Wine industry, IRS closer on LIFO compromise

NORTH BAY – An IRS audit sweep on winery inventory accounting methods in Napa and Sonoma counties may not bring as much financial impact as had been feared when it began earlier this year, following recent meetings with winery accountants.

In late August, an IRS inventory specialist and auditors started individual meetings with 28 local operations targeted in a "compliance initiative project" on whether common wine industry last-in, first-out – LIFO – inventory pool "items" are too broad and, thus, distort income to be taxed.

"The good news is that the IRS seems willing to compromise a little bit," said Jeff Gutsch, founder of the wine practice at CPA firm Moss Adams and part of a group of wine-focused accountants trying to resolve the LIFO question. "I'm mildly encouraged that some sort of resolution can be reached. I don't think LIFO will be as it's been, but I don't think it will be as extreme as they pushed for."

Nothing final was resolved in the recent meetings with the IRS, but the discussions provided a framework for the coalition of about 30 accountants from several firms to meet in the next couple of months to draft a proposal to the IRS on a solution, according to Mr. Gutsch.

That resolution may parallel the deal worked out between the automobile industry and the IRS, he noted. Changes in vehicle platforms were considered different vehicles requiring separate LIFO inventory items, while vehicle options such as transmission and roof types wouldn't.

Wine accountants have been asserting that the IRS call for more narrowly defined LIFO items than the two "casegoods" and "bulk wine" items used by several of the audited wineries may be warranted, but the IRS' insistence on item definitions by vintage or size of package isn't. The IRS position came from a 2006 legal advice letter from an IRS attorney during an examination of a winery's use of LIFO.

That 2006 audit led the IRS' Large and Mid-Size Business Division to start a wine industry "compliance initiative project," a system of comparing similar businesses to find out whether further taxpayer education, examination of returns and legislation is needed, according to a recent IRS explanatory note to Congress. Rep. Mike Thompson, D-St. Helena, asked the IRS in conjunction with an early June budget hearing why 28 Napa and Sonoma wineries received audit letters dated April 10.

The project was to target six California winegrowing counties, but the "largest concentration of tax returns with the potential LIFO issue were identified in two counties – Napa and Sonoma," according to the IRS reply.

The late August meetings achieved some clarity on current-period tax deductions such as carveouts for bonus depreciation and the ability to use cash-basis accounting for both purchased and owned grapes, according to Mr. Gutsch. The IRS wanted different calculations based on grape sourcing.

A few LIFO-item disagreements remain to be resolved, perhaps in item-by-item analysis, according to Mr. Gutsch.

One chasm of opinion between the wine accountants and the IRS relates to the cost to make wine that takes longer than a year from harvest to shipment.

"They said wine in production two years is not comparable with wine in production one year," Mr. Gutsch said. "In theory, we have a hard time agreeing with that concept."

Another tax-accounting issue related to LIFO looming over the wine business is the Financial Accounting Standards Board's Accounting for Uncertainty in Income Taxes rule, or FIN 48. By the end of this year, businesses small and large will have to note on financial statements how much of an adjustment might have to be made if a position on tax deferral or deduction is overturned in Tax Court.

"It will put pressure on wineries to look at their LIFO reserves on how much can be sustained and if they have to have contingencies," Mr. Gutsch said, noting that the winery LIFO question may not be resolved by the FIN 48 deadline.

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