Considering the Implications of a New Bourbon Tax

By: Arthur Cook, Staff Member

Any person that has toured (or tasted from) one of Kentucky’s premium Bourbon whiskey distilleries can tell you, no drink would be the same without a water source of superior quality. Kentucky’s abundant supply of limestone, which provides a natural water filter, allows much of the world’s top Bourbon to be produced there.[1] A recent study of Kentucky’s economy revealed that the Bourbon industry contributed $2 billion in gross state product each year for the last decade.[2] Governor Steve Beshear has observed that the industry accounts for 43% of the distilling jobs in the nation.

With a lagging national economy and Kentucky behind the national recovery rate, citizens of the Commonwealth are very interested in maximizing tax revenue from the Bourbon industry. One proposed solution is re-examination of the state’s “barrel tax.[3]” By way of example, the citizens of Moore County, Tennessee recently sought to impose a barrel tax on Lynchburg’s most famous resident, Jack Daniels.[4] The “barrel tax” is an annual ad valorem tax of $.05 per $100 of value for goods “held for sale in the regular course of business, which includes . . . distilled spirits and distilled spirits inventory, and in-process materials, which includes distilled spirits and distilled spirits inventory, held for incorporation in finished goods held for sale in the regular course of business.”[5]

A Kentucky barrel tax would be cumbersome for the distilling industry. Many spirits, such as Bourbon, can take up to 12 years to age in barrels, increasing in value per year. Rep. Linda Belcher of the Kentucky General Assembly has proposed House Bill 418 to take an income tax credit to offset the cost of the tax.[6]

A recent op-ed by industry leaders concedes that the ad valorem tax supports critical needs in multiple fields, but also attempts to undermine concern that the tax credit envisioned by House Bill 418 would denigrate tax coffers by arguing the tax credit would be “reinvested in the commonwealth.”[7]

Kentucky’s natural resources - the climate and limestone bedrock - are ideal for the production of premium spirits like Bourbon. However, without a clearer statement of the “reinvestment” which would offset the loss in tax revenue from the tax credit, forgoing taxes on an industry that has boomed in the last few years would be a stiff drink to swallow.

[1] Buffalo Trace Distillery, Whisky.com, http://www.whisky.com/distilleries/buffalo_trace_distillery.html (last visited Feb. 6, 2012); Woodford Reserve Kentucky Straight Bourbon Whisky, Whisky.com, http://www.whisky.com/brands/woodford_reserve_brand.html (last visited Feb. 6, 2012) Maker's Mark Kentucky Straight Bourbon Whisky, Whisky.com, http://www.whisky.com/brands/makers_mark_brand.html (last visited Feb. 6, 2012).

[2] Kevin Wheatley, State-Journal.com - Bourbon industry booming, study reveals, http://www.state-journal.com/news/article/5153644 (last visited Feb. 6, 2012).

[3]Id.

[4] Tim Ghianni, Jack Daniel's wins battle over whiskey barrel tax, Reuters, http://www.reuters.com/article/2011/11/22/us-tennessee-whiskey-idUSTRE7AL1OR20111122 (last visited Feb. 6, 2012).

[5] Ky. Rev. Stat. §132.020(1)(n)

[6] Barrel tax hobbles bourbon industry, Kentucky.com, http://www.kentucky.com/2011/03/08/1661958/barrel-tax-hobbles-bourbon-industry.html (last visited Feb. 6, 2012).

[7]Id.

Rentals, Tax Consequences, and the World Equestrian Games

By Stephen Frazier, Staff Member

In 2004, Governor Ernie Fletcher submitted a bid to host the 2010 World Equestrian Games. The two-week event is expected to bring approximately 250,000 international athletes and tourist to Kentucky. Staff Writer,

Kentucky To Bid For 2010 World Equestrian Games

, July 8, 2004,

available at

http://www.alltechfeigames.com/news/detail.aspx? id=1116. Experts estimate that the games will have a $90 million economic impact on the state of Kentucky.

Id

.

