Economic Losses: Blame the Virus? Not Entirely

By Louis Vlahos | March 26, 2020

We are in a Coronavirus-induced lockdown. Most places of business are either closed or are open on a very limited basis. Social distancing is the order of the day. Those who can work remotely are doing so. Many don’t have that option.

Certain businesses are experiencing an uptick in revenue as a result of the lockdown. Other businesses, including restaurants, are floundering as demand for their goods or services has plummeted.

Then there are those businesses – mostly closely held – which basically live “from paycheck to paycheck.” It is a truism that they need to collect on their receivables in order to satisfy their payables.

In bad times, these businesses may be able to rely on a line of credit for some period (assuming the line is adequate) – the question, of course, is for how long – or they may have to dip into their reserves or even request an infusion of capital from their owners.

Many of these businesses are struggling to stay afloat.

They are trying to generate a steady flow of work from those other businesses with which they ordinarily transact, as well as from the general public – this can be a challenge in normal times, let alone under the circumstances in which they now find themselves, where even these potential or existing “client businesses” are experiencing the same challenges.

Even when this work can be found, one has to wonder whether the client will ultimately be able to pay the usual price charged by the business, or whether they will negotiate a discounted charge from the get-go. It is not at all unusual for a business to settle for a near-to-below market rate just to keep its doors open and its workers employed – we’re talking damage control until one can round the proverbial corner.

And while it may be difficult to generate the necessary business and the resulting receivables, which hopefully will be collected sooner rather than later, many business expenses are fairly fixed – unless the business is able to negotiate concessions from its landlord, bank, vendors, etc.; for example, rent, debt service, salaries, insurance, and others.

Clearly, the leaner a business was going into this situation – no unnecessary obligations (so-called “fat”), an available line of credit, adequate reserves – the greater its chances of enduring the slowdown and ultimately emerging from it.
Examples of items that may be characterized as fat include the following: above-market salaries and benefits, excess labor (meaning that a function that should reasonably be performed by one person is spread out over two), unnecessary overhead expenses, personal expenses, travel and entertainment, non-targeted charitable contributions.

Federal Government Response

In response to this stressful – but hopefully short-lived – business environment, the Federal government has taken some extraordinary measures over the last few weeks to help American businesses, and the public generally, to cope with what is expected to be the significant economic toll attributable to the Coronavirus.

Businesses that are required to provide paid leave for employees are being granted a refundable tax credit pursuant to the recently enacted Families First Coronavirus Response Act to defray the associated cost.

And on March 25, the Republican and Democratic leadership in the Senate announced an agreement on an economic stimulus plan that provides for more than $2 trillion in spending, as well as tax breaks, to bolster American business and consumers. A well-reasoned Keynesian-inspired approach? Doubtful, because how will this infusion of cash into the economy stimulate consumer demand under the circumstances in which we find ourselves? After all, folks are either not allowed to, or are fearful of, going out to places where they may encounter groups of other people.

Or an election year vote-shopping spree by both parties? One has to wonder. Take a look, for example, at the alternative stimulus plan proposed by the House Democratic leadership which included all manner of provisions having nothing to do with economic stimulus.

This at a time when the country’s Gross Domestic Product is approximately $22 trillion, and when the Federal deficit for the 2020 fiscal year (ending September 30, 2020) was already projected to top $1 trillion on projected revenues of over $3.6 trillion. What’s more, there is already talk among our representatives in D.C. of yet another stimulus package in the not-too-distant future.

Rescue Package Concerns

Query how we will pay for these rescue packages? Presumably, those being helped today (or their children) will have to repay the “favor” in one form or another, perhaps through higher taxes, and probably sooner than most would prefer.

Now don’t get me wrong. Government has a duty to fill the breach and then repair the cracks when the walls of economic security suddenly start to crumble. As we are presently constituted, no other organization has the logistical and fiscal ability to react to a crisis.

That being said, why should a crisis like the present one cause so much harm in such a short period of time? Many businesses will fail that should not have failed. Others will rack up significant losses that they should not have realized. As a consequence, people will lose jobs they should not have not lost. The ripple effects are obvious, and I doubt they will be short-lived.

Those closely held businesses that survive – whether because they were “lean and mean” before the coronavirus-induced economic crisis, or had adequate reserves or other financing sources, or for some other reason, including plain luck – are still likely to have realized significant losses. They are also likely to be in need of new capital.

Proposed Changes to the U.S. Tax Code to Help Preserve and Protect the Economy

I am not an economist. I have never served in government. I’m a tax attorney. As such, I recognize that tax legislation can be a powerful tool for promoting the achievement of economic and other goals that our society deems worthy. One such goal should be the security of business and, thereby, of jobs.

The Internal Revenue Code encourages certain behavior by business by allowing the business to claim deductions or credits for expenses incurred as a result of such behavior. Similarly, the Code allows the deferred recognition of income or gain that is realized in connection with certain transactions that the government wants to encourage.

Why not use the Code to encourage a business to establish emergency reserves for salaries and other expenses for a prescribed period of time (say, between 30 and 60 days?) in the event of a “Crisis” as declared by the President or, where appropriate, by the governor of a State? For example, the business would retain as reserves in a segregated account those funds that would otherwise have been distributed in their entirety to owners. In exchange, the business would receive a tax credit. