In late 2015, President Obama signed into law the Protecting Americans from Tax Hikes Act of 2015 (the “PATH Act”). As a result of the passage of the PATH Act, certain sections of the Internal Revenue Code were amended to change excise tax due dates and remove bond requirements for some eligible taxpayers. These changes go into effect on January 1, 2017. And this week, the TTB provided public guidance as to the implementation of some of those changes.
As industry participants are all to aware, substantial federal excise taxes are levied on the production of spirits, wine and beer. That tax comes into existence at the time the hooch is produced in (or imported into) the United States. But payment of the tax is not technically required until the hooch is removed or withdrawn from the distillery, winery or brewery (or – in the case of imported hooch- at the time of removal from customs custody or bond).
Because paying tax at the time of removal can be tricky to manage (and really, do you want to make a federal excise tax payment every time you sell a bottle out of your tasting room?) – hooch producers (i.e., taxpayers) have historically been required to obtain a removal bond before commencing operations and to maintain that bond going forward. With such a bond in place, the taxpayer is permitted to report taxes owing (and pay tax liabilities) on a semi-monthly basis. Going this route means that the taxpayer will have two federal tax obligations every month: an obligation covering the 1st through the 15th day of the month and an obligation covering the 16th through the last day of the month. In each case, the returns and payments are due within 14 days of the end of the applicable semi-monthly period. For the smallest producers (i.e., producers who expect to be liable for not more than $50,000 in federal excise taxes for a calendar year) – this obligation may be satisfied quarterly rather than semi-monthly. [Note: under current law, wineries that expect to have less than a $1,000 annual federal excise tax liability may file and pay annually – a benefit that the PATH Act extends to these smallest of distilleries and breweries as well.]
As a result of the passage of the PATH Act, a removal bond will no longer be required for any producer that expects to be liable for not more than $50,000 per year in federal excise taxes (and who was not liable for more than $50,000 in federal excise taxes in the preceding calendar year). Doing some simple arithmetic on the basis of a recent favorite (relatively) new release, this means that if Copperworks Distilling Co. only made their new American Single Malt (which of course they don’t – they offer several other fine products as well – that just happens to be my favorite among their offerings), they could make and sell just under 1,500 cases of the Single Malt in any given year without needing to post a bond.
Great, right? Not so fast.
Beyond being somewhat cumbersome, producers should remember that the bond actually serves two purposes here. The first is to give our friends at the IRS comfort that they will get paid. And the second is to give producers comfort that the folks at the IRS will get paid.
Occasionally forgotten by producers (or perhaps missed among the myriad arcane tax laws and regulations relevant in the context of spirits production in the US) is the fact that the owners and operators of DSPs can be personally liable for the payment of federal excise taxes owing with respect to the business. Specifically, Section 5005 of the Internal Revenue Code (26 USC 5005) imposes joint and several liability on “every person in any manner interested” in the operation of a distillery with respect to the tax. [Note: “every person” doesn’t actually mean “every person” – there is a carve-out from liability for individuals who own less than 10% of the stock of a corporate distillery and who are not officers or directors.]
So consider the scenario in which something unfortunate happens and the excise tax is owing but the cash isn’t available to make the payment. With a bond in place, the efforts of our federal government to collect the tax would first be directed toward recovery under the bond. Only if the bond proved insufficient to satisfy the obligation would the G-Men then coming looking for additional cash. But if there is no bond in place then the owners of the business (even large but passive owners) can look forward to uncomfortable conversations with the IRS. For businesses such as craft distilleries (which after all are perennially strapped of cash), this can be a real problem.
So if you’re running a DSP and considering scrapping that withdrawal bond this coming January – consider too whether you may actually benefit from having that insurance policy in place. And if you’re an investor in a small DSP (or about to become one), consider whether you want to require the DSP to maintain this coverage in place – particularly if you’re going to be a non-officer member of the board of directors. You would think twice about joining the board of a company that didn’t have directors and officers insurance coverage. Protection against personal liability for unpaid federal excise tax is every bit as important.