One method that citizens of Kentucky are cashing in on the arrival of the World Equestrian Games is by renting their residence during the weeks before, during, and after the games. Depending on the size of the house and location, homes are generating rental income ranging from a couple hundred dollars a night, up to $30,000 for the full duration of the event.

See generally

World Equestrian Game Housing, http://www.2010weghomes.com/ (last visited Sept. 25, 2010). This seems to be a great method for Kentucky residents to generate additional income; however, homeowners need to be aware of a possible issue with huge tax consequences.

Section 61 of the Federal Taxation Statutes states that “gross income means all income from whatever source derived,” including rents. I.R.S. §61 (West 2008). However, Section 280A of the Federal Taxation Statutes provides a tax loophole of which homeowners must be aware. Section 280A(g) states if a taxpayer uses a dwelling as a residence and the unit is rented for less than 15 days during a taxable year, then the income generated from such use shall not be included in gross income under section 61. I.R.S. §280A (West 2008). The World Equestrian Games start on September 25 and end on October 10. Since the World Games occur for a period of sixteen days, homeowners cannot rent their residence for the entire duration of the event and receive the benefit of section 280A.

Over the next month, citizens of Kentucky will have the opportunity to make thousands of dollars by vacating their homes and renting them to tourists. The World Equestrian Games provide an opportunity for homeowners to generate funds to pay off their mortgage and cover living expenses. However, if homeowners are not aware of section 280A, the World Equestrian Games could result in taxpayers having an increased taxable income and large tax due come April 15th.

Gregory A. Napier, “Got Gas? A Comment on Shell Petroleum, Inc. v. United States.” JNREL Vol. 19, No.2

Comment By: Gregory A. Napier, Former Staff Member; Comment originally appeared in JNREL Vol. 19, No. 2.

Abstract by: Stephanie Wurdock, Staff Member

In 2004 the United States of America faced skyrocketing prices at the gasoline pumps for the second time in decades. The country first dealt with such monolithic price hikes during the 1973 oil embargo which placed stringent restrictions on gasoline distribution and usage. President Carter's administration began to phase such controls out in 1979 which led to Congress's enactment of the "Crude Oil Windfall Profit Tax Act of 1980" (COWPTA or Act). One of the Act's main tools was a tax credit for the use of shale and tar sand oils as alternatives sources of energy. However, the definition of those substances eluded documentation and resulted in a trilogy of cases involving Shell Petroleum, Inc. ("Shell") and the United States. The most recent of which being Shell Petroleum, Inc. v. United States, 319 F.3d 1334 (Fed. Cir. 2003).

When Shell was denied tax credit for oil it produced in California during 1983 and 1984, it filed suit against the United States and was defeated both in trial and on appeal. Strike one. The company made a second attempt in 1989 and was again denied the credit. In its opinion, the Shell II court mandated that in order to qualify for the credit, a company must physically inject new technology into the oil well or otherwise use that technology to remove the highly viscous hydrocarbons from the well. Strike two. Unfazed by the court's ruling, Shell moved forward with its third suit, unsuccessfully arguing that the court's previous definitions of shale oil and tar sand oil were erroneous. Strike three. And Shell is out.

So who is right? The main question of these ground-breaking cases is whether or not Congress intended to exclude from tax credit eligibility technologies that already existed in 1980 at the time of the Act. The courts in the Shell series relied upon public policy and congressional intent to support their rulings that it did. However, a closer look at those same sources reveals that Congress may have intended to do no such thing. In fact, the Shell definitions not only seem to sacrifice any semblance of a scientific basis, but also undermine the overarching intent of Congress in creating tax incentives – to encourage domestic oil.

The impact of the Shell decisions is not a gentle one. It has numerous negative implications for the industry and the state of Alaska – the new target for large-scale drilling. The credit also creates opportunities for abuse in both direct and indirect ways. Finally, in setting such a high standard to receive the tax credit, these decisions fail to encourage or achieve domestic tar sand oil productions.

