State tax considerations for the fashion industry coping with COVID-19
INSIGHT ARTICLE |
As more Americans are mandated to “shelter-in-place” to slow the spread of COVID-19, many non-essential businesses are forced to shut down. Most clothing and beauty supply retailers are not considered essential businesses under the mandates. Before the virus spread into Europe and the United States, reports of supply chain shortages due to closure of Chinese and other foreign manufacturing had been a major concern for the industry. A month later, there is now a surplus of product inventory building up in warehouses as major designers, manufacturers and retailers are struggling to keep the business and supply chains intact. Each week, unsold fashion merchandise stored in warehouses may be losing value due to obsolescence.
Even if some beauty and fashion stores are allowed to remain open, several large department stores have closed stores, plants and warehouses worldwide resulting in thousands of layoffs, furloughs or reduced schedules for employees. There are reports of anticipated bankruptcies and permanent closures of brick-and-mortar locations. Businesses that have invested in e-commerce, utilize marketplace online distributors or sell their products through superstores that remain open will continue to see some revenue during this period, but it may not be enough to weather the storm. Off-price stores and small individual shops often do not have a large e-commerce presence.
The fashion and beauty industry is not limited to department stores, retail stores, and product manufactures. Smaller and more common beauty industry service businesses include professional nail artists, stylists, makeup artists, tattoo artists, and aestheticians. Most of the professionals have temporarily closed their shops and practices due to the close contact nature of their service. These businesses are not stocking up on goods and services they would otherwise purchase.
There is some good news. Some of the leaders in this industry have quickly pivoted from their traditional products to aid the world in producing essential products to combat the spread of the virus. Perfume manufacturers have repurposed fragrance making facilities to manufacture sanitizer. Designers are using their skill and expertise to produce face masks for hospitals around the globe. Other companies have started producing hydro-alcoholic gels for hospitals, nursing homes and food distribution channels. While these products may not provide the same margins that high-end manufacturers are accustomed to generating, the products that are sold, rather than donated, are providing a necessary cash flow to the businesses. Although live fashion shows may be canceled or postponed, some have turned to online broadcasts to continue to promote the next season’s products.
It will be difficult to understand the full impact of the virus on the fashion and beauty industry until the pandemic has passed and consumers go back to business as usual. In the long run, we anticipate seeing increased focus on the investment in e-commerce infrastructure and diversification of supply chain and products.
With the exclusion of mass merchandisers, the majority of businesses in the fashion and beauty sector are not actively hiring except for temporary workers used to produce and distribute essential products. As businesses make decisions regarding potential layoffs, furloughs, and reduced schedules it is important to consider employment tax implications. A number of strategies are available to employers to maintain workforces when the likelihood of layoffs increases. Minimizing the state unemployment tax impact of workforce reductions and analyzing independent contractor approaches from a tax perspective are key considerations for businesses struggling with these overwhelming decisions. Additionally, larger operations may have current employees working remotely. Remote employees can impact employment tax and withholding responsibilities.
Sales and use tax
Retailers are quickly investing in e-commerce technology to sell products online. As online sales increase, retailers should consider sales and use tax automation and assistance. The burden of sales and use tax compliance can quickly increase personnel responsibilities and cause process disruptions. Implementing an automation solution may alleviate such problems.
Manufacturers reengineering product lines to produce sanitary goods should consider the potential sales and use tax implications. Additionally, during an economic downturn, consumer credit failures and business defaults rise. Sellers might be able to use bad debt deductions and exclusions for gross receipts and sales and use purposes for improved cash positions.
Even during times of economic downturn, retailers and businesses must remember that sales tax charged and collected must be properly and timely remitted, or there could be risk for substantial monetary penalties and potential criminal penalties. Some states have delayed filing dates or waived interest and penalties on late payments.
Credits and incentives
One of the centerpieces of the economic stimulus package is the relief provided by the CARES Act through various options including U.S. Small Business Administration Economic Injury Disaster Loan Assistance, Paycheck Protection Programs, or loans for midsized businesses. These loans hope to incentivize businesses in retaining and paying employees. In addition to loans, the Employee Retention Credit further provides relief for businesses in this downturn. For more information on potential relief provided by the CARES Act, please read our article, Loans for small and midsize business.
Several state and local jurisdictions, have created specific COVID-19-related programs, the majority targeting small businesses. For more information on potential COVID-19 relief, please read our article, Coronavirus Credits and Incentives Relief for small businesses.
Even without the current crisis, retailers often overlook credits and incentives available to their business. In addition to retail stores, beauty and fashion companies often have manufacturing, distribution, and back-office teams that oversee operations. Depending on the jurisdiction, state and local programs may offer tax incentives to retain employees, train employees, or encourage innovation in new processes.
Lastly, for those companies with existing inventive agreements, it is possible they will fall behind on compliance or job commitments required. Getting in front of these issues will ensure they do not default the terms of the agreement, or allow time for renegotiation of the agreement because of the current extenuating circumstances. However, if the business has already defaulted, they can still work with the local jurisdiction to potentially minimize any claw back and associated penalties.
The CARES Act presents several federal income tax considerations that will impact current year and potentially prior year state income tax filings. Some of the major federal updates include the change to qualified improvement property eligible for bonus depreciation (Fix for the retail glitch), five-year net operating losses (NOL) carryback and interest limitation easing.
If the business is able to carryback NOLs for federal purposes under the new stimulus package there may be states where this opportunity also exists or is even required. Through state conformity of the Internal Revenue Code some states allow bonus depreciation and follow the interest expense easing, while other states will have their own specific rules that will need to be analyzed. Reviewing prior year filings and identifying refunds for taxes paid in prior periods could create additional cash flow. However, there are a number of considerations on the state level that should be reviewed in addition to conformity before exploring the carryback provisions.
Additionally, monitoring state and local tax extended compliance due dates for filings and payments can be a solution for immediate and short-term cash needs as most states have provided payment extensions. For more information on resources to aid in addressing extended filing and payment deadlines, please read our article, State taxing authorities address COVID-19 filing and business changes.
The COVID-19 crisis is having an unprecedented impact on the beauty and fashion industry. The scale of the decline in revenue will be different for each business, but businesses that adjust quickly should think beyond the immediate crisis to best position themselves when both the health and economic crisis recedes. Addressing state and local tax matters during this period can prevent the rise of state tax exposures and even result in substantial tax or cash savings for businesses that plan appropriately. RSM’s state and local tax team has the industry experience required to provide comprehensive services to all sectors of the industry at this time.