Liquor Tax Hammers Local Brewers

A tax designed to make "cheerleader beer" and "alcopops" too expensive for teens has instead hurt local craft-beer makers.

In the fall of 2006, concerned parents and anti-alcohol-abuse groups set out to curb the proliferation of sugary, hard drinks that appeal to teenagers. They were particularly worried about so-called “cheerleader beer” and “alcopops” — soda-like drinks that are fortified with alcohol, such as Mike’s Hard Lemonade and Smirnoff Ice. So they convinced state regulators to levy a huge new tax on these low-priced drinks to make them less affordable for teens. But now, more than three years later, the alcopop manufacturers have found a loophole in the new regulations and the hefty tax is instead coming down hard on an unintended victim — small, local breweries.

Among them are Bison Brewing Company of Berkeley and Black Diamond Brewing Company in Concord. The reason is that these brewers are increasingly selling beer that they age in barrels that once held bourbon, brandy, rye or rum. Such beers are favored for their potent flavors of coconut, vanilla, and butter, but they may also absorb a stiff shot of alcohol from the booze-saturated barrel wood. Although these upscale artisan beers are marketed to adults, they’re now subject to the hefty tax originally meant for cheap alcopops.

And the tax is considerable. The standard beer tax in California runs 20 cents per gallon sold within the state. But under the changed rules, the state treats barrel-aged beers as if they were hard liquor and taxes them at a rate of $3.30 per gallon.

Craft beers are being hit with the high tax because when the bourbon or brandy in the barrel wood seeps into the brew, it raises the alcohol content. Parents and anti-alcohol-abuse groups decided to target such “fortification” processes because alcopops have been made in a similar fashion — by adding alcohol to a weaker drink.

But craft brews are expensive to begin with, and a tax hike of nearly 1,600 percent has made them too costly for many beer lovers. A 16.9-ounce bottle of North Coast’s bourbon barrel stout, for example, retails at approximately $20 with the higher tax.

Dan Del Grande, owner of Berkeley’s Bison Brewing Company, believes that the rules adopted by the state Board of Equalization were poorly written. And when his barrel-aged brown ale goes on the market later this spring, it may be subject to the heavy tax. “The people writing these regulations just don’t understand anything technically about what we’re doing in our breweries,” Del Grande said.

Breweries like Anchor, Deschutes, Drake’s, El Toro, Lagunitas, Magnolia, and Rogue have all worked with spirits barrels. Concord’s Black Diamond Brewing Company has a particularly active program, with 22 brandy and bourbon barrels currently filled with beer. Brewmaster Derek Smith said he understands the state’s concerns over alcohol abuse and cheap alcopops, but barrel-aged beers are about more than alcohol. “Gaining flavors from barrels is a true art form, whereas alcopops are just a way to put alcohol into a sweet drink, and they’re aimed at a young crowd,” he said. “Barrel-aged beers are for specialty high-end retailers.”

The controversy over barrel-aged beers comes on the heels of a debate involving bartenders who infuse spirits with herbs and other ingredients to add flavors to their drinks. As reported in the San Francisco Chronicle, the Department of Alcoholic Beverage Control cracked down last month on bartenders who infuse. The state says that mixing ingredients and immediately serving them as cocktails is legal but that allowing the infusions to mature is a breach of law, prohibited because it poses possible health risks associated with leaving foods on the shelf for long periods. But opponents of the crackdown, including the United States Bartenders Guild, have vowed to fight, arguing that liquors containing high alcohol levels naturally protect against pathogens and that the law is affecting bartenders unnecessarily.

The craft-beer industry, meanwhile, saw the tax problem coming two years ago, said Tom McCormick, executive director of the California Craft Brewers Association. McCormick attended a public hearing in 2008 at which he unsuccessfully urged the Board of Equalization’s members to amend the wording of the tax regulations and avoid an inadvertent hit to the beer industry. The board listened but made no such amendment. “Now we’re just getting caught in the net,” McCormick said. The law’s proponents “were going after cheap high-alcohol drinks that people drink out of a paper bag, not craft beer.”