Perhaps, though the court set a couple things right by getting a lot of things wrong. Realizing that the tax credit offered potential for abuse and little else, the court preened its applicability to avoid its ineffectiveness thereby preventing such abuses.

Horse sales tax exemption: Good for the industry, bad for the state?

By: Adrianne Crow, Staff Member

According to a recent article in the Lexington Herald-Leader, some Kentucky citizens have begun to question tax exemptions provided to horse sales and the impact of this exemption on the state's economy. Janet Patton, Horseman say exemption crucial for Ky., Lexington Herald-Leader, Jan. 17, 2010, available athttp://www.kentucky.com/horse_racing/story/1099255.html (last visited Jan. 20, 2010). Kentucky Revised Statute § 139.531 provides exemptions for sales tax and use tax for the sale or use of horses made for breeding purposes only as well as for the sale of horses less than two years of age bought by out-of-state residents who take the horses out of Kentucky. Ky. Rev. Stat. Ann. § 139.531(2) (2009).

Based on estimates supplied by the state, this practice has cost the Kentucky almost $220 million in lost revenue from 2004 to 2010. See Patton. For example, SheikhMohammed bin RashidalMaktoum of Dubai, Kentucky's top buyer of thoroughbreds, has purchased more than $60 million in broodmares at Keeneland's fall sales since 2002. Id. Had these purchases been taxed at Kentucky's rate of six percent, they would have generated more than $3.6 million by themselves. Id. During this time of budget short-falls and overall cut-backs in our state, some suggest that it is time to reevaluate Kentucky's tax code.

However, others worry that that taxing more sales would cost Kentucky a competitive edge in the horse industry, which is already hurting. Those in the horse industry are afraid that if Kentucky imposes a sales tax, buyers will simply go to other states that offer exemptions, including Maryland, New York, California, Florida, Pennsylvania and Texas. Id. Additionally, those who support keeping the tax exemptions point out that the horse industry is taxed in ways that other agriculture sectors are not. Jay Blanton, spokesman for Keeneland, explained "that sales of many horses, including those of racehorses, are taxed, and that horse farms pay sales taxes that other agricultural enterprises don't. Feed and hay for cattle, for instance, are exempt while the same products for horses are taxed." Id.

During these continued tough economic times for people in Kentucky and across the country, these issues regarding tax reform are surely to be debated by our legislators in the near future.

“Federal Income Tax incentives for Energy from Renewable Resources”

Appearing in JNREL Vo1. 20, No.2, the following article was written by John Kaufmann. Staff member Kyle Hermanson wrote the following abstract. Readers should note that this article discusses the tax code as it existed at the time of the article's publication. Any person citing the article or engaged in tax planning should consult the current edition of the Code.

Countless experts have discussed the necessity for the United States to develop clean, renewable sources of energy in order to avoid the parade of horribles attendant upon continued dependence on fossil fuels. Despite this national dialogue, businesses and consumers have not invested heavily in renewable energy projects until recently. Two things are now beginning to make these projects cost effective. First, the tremendous increase in the cost of fossil fuel in the recent past has encouraged academics and business people alike to turn to renewable energy sources as a way to avoid the risks of price fluctuation in the fossil fuel markets. Second, the cost of energy from renewable sources is approaching that from traditional sources. Given these factors, investment in renewable energy sources presents a unique opportunity to do normative good and at the same time, to succeed economically.

When weighing an investment in a renewable energy project, one of the factors a business person needs to consider is the tax effect of the project. The Internal Revenue Code contains several sections which provide tax subsidies for users and producers of renewable energy sources. Many of these tax credits were added or amended by the American Jobs Creation Act of 2004 and Title XIII of the Energy Policy Act of 2005. The tax code implicates everything from events as small as a taxpayer adding a residential solar water heater or photovoltaic cell to events as large as an agricultural operation becoming an open-loop biomass energy facility. This article explores and explains the federal income tax benefits of renewable energy investments, listing subsidies and discussing their real effect on different classes of taxpayers.

Conservation Easement Tax Advantages Are Set to Expire

The following post was written by staff member Katie Shoultz.

