The U.S. brewing industry represents a $111.4 billion-a-year market, with craft brewers accounting for $26 billion of all retail dollars being spent. According to Boulder, Colorado-based Brewers Association, overall U.S. beer production fell 1 percent in 2017, while craft brew production increased by 5 percent. Microbrewers and brewpubs now represent nearly 25 percent of the total beer production in the marketplace. With the increasing craft brew popularity, startup breweries, microbreweries and established craft brewers are capitalizing on this growth by investing in product development and cost-saving techniques to grow their businesses. Investment in the development of new beers, refinement of hopping techniques, new packaging processes and other activities could qualify for federal and state research and development (R&D) tax credits. However, many craft brewers aren’t taking advantage of this incentive due to a misunderstanding about the types of activities that would qualify for the credit.
The R&D Tax Credit
Enacted in 1981, the Research & Experimentation Tax Credit allows companies investing in R&D to claim a dollar-for-dollar tax credit against income tax liability. In 2015, the R&D tax credit became permanent with the Protecting Americans from Tax Hikes Act of 2015 (PATH Act). The PATH Act also made a number of beneficial changes to the R&D tax credit, making it more accessible to craft brewers. Eligible small businesses and startups with no income tax liability can now use the R&D tax credit to offset their payroll tax. Unused tax credit amounts also can be carried forward for 20 years, thus allowing companies to build up a tax credit asset for future years. Currently, there are 38 states offering an R&D tax credit, which gives brewers operating in these states the ability to increase their potential tax savings even further.
By taking advantage of the credit, companies can reduce their tax burden, thereby freeing up essential cash flow to reinvest in the company, e.g., hiring new employees, creating new products and improving operations. Startup breweries often spend their first several years engaging in new product development, creating new bottling techniques, developing new hop mixtures and improving manufacturing processes, which could potentially lead to large research expenses that might qualify for the credit.
Expenses that qualify for the R&D tax credit include wages for employees engaging in qualified research activities, supply expenses for developing prototype batches and third-party fees for development assistance and outside testing. These expenses could be significant for craft brewers investing heavily in product development. Activities that qualify for the R&D tax credit aren’t just performed by scientists and engineers in laboratories. In fact, R&D occurs during meetings, on the production floor or when evaluating your creation. This means many of the activities you’re likely already performing in your test kitchen and on the production floor might qualify for the R&D tax credit. The following are examples of activities that may be eligible for the R&D tax credit:
- Creating and/or improving fermentation and distillation processes
- Designing and developing customer equipment
- Creating prototype batches
- Testing consistency and shelf life
- Improving filtration and/or straining methods
- Developing new mash mixtures
- Developing new bottling or casking methods
- Automating processes
Capitalizing on Missed Opportunities
If a brewery has never claimed the R&D tax credit, it might be eligible to look back at all open tax years—typically the three prior years—to claim missed tax credit opportunities. Companies with net operating losses could potentially look back even further. For craft brewers there might be missed opportunities that can be recaptured and reinvested into the business. Options like the payroll tax credit election and the ability to carry forward the tax credit allow craft brewers the flexibility to use the credit.
Part of claiming the R&D tax credit is the process of quantifying and qualifying both qualified expenses and qualified activities. Without a proper documentation strategy in place to help substantiate the R&D tax credit, claims might be subject to disallowance by the IRS. Craft brewers looking to claim the R&D tax credit for the first time might benefit from an R&D tax credit study, which helps identify and document qualified expenses and activities in accordance with IRS guidelines. With the shift in the market’s tastes and preferences toward craft brews, brewers are well positioned to take advantage of this growth opportunity.
Contact Patrick or your trusted BKD advisor if you have questions.