Manufacturers and distributors were among the first sectors to feel the impact of the COVID-19 pandemic. Supply chains took an immediate hit as travel restrictions and distancing guidelines went into place across the globe. Organizations may continue to feel the effects during the recovery phase as social distancing guidelines augment typical production environments and suppliers respond to the financial repercussions of the pandemic’s disruption.
A number of strategies may be available, however, to help manufacturers and distributors expedite their financial recovery as they adjust to the new normal. Tax relief provisions, insurance process updates, and monitoring of key performance indicators can provide liquidity relief together with insight into the manufacturing and distribution recovery process. The following provides a closer look at these objectives.
Recent COVID-19 legislation, including the Families First Coronavirus Response Act (FFCRA) and the Coronavirus Aid, Relief, and Economic Security (CARES) Act enhanced tax planning opportunities. Among other measures, the legislation created an employer Payroll Tax Holiday and an Employee Retention Credit. The Payroll Tax Holiday applies to the employer portion of Social Security taxes on wages that span March 27 through Dec. 31, 2020, so long as the employer did not obtain forgiveness on any Paycheck Protection Program (PPP) loans. The Employee Retention Credit covers up to 50% of qualified wages between March 13, 2020, and Jan. 1, 2021, regardless of whether an entity receives forgiveness for a PPP loan.
The CARES Act also opened up the ability to carry back net operating losses (NOLs) to the previous five tax years, applicable to losses that arise during 2018 to 2020. For organizations with fewer than 500 employees, utilizing the FFCRA’s Paid Sick and Paid Family Leave Credits provides payroll tax benefits to employers that compensate employees for this needed additional time off related to the COVID-19 pandemic. The limitation on deductions for business interest was also increased from 30 to 50% for many businesses during 2019, and all businesses during 2020. Additionally, there are new procedures to implement the fix to the retail glitch, a drafting error that limited an organization’s ability to deduct improvements to qualifying property.
Combined, these tax relief measures can significantly decrease 2019 tax liabilities due in 2020, and potentially create opportunities for tax refunds from 2018.
New Tax Opportunities
Your organization may find that it qualifies as a small taxpayer for the 2020 or 2021 tax year if your operations were severely impacted by the pandemic. The Internal Revenue Code classifies a small taxpayer as one that is not a tax shelter (35% or more of losses allocated to limited partners or limited entrepreneurs) and that has a three-year average of gross receipts that does not exceed $26 million (indexed of inflation).
Designated small taxpayers are not subject to business interest limitations, and they are also eligible to use the cash method of accounting. Additionally, if you qualify as a small taxpayer, you may also be able to opt out of previous provisions for accounting for inventory as well as being able to dismiss uniform capitalization rules. Long-term contracts may now be classified under an exempt-contract method (such as completed contract method). Additionally, higher revenues from a specified service trade or business (SSTB) can qualify for the QBI deduction not traditionally available for companies treated as a SSTB.
Another tax opportunity that may be available falls under Section 165(i). This code provision permits you to take a loss otherwise deductible under Section 165(a) in a prior tax year, if the loss is attributable to a federally declared disaster. The COVID-19 pandemic is considered to be a federal disaster because President Trump invoked the Stafford Act on March 13. This could dramatically affect any tax obligations that would be due on July 15, 2020 (the extended 2019 federal income tax filing deadline).
Manage Insurance Expectations
Although the COVID-19 pandemic disrupted operations, you will not be able to utilize business interruption claims because these property coverage policies require a covered property loss to have occurred. A COVID-19 virus outbreak at your facility might also make you eligible to take a liability claim.
Additional industry-wide insurance changes may be coming due to the unprecedented scale of disruption. Some federal and state legislation is now being discussed that may force insurers to cover certain claims, but this will most certainly be met with a multitude of legal challenges, and possibly be left to the states’ supreme court for a final determination. The more likely response will be the enactment of a federal backstop to protect businesses in the event of a future pandemic, much like the Terrorism Risk Insurance Act of 2002, which was enacted after the events of 9/11. You should prepare for potential liabilities associated with reopening by putting the safety of employees and clients first, as well as keeping accurate records of related expenses.
Be mindful when making any decisions about your insurance coverage that anticipate the business landscape because if the pandemic has demonstrated anything, it’s unpredictability. Just because operations appear to be stabilizing, your new exposure may be quite different depending on the maneuvers you have made to adjust to this period of uncertainly.
See also: P&C Market Outlook -- factors that influence your rates, emerging risks and trends, lines of coverage forecast (will be included in newsletter - draft provided to editorial committee 6/9)
Monitoring Recovery Progress
One of the most crucial elements manufacturers and distributors will need to prepare for their COVID-19 recovery involves a clear understanding of their current and expected financial performance. The situation around the COVID-19 pandemic created a dynamic operating environment. You may find that you need to move away from an infrequent and lagging profit and loss (P&L) focused review to a more frequent and timely review of KPIs to identify new developments and opportunities.
Now is the time to implement dashboards and performance reporting processes that highlight key drivers of financial performance, including revenue, cost, and working capital so that management teams focus on what can be influenced in the short term.
You may also find value in creating ongoing cash flow forecasting processes that reflect supply chain considerations for your materials and inventory. For example, if you expect to experience a disrupted supply chain over the next several weeks, your organization may want to account for accelerated disbursements associated with ramping up safety stock and average inventory on-hand.
Lastly, manufacturers and distributors should move to the regular (e.g. monthly at a minimum) use of a flexible three-statement forecasting model that includes at least three scenarios— Best, Most Likely, Worst — for how management expects the organization to perform. Using a comprehensive, assumption-based model to forecast the P&L and balance sheet (B/S) will help identify more nuanced dependencies in the financial position of the business. For example, you might find that you do not expect to have the cash required to increase inventory balances to the desired coverage level given the next three months of anticipated sales with a growing customer days sales outstanding (DSO).
Efforts made now to optimize tax liabilities, insurance coverage, and financial performance management may help your organization come through the recovery phase poised for its new normal. Potential tax savings and policy premium savings from reduced exposure from downtime may provide some breathing room to cash flow to make adjustments to operating strategies, such as production environment and inventory changes. Up-to-date dashboards can provide the insight to see how those pivots are affecting your organization’s financials, and early indicators about what the new normal may look like for revenues.
Feel free to contact us for additional information about the recovery process.
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Copyright © 2020 CBIZ & MHM (Mayer Hoffman McCann P.C.). All rights reserved. CBIZ and MHM are separate and independent legal entities that work together to serve clients. CBIZ is a leading provider of tax and consulting services. MHM is an independent CPA firm providing audit and other attest services. This article is protected by U.S. and international copyright laws and treaties. Use of the material contained herein without the express written consent of the firms is prohibited by law. Material contained in this alert is informational and promotional in nature and not intended to be specific financial, tax or consulting advice. Readers are advised to seek professional consultation regarding circumstances affecting their business.