On December 31, 2009, favorable tax deductions for individuals with qualified conservation easements will expire. Farm and Dairy, Land conservation tax break is set to expire Dec. 31, http://www.farmanddairy.com/news/land-conservation-tax-break-is-set-to-expire-dec-31/13279.html (last visited Nov. 16, 2009). A conservation easement is a restriction placed on a piece of property. The Nature Conservancy, Conservation Easements, http://www.nature.org/aboutus/howwework/conservationmethods/privatelands/conservationeasements/about/art14925.html (last visited Nov. 16, 2009). In executing an easement, a landowner either donates or sells certain rights attached to his or her property whereby a private or public organization then agrees to enforce the landowner's promise not to exercise the rights. Id. Such easements are generally seen as favorable in the farming industry because they serve as a protective measure for family farms. Farm and Dairy, Land conservation tax break is set to expire Dec. 31, http://www.farmanddairy.com/news/land-conservation-tax-break-is-set-to-expire-dec-31/13279.html (last visited Nov. 16, 2009). Advocates of easements also tout the added benefit of creating needed cash flow for many in the farming industry. Juan Espinosa, Rocky Ford, Colo., Farmers Receive Tax Advantages by Conservation Easement, The Pueblo Chieftain, June 22, 2002 available at http://www.encyclopedia.com/doc/1G1-120638712.html. This cash flow is particularly beneficial in depressed economic times and can help encourage sustainability. From a greater public perspective - these tax benefits provide incentives to a crucial sector in our society as "[a]gricultural producers not only provide the food we eat, but open space, wildlife habitat, and potentially carbon sequestration." Private Landowner Network, Conservation Tax Provisions making their way through Congress, http://www.privatelandownernetwork.org/plnlo/taxprovisions.asp?pp=true (last visited Nov. 16, 2009). In fact, one source indicates that from 2003-2007, over a half million acres have been placed in conservation easements. Id.

Currently, the legislation allows landowners to take deductions of up to fifty percent of their adjusted gross income (AGI). Farm and Dairy, Land conservation tax break is set to expire Dec. 31, http://www.farmanddairy.com/news/land-conservation-tax-break-is-set-to-expire-dec-31/13279.html (last visited Nov. 16, 2009). This percentage "allows grantors to realize the value of preserved property more quickly." Id. Qualified farmers who earn more than half of their income from farming operations are allowed to deduct up to one hundred percent of their AGI. Id. The expiring legislation also provides a longer time period for those claiming such deductions. Id. Those who have taken advantage of the more favorable legislation have up to 16 years "to carry forward the unused balance(s)." Id. Prior to the legislation, only six years was allowed. Id. For further information, the IRS released Notice 2007-50 to provide guidance for such deductions. I.R.S. Notice 07-50, 2007-25 I.R.B. (Jan. 4, 2007).

Two bills are currently set before Congress that would extend the aforementioned benefits permanently - HR 1831 (the Conservation Easement Incentive Act) and S 812 (the Rural Heritage Conservation Extension Act). It would obviously be quite advantageous for individuals, particularly farmers and ranchers, interested in placing an easement on their property if such proposals were adopted. Permanency would also lend "legal certainty for those involved in these long term projects." Private Landowner Network, Conservation Tax Provisions making their way through Congress, http://www.privatelandownernetwork.org/plnlo/taxprovisions.asp?pp=true (last visited Nov. 16, 2009).

Would the Commonwealth Benefit from a Tax on Marijuana?

This post was written by staff member Zach Greer.

These bad economic times have forced many people to find additional sources of income. For some, growing marijuana has been a popular solution to their economic needs. In 2008, more than 1 million marijuana plants were confiscated in east Tennessee, Eastern Kentucky and West Virginia. Roger Alford, Marijuana farming rebounds in economic hard times, LEXINGTON HERALD-LEADER, Sep. 10, 2009, available at http://www.kentucky.com/news/state/story/929103.html.

