Starting a Winery
It is best industry practice to put all the operations involved in producing and selling wine into separate legal entities.
The winery operations in particular are usually put in a separate entity, usually an LLC. This provides protection from potential liability issues. Wineries involve manufacturing processes and wine tastings; both of these activities can easily lead to accidents and potentially serious liability issues.
A formal structure indicates to the IRS you are following that a business approach, providing a strong defense against potential attacks by the IRS based on “hobby losses.” It is very important that the business structure is not only put in place, but is also actually adhered to, i.e., the entities are treated as separate entities operationally, and for financial reporting and management purposes. If the different entities are just for show, the IRS or any creditor could easily succeed in having the courts ignore the structure.
LLCs are usually preferred over C and S Corporations because of lower effective tax rates for the individuals holding the interests. C Corporations are subject to double taxation. Income is taxed to the corporation, and then a second time when paid to shareholders as a dividend. S Corporations in California are subject to a 1.5% net income tax at the S Corporation level. Distributions of property by S Corporations could also trigger tax on any gain on the property. Furthermore, LLCs are much more flexible for enacting tax planning changes in the future, should tax rates and laws change significantly.
If an LLC only has one owner (husband and wife filing jointly is seen as one in California), then the default classification is that the entity is “disregarded” for federal income tax purposes. “Disregarded” means that the entity, while clearly a distinct entity for legal purposes, is ignored for federal income tax purposes.
Regarding the contribution of assets to an LLC, there is no gain recognized for property that has a fair market value higher than its tax base. Contribution of an asset with a fair market value higher than its tax basis to C Corporations triggers gains taxes. For an S Corporation, any asset contributed to the S Corporation by an individual is unlikely to come back out without triggering gains taxes.
LLCs are preferable for estate tax planning; for instance, interests in the holding LLC can be gifted in minority interests over a few years, enabling the use of valuation discounts.
A holding LLC, furthermore, facilitates an employee incentive program where key-employees can be granted a “profits interest” in the overall winery business, or only in the sub-LLCs in which they are directly involved.
The above is a general discussion. Everyone’s circumstances and needs are unique, and therefore we commend that you obtain a formal opinion. If desired, Capital Coast would be pleased to perform the requisite research and provide you with a detailed written analysis, taking into account your unique personal and business situation and objectives. Contact us for more information.
Integrated wineries have the ability to implement some very beneficial tax planning strategies. The most important one being the ability to use the cash basis of accounting for their vineyard operations and the accrual basis of accounting for their winery operations. All the wine making activities can, if correctly structured, be viewed for tax purposes as forming part of one “group”. This results in large deductions for producing the grapes being deductible when incurred, and revenue only being taxable when the product leaves the group, i.e., when the bottles of wine are sold. You can read more about this in Greg Scott’s article Tax Deferral of Combined Vineyard and Winery Operations.
Contact us today for tax consulting, accounting, and other related services.