We all know that (most) wines come from grapes, but many of us might not know exactly when grapes turn into wine for federal income tax purposes. According to the IRS (in Chief Counsel Advice Memorandum 200713023), grapes turn into wine when a taxpayer begins crushing the grapes. This IRS Memorandum highlights a few of the tax planning considerations for businesses that produce and sell their own goods.
In general, taxpayers are not entitled to immediately deduct the cost associated with producing a good. Rather, the taxpayer has to add the associated costs to their tax basis in the good, which permits the taxpayer to claim tax deductions over time or it reduces the amount of taxable gain that the taxpayer will have when they sell the good. Production costs can include everything from direct labor and materials costs to indirect rents, taxes, and other costs.
This is problematic for taxpayers who grow grapes and operate wineries, as it appears that the taxpayer would have to capitalize all of their expenses up until the time that the wine was sold. This would be especially harmful for wineries because the wine making process can take many years.
This Chief Counsel Advice Memorandum says that this is not the case. Instead, the IRS will treat the grape growing and winery functions as separate businesses – even though (1) the grapes themselves are never subject to a ‘sale or other disposition’ as these terms are customarily used in federal income tax law and (2) the taxpayer did not operate their business as two separate and distinct businesses.
Of course, the taxpayer could have just separated out their different business functions by operating two or more separate and distinct business operations. This could provide the taxpayer with the ability to choose what items it wanted to capitalize or deduct and when….