In a recent statement, State Budget Director Mary Lassiter said: "The state finished fiscal year 2009 on June 30 with 2.7 percent less revenue than it received in 2008. Things are getting worse, not better." Ronnie Ellis, Kentucky budget picture 'getting worse, not better', RICHMOND REGISTER, Aug. 27, 2009, available at http://www.richmondregister.com/statenews/local_story_239210926.html. Moreover, it is predicted that Kentucky revenues will drop another 2.5 percent this year. Id. Furthermore, the Commonwealth's unemployment rate remained above 11 percent for August 2009. Ky. Unemployment rate steady at 11.1%, LEXINGTON HERALD-LEADER, Sept. 18, 2009, available at http://www.kentucky.com/101/story/939767.html.

An in-depth analysis of the advantages and disadvantages of legalizing marijuana is beyond the scope of this blog posting. Instead, this posting merely poses a question to its readers, instead of funding eradication efforts to destroy this recession-proof crop, could the Commonwealth and its residents benefit from the legalization of marijuana? Ed Shemelya, head of marijuana eradication for the Office of Drug Control Policy's Appalachian High Intensity Drug Trafficking Area, said: "I've never seen any decline in demand for marijuana in bad economic times. If anything, it's the opposite." Roger Alford, Marijuana farming rebounds in economic hard times, LEXINGTON HERALD-LEADER, Sep. 10, 2009, available at http://www.kentucky.com/news/state/story/929103.html. As one of the largest marijuana producing states in the country, the Commonwealth of Kentucky will continue to be a forum for this highly debated political topic.

According to officials at the Office of National Drug Policy's Appalachia High Intensity Drug Trafficking Area Program (HIDTA), Kentucky produces more marijuana than any other state except California, making it home to one of the nation's more intensive eradication efforts — a yearly game of harvest-time cat and mouse in national forests, abandoned farms, shady hollows, backyards and mountainsides.

Chris Kenning, Kentucky goes after 'Marijuana Belt' growers, LOUISVILLE COURIER-JOURNAL, Sep. 30, 2007, available at http://www.usatoday.com/news/nation/2007-09-30-kentucky_N.htm.

Empirical evidence suggests that there could be significant financial incentives to legalizing marijuana. Nitya Venkataraman, Marijuana Called Top U.S. Cash Crop, ABC NEWS, Dec. 18, 2006, available at http://abcnews.go.com/Business/Story?id=2735017&page=1. In 2005, a study by Jeffrey Miron (a visiting professor at Harvard) projected that if the "United States legalized marijuana, the country would save $7.7 billion in law enforcement costs and could generate as much as $6.2 billion annually if marijuana were taxed like alcohol and tobacco." Id.

However, others argue that such large financial gains are unlikely. Rosalie Pacula, a senior economist at the Rand Corp. and co-director of its drug policy research center, said:

First, you have to consider that legalizing it [marijuana] would have its own costs. Recent research . . . shows marijuana to be more addictive than was thought. Because marijuana is illegal, and because its users often smoke tobacco or use other drugs, teasing out marijuana's health effects and associated costs is almost impossible. And more people would smoke it regularly if it were legal -- Pacula estimates 60% to 70% of the population as opposed to 20% to 30% now -- and the social costs would rise. She takes issue with figures from Harvard's Jeffrey Miron, among others, who says that billions spent on enforcing marijuana laws could all be saved by legalization. Rand's research, Pacula says, finds that many marijuana arrests are collateral -- say, part of DUI checks or curfew arrests -- and many arrestees already have criminal records, meaning they might wind up behind bars for something else even if marijuana were legal.

Patt Morrison, Should we tax pot?, LOS ANGELES TIMES, Dec. 4, 2008, available at http://www.latimes.com/news/opinion/la-oe-morrison4-2008dec04,1,2468640.column. This excerpt shows that a tax on marijuana might not result in the economic windfall that many predict.

