Manufacturing and the state tax ramifications of COVID-19
INSIGHT ARTICLE |
The COVID-19 pandemic has profoundly affected the manufacturing industry and significantly transformed the way many companies do business. A segment of the industry is conducting business as usual with minor adjustments. But most companies are facing change. Shelter-in-place orders impact operations. There are market changes for many products including significantly lower demand, and in some cases much higher demand. Businesses in the sector are also affected by supply chain issues. The pandemic has made getting supplies and components more difficult, ultimately affecting the ability to get products to market.
Many manufacturing companies have been deemed essential to the economy. Those companies are trying to carry on as normally as possible, but for those companies it is hardly business as usual. High-risk employees are working remotely. Companies are practicing social distancing. And perhaps unexpectedly, many companies producing essential products are hiring employees and expanding production.
But most companies are suffering from the effects of the pandemic. Companies that produce non-essential products are pausing operations, while others are quickly retooling to create products in demand like ventilators, masks and scrubs. Layoffs are mounting even for companies that are highly automated. Overall demand is down dramatically as the global economy slows and most companies experience cash flow issues with mounting debt.
Manufacturing companies are concerned about their short-term viability and need influxes of cash. Perhaps more importantly, they want to protect existing employees so that when the COVID-19 crisis ends, the business still exists. Those companies will want to recall their workforce. But they face other concerns such as determining the time and resources necessary to return to operations.
Not surprising, most industrial product companies want to know how to maintain sufficient working capital during these uncertain times. The Coronavirus Aid, Relief, and Economic Security Act will provide some relief to companies and unemployed workers.
First, all companies should be aware of all business entity and personal income tax filing and payment extensions. While temporary, the filing AND payment extensions will provide some short-term relief. Some states have even delayed filing and remittance of sales taxes. For more information on extensions, please read our articles, State taxing authorities address COVID-19 filing and business changes and State and local sales tax extensions and relief due to COVID-19.
Companies should carefully evaluate their operations to determine if planned projects with demonstrated returns on investment make financial sense even where cash flow is restricted. But companies need to carefully examine tax changes that may result in an economy dominated by COVID-19. For example, employees working remotely in another state could create employment tax issues. Remote employees could affect nexus determinations, as well as Public Law 86-272 protections – the federal safe harbor prohibiting a state from imposing a net income tax on a seller's business activity if it is limited to the solicitation of orders for sales of tangible personal property. There are ways to mitigate the unintended tax consequences of remote employment.
Manufacturing companies should also explore taking advantage of the various credit and incentive programs available from both the federal, state, and even some local governments. For example, companies may be eligible for assistance through the Federal SBA Disaster Loans. These loans are administered by state economic development authorities in conjunction with the U.S. Small Business Administration and provide up to $2 million in working capital through a streamlined application/approval process with long-term repayment options. As importantly, there are numerous state credit and incentive programs that are designed to assist companies in the retention of employees and to foster continuous business operations. Many of these programs have existed for years. But many are recently enacted because of the COVID-19 crisis.
Depending on the jurisdiction, more state programs are likely to be created. Companies with existing negotiated incentive agreements with states may face hardship because they fail to maintain the required employment or investment levels. Most states impose clawbacks in those situations. But it may be possible to renegotiate the incentives agreements. Some states may waive the employment and investment requirements during the crisis.
The economic crisis has understandably caused widespread disruption in the workforce. Layoffs and furloughs are commonplace. Unemployment claims have increased dramatically. Companies with vacation and sick leave policies should consider having employees exhaust those pay methods before turning to layoffs. The Families First Coronavirus Response Act provides incentives and guidance for employers. Manufacturers that are forced to furlough a significant portion of their workforce normally face increased ratings for their unemployment insurance premiums. But many states are providing relief through specific COVID-19 programs to prevent increased ratings.
Finally, manufacturers should examine their current operations with a focus on existing tax liabilities. While filing requirements are delayed, the tax will eventually be due. Some companies would see a short-term benefit in reducing current income, franchise, and sales taxes. A nexus review for example may lead to a lower income liability. Many manufacturers have orders for equipment and supplies that may not be subject to tax. Such a review could be a cost effective way of keeping more cash in the business.
For more information on credits and incentives opportunities because of the COVID-19 pandemic, please read our articles, Coronavirus credits and incentives relief for small businesses and Middle market relief for businesses impacted by the coronavirus.
There are ways to improve cash flow in the intermediate terms as well. Companies should consider looking at both their income/franchise and sales and use tax payments for the past three years or in some cases longer. A reverse income tax audit often results in substantial refunds. Situations that give rise to such refunds include, but are not limited to, income incorrectly apportioned, erroneous elections, and the failure to claim credits.
Similarly, many companies pay sales and use tax on products and services that are not actually subject to tax, which is especially true in the manufacturing industry. In those cases, the company is entitled to refunds for the tax collected but not due. Companies often pay sales and use tax on new software, hardware, machinery, and other purchases. The taxation of such purchases varies from state to state, but almost every state provides some type of manufacturing exemption. Many companies will pay tax in all states because a particular state subjects a purchase to tax. Income and sales tax refunds do not materialize overnight. But they can provide a cash infusion in the near term. Moreover, refund reviews can reduce effective tax burdens in future periods.
Finally, for many manufacturers, accounting and finance personnel are working remotely. Most companies are ill equipped to conduct business remotely for long periods of time. Outsourcing some compliance functions either temporarily or permanently could reduce internal costs.
COVID-19 is significantly impacting the industrial products industry. State and local tax can play an immediate and longer term role in helping provide various bridge financing methods to those facing a direct shutdown or reduction in orders and looking to preserve cash. Those providing goods to deemed essential service industries such as medical, food safety, and government, may see significant uptick in demand and face unique challenges meeting those needs in the current environment that can also be offset by state and local tax options and provide future benefits. RSM’s state and local tax team are first choice advisors serving the industrial products industry with the right tools to navigate the current economic situation.