Brewers point out that the state regulations operate in head-scratching ways. Many non-barreled beers, for example, are yeast fermented to levels of 15 percent alcohol and more, but they aren’t subject to the tax. But barrel-aged beers can have a lower alcohol content of 9 or 11 percent, and yet, under the revised rules, they’re considered a distilled spirit subject to the huge tax.

The problem is that tax regulations were designed to nab alcopops — not craft beers. Alcopops are traditionally made by starting with a flavorless beer-derived base of roughly 2 percent alcohol by volume and subsequently fortifying it to about 5 percent using neutral grain alcohol, according to Del Grande of Bison Brewing Company, who’s familiar with alcopop production. Under the changed rules, that type of fortification qualifies the drink as a distilled spirit subject to the higher tax.

Similarly, some barrel-aged beers can gain as much as two percentage points of alcohol by volume — far exceeding the half-percent increase that the Board of Equalization decided would be the fortification limit before a beverage must be classified and taxed as a distilled spirit. “I can make a 13- or 14-percent beer with no problem,” explained brewmaster Steve Altimari at Valley Brewing Company in Stockton. “But if I put a 10-percent beer in a barrel and it gains a half-percent alcohol, then it’s a distilled spirit and I have to pay a tax.”

However, the original backers of the new tax regulations appear to have little sympathy for craft brewers. In an interview, Michele Simon, research and policy director of the Marin Institute, an anti-alcohol-abuse organization in San Rafael that was one of several groups that initially petitioned the state to tax alcopops as distilled spirits, seemed unconcerned that an effort to go after “soft” drinks aimed at children had ensnared craft brews meant for adults. “It’s typical of people to whine about new regulations causing them problems,” Simon said. “We’re busy trying to keep alcohol out of the hands of minors, and it’s up to them to figure out how to reformulate their recipes.”

But it’s the alcopop makers who have reformulated their recipes since the higher tax took effect about eighteen months ago. And now the higher tax no longer applies to them. Board of Equalization spokeswoman Anita Gore said that after the tax was approved, major alcopop producers crafted new product formulas that allowed them to dodge the tax, while still selling sweet, soda-like drinks with as much alcohol as the average pale ale.

Mike’s Hard Lemonade Company, one of the nation’s biggest alcopop producers, has reported to the state that 27 flavors of its leading product line no longer meet the definition of a “distilled spirit.” Diageo-Guinness USA Inc. has reported that 14 flavors of Smirnoff Ice drinks do not fit the bill. Anheuser-Busch has reported that seven Bacardi brand beverages formerly fortified with liquor no longer are.

The change of recipe for alcopop makers was simple, according to Del Grande, who said he learned the details through conversations with a producer. He said that instead of fortifying their drinks with alcohol, the alcopop manufacturers just reversed the process. They now start with a clear malt beverage base — by definition a beer — of about 8 percent alcohol by volume and blend down the strength with syrups, flavorings, and water. Although they add no distilled spirits, the final product has about the same alcohol content as a traditional alcopop and is still as sweet as ever and still readily available today — and yet free of the higher liquor tax. “They just skirted the law,” Del Grande explained, “and these alcopops are still out there.”

Some craft brewers, such as North Coast Brewing Company, have decided to just pay the tax, but others are following the alcopop makers’ lead. Altimari of Valley Brewing Company in Stockton slightly dilutes his barrel-aged beers with weaker ales. That way there is no fortification process that would trigger the higher tax. Altimari has also rinsed out new barrels with water to remove any lingering pools of whiskey, though he wishes he didn’t have to. “I’d love to soak up my beer with bourbon if I could,” he said.

In the coming year, Black Diamond’s Derek Smith said has plans to release multiple batches of bourbon and brandy barrel beers, and he also doesn’t plan to pay a dime in alcopop taxes. Like Altimari and others, he will simply blend down his barrel-aged beers to keep them out of the distilled spirit tax bracket. It’s probably the easiest legal fix there is. But the required paperwork, Smith said, is a different story. “Since the law passed it’s now up to us to submit these reports proving that every single new beer we make isn’t fortified with other alcohols,” he said. “I’m not a big fan of alcopops myself, and I understand what they’re trying to achieve, but it’s become a pain in the ass.”

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