The fact remains that Kentucky is a major producer of marijuana, a crop that, if taxed, could result in large revenues for the Commonwealth. However, some people have doubts that a "tax revenue [from marijuana] would offset the full cost of regulating and enforcing the legal market." Id. Although economic incentives alone might not be enough to justify the legalization of marijuana, it remains a topic for discussion.

World Equestrian Games Bring Tourists (and Transient Tax?)

This post was written by staff member Tanner James.

With the Alltech FEI World Equestrian Games coming to Lexington in September of 2010, masses of spectators will likely descend upon the Commonwealth in record numbers. Local hotels and inns will thrive, but at some point they will almost certainly reach maximum occupancy, and the prospect of cashing in on this problem has come to the attention of local homeowners. Many Lexington residents are willing to rent out their homes to the city’s newest visitors—for a healthy fee, of course. But things may not be so simple.

As of this writing, Lexington officials are engaged in research and deliberation regarding state and municipal laws that may present obstacles to the would-be temporary lessors. Linda Blackford, WEG rentals might face hurdles, LEXINGTON HERALD LEADER, available at http://www.kentucky.com/news/local/story/894703.html. From zoning laws to health department rules, these rentals may be subject to the same legal standards as full-sized hotels. Id. Particularly complex and noteworthy, however, is the potential for tax liability. Id.

Established by the Kentucky Code, there exists a “special transient room tax” that may be levied by an urban-county government upon “all persons, companies, corporations, or other like or similar persons, groups, or organizations doing business as motor courts, motels, hotels, inns, or like or similar accommodations businesses.” Ky. Rev. Stat. Ann. §91A.390(1) (West 2008). Monies collected from this tax are for the benefit of tourist and convention commissions under the theory that hotels, motels, inns, etc. all benefit from the use of this revenue. Lexington v. Motel Developers, Inc., 465 S.W.2d 253, 254 (Ky. 1971).

The amount of the tax is initially restricted to no more than three percent (3%) of the rental price, though additional taxes may be applied dependant upon factors too complicated and numerous to discuss here. Ky. Rev. Stat. Ann. § 91A.390 (West 2008).

This all adds up to substantial source of confusion for those wishing to rent out their homes, as well as for Lexington officials who must research and clarify the issue. Will local homeowners be taxed like hotels? Or, will the state provide for an exemption? The answers to these and related questions stand to have a substantial impact on the atmosphere surrounding the World Equestrian Games.

Topping v. Commissioner: An Example of How an Equestrian Taxpayer Can Utilize "Single Activity" to PReclude the IRS "Hobby Loss" Challenge

This comment appears in KJEANRL Vol. 1 No. 1 and was written by comments editor Anna Garcia. The abstract was written by staff member Sunni Harris.

Professionals in the equine industry are prone to having their horse-based activities classified as “hobbies” by the IRS. Examples of activities that are considered hobbies by the IRS include, but are not limited to: racing, showing, boarding, and breeding horses. Often professionals in the equine industry utilize these same activities to promote their equine businesses. The equine professional taxpayer suffers non-deductible losses when horse-based activities relating to his or her business are classified as hobbies instead of what they really are: business pursuits. Mrs. Garcia’s comment advises equine professionals on how to avoid hobby loss challenges.

In order for an equine professional to avoid a hobby loss challenge, he or she must prove that the activities the IRS classifies as “hobbies” are in reality business activities. The best way to convince the IRS that horse-based activities are business related is by aggregating the activities together, showing that they are sufficiently interconnected to be considered a single activity. When hoping to avoid a hobby loss by claiming a “single activity,” taxpayers should: (1) develop a written business plan integrating the various business activities, (2) keep and consolidate the records and books of multiple activities, (3) utilize services of the same manager and CPA for all activities, (4) use the same assets for both businesses, (5) file a single Schedule C form for sufficiently related business and hobby activities, (6) employ conventional advertising, unless the industry custom creates an exception, and (7) create “goodwill” by participating in and actually winning public competitions related to the hobby. By employing the aforementioned advice, the taxpayer is often able to show the organizational and economic relationship of their activities, thus improving the taxpayers chance of winning against the IRS.