recognizes taxable compensation income and the entity is entitled to a corresponding deduction.
In addition, the entity could be required to withhold income and employment taxes from the
compensation.
Contributions. Contributions of property (as opposed to services) to a corporation, upon
either its initial organization or its admission of additional owners, may trigger recognition of
gain with respect to contributed property unless certain ownership requirements are satisfied. On
the other hand, except in certain limited circumstances, contributions to partnerships or LLCs in
exchange for an ownership interest are generally not taxable events.
Distributions. Generally, a shareholder in a C corporation must recognize ordinary
dividend income when a corporation makes a distribution from earnings and profits to that
shareholder with respect to the shareholder’s stock. The distributing corporation generally is not
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entitled to a deduction for such a distribution. Shareholders in an S corporation, partners in a
partnership or members of an LLC are generally not subject to tax on distributions from the
entity unless and until the amount of the distribution exceeds the owner’s tax basis in the entity.
Raising Capital. A business entity can raise capital from investors either by selling stock or
membership interests or by borrowing. Every financing is characterized either as debt or equity
(or some combination of the two) for federal income tax purposes, although it is often difficult to
distinguish one from the other (e.g., plain vanilla preferred stock). The tax consequences of debt
and equity, however, are vastly different since interest paid with respect to indebtedness
generally is deductible by the corporation, whereas distributions with respect to stock (e.g.,
dividends) generally are not.
Business Operations. Operating a winery or vineyard raises a host of tax issues, some of which
were addressed in a Market Segment Specialization Program (MSSP) paper directed at the wine
industry that was published in 1995. The Internal Revenue Service (IRS) reiterated many of
these principles as they relate to vineyard operations in a 2006 MSSP directed at farmers and
grape growers. The positions taken by the IRS in these MSSPs are discussed below.
Accounting Methods. The computation of income for federal tax purposes depends in
part on the taxpayer’s method of accounting. The two typical methods of accounting are the
accrual method and the cash method. Under the accrual method of accounting, a seller generally
recognizes income and is entitled to deductions when all events have occurred such that the
seller has a right to the income or owes the expense and the amount can be determined with
reasonable accuracy. Under the accrual method, income usually is recognized at the time of sale
and expenses are taken into account at the time payment becomes due. Under the cash method
of accounting, a seller generally recognizes income at the time of actual or constructive receipt of
payment from the sale and claims a deduction for expenses as they are paid.
Winery Operations. Wineries are considered manufacturers for tax accounting purposes
because they transform one product (grapes) into another product (wine). Manufacturers
generally are required to follow the uniform capitalization (UNICAP) accounting rules. Under
UNICAP’s inventory method of accounting, the costs of producing, acquiring, storing and
handling wine inventories generally are incorporated into the cost of goods sold (i.e.,
capitalized). As a result, deduction of those costs is delayed until the wine is sold. In
accordance with the inventory method of accounting under UNICAP, all of the costs associated
with manufacturing wine during the “production period” must be capitalized, and any
manufacturing costs incurred after the production period may be expensed. In the case of wine
that is aged before it is sold, the production period begins when the grapes are crushed, continues
through the aging period, and ends when the wine is released for sale.
The process of accounting for costs under the UNICAP rules begins with assigning costs
to the appropriate cost center. The IRS has recognized four areas that generate costs in the wine
making process: (1) grape crushing/juice fermentation, (2) wine aging and storage, (3) general
and administrative, and (4) wine marketing and sales.
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Vineyard Operations. A winery is considered a manufacturer and as such must use the
accrual method of accounting. A vineyard, on the other hand, generally can use the cash method.
With regard to vineyard operations, certain costs must be capitalized, including vine
development costs (e.g., direct costs of vines and labor and indirect costs of planting); costs of
converting vineyard production from one type of grape to another; fumigation costs; vine
replacement costs (e.g., costs of new vineyard engineering and design, preparation of land for
replanting, planting, installation, budding, and purchase of new vines, irrigation equipment and
trellis systems); costs of acquiring, protecting, expanding, registering, or defending a trademark;
and, costs of designing or developing labels and packaging designs.
Although certain expenditures must be capitalized, these expenses may be recovered over
time through depreciation. Depreciation is the decline in value of property over time due to
normal wear and tear and deterioration caused by use and the passage of time. Thus, a taxpayer
will generally claim depreciation deductions over a period of time determined in part by the
useful life of the property. Generally, Modified Accelerated Cost Recovery System (MACRS)
applies when determining depreciation deductions. MACRS employs two depreciation systems:
general and alternative. For example, depreciation deductions for the direct costs of vines and
labor and indirect costs of planting begin when vines start producing grapes, vines generally are
depreciable over ten years under the general depreciation system and over 20 years under the
alternative depreciation system and must be calculated under the straight-line method.
Mixed Operations. There may be circumstances in which a winery owns or controls or is
otherwise related to a vineyard that produces grapes later used by the winery. If the vineyard
uses the cash method of accounting and the winery pays for grapes purchased in a later year, the
vineyard could have an unwarranted deferral of income recognition. If the vineyard were
allowed to defer the recognition of income, the vineyard generally would be able to claim
deductions for expenses relating to growing grapes before reporting income from the sale of
grapes. The IRS takes the position that a vineyard cannot defer income from grape sales beyond
the year following the year of sale. The IRS may attempt to prevent deferral of income by
claiming that the vineyard has constructively received the proceeds of the grape sales. In
addition, the IRS may require the vineyard to change its accounting method from the cash
method to the accrual or installment method of accounting. Finally, if promissory notes from the
winery to the vineyard exist as evidence of the payment for grapes, the IRS could claim that the
fair market value of the notes was received as income during the year of sale.
In addition, a winery that owns its own vineyard generally cannot claim a current
deduction for grape-growing expenses. Rather, the costs of growing the grapes must be
capitalized, because the vineyard operation is considered part of the overall manufacturing
process and is therefore subject to the UNICAP rules.
On-site Personal Residence. A winery owner or employee may reside on vineyard or
winery property. If the entity holds title to the residence, the entity may be able to claim
depreciation and other deductions with respect to the residence, and the owner or employee may
be able to live at the residence without recognizing income relating to the residence. For the
entity to claim deductions and the owner or employee to live at the residence without
recognizing income, the residence must be located on the winery or vineyard premises, the
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residence must be provided for the benefit of the entity as an employer (i.e., there must be a valid
business reason for having the employee live on the winery or vineyard premises), and the
owner, as the entity’s employee, or employee must be required to live at the residence as a
condition of employment.
The foregoing summary describes just some of the many federal tax issues faced by wineries and
vineyards. Application of these rules to your business entity and operations will depend on your
specific facts and circumstances.
IRS Circular 230 notice: Any tax advice contained herein was not intended or written to be used,
and cannot be used, by you or any other person (i) in promoting, marketing or recommending
any transaction, plan or arrangement or (ii) for the purpose of avoiding penalties that may be
imposed under federal tax law.
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