Tax pitfalls for bourbon counterfeiters

Your Guide to State, Local, Federal, Estate + International Taxation

“Empty Bottles of Whiskey are Fetching Hundreds of Dollars on eBay as Counterfeiters Buy Them for Scams.” This was a title of a recent news article I stumbled (pun intended) upon. Being a tax guy and a moderate bourbon enthusiast, I was intrigued and thought it would make for a fun tax blog!

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Let me start off for those not versed in the bourbon world. Bourbon has become a hot commodity in recent years, and it is only getting hotter. The days of finding your preferred bourbon of choice on the shelf of your local liquor store are practically gone. This has created a huge secondary market for bourbon and whiskies as people hoard them and sell them at astronomical prices. If you are curious, search Pappy Van Winkle and take a gander at the different prices you see pop up.

People are buying these rare empty bottles for hundreds of dollars, filling them up with cheap whiskey and reselling them for large profits. Brilliant… and, well… illegal! Of course, the entire time I read this article I was thinking about tax implications. Is the money taxable for the person selling the empty bottle? Is it taxable to the person illegally reselling the bottle with cheap whiskey in it? Is your basis in the bottle or the contents?

Person selling the empty bottle – Assuming this person enjoys bourbon, purchases the bottle, drinks the contents and then recoups some of the cost by selling the empty bottle. If they sell the empty bottle for less than the total original cost, then they would have a net loss. The loss would arguably be subject to hobby loss rules, meaning your taxable amount would only be reduced to zero. No tax effect in the end.

Counterfeiter illegally reselling – Counterfeiter buys the empty bottles, fills it with cheap whiskey and sells it for a profit. IRS has the right to tax income from illegal activities and because this is clearly for profit (otherwise there would not be counterfeiters) it is 100% taxable as a business. The counterfeiter would report this on Schedule C of their Form 1040 and allowed to take any ordinary and necessary business deductions to offset the income. (Fun Fact: Alcohol is not considered a controlled substance within the meaning of schedule I and II of the Controlled Substance Act and therefore is not limited to only deducting cost of goods sold. This differs from other illegal activity reporting for drugs that are controlled substances under the act.)

Is your basis in the bottle or the contents? – For the person selling the empty bottle, I would argue the basis is what you purchased it for, including contents, even though the contents are now gone. This also assumes you are not reselling the whiskey outside of the bottle, because that of course would change the answer. For the counterfeiter, it is clear they have basis in the cheap whiskey they used to refill the bottle and the bottle they purchased to resell.

The basis answers seem obvious, but this question popped into my head, because if you have ever been to the Jack Daniel’s distillery in Lynchburg, TN you will know that it is in a dry county, meaning they cannot sell alcohol, but they kind of do! They sell commemorative bottles that happen to be filled with Jack Daniel’s and they claim you are buying the bottle not the alcohol. I guess it is all about perspective here.

Anyways, moral of this blog, different scenarios result in different answers and income from illegal activity is still taxable, so counterfeiters, do not forget to reach out to your tax professional and pay your share of taxes. Otherwise be prepared to add tax fraud to your charges!

Contact your Henry+Horne advisor for more information!

Chris Morrison, CPA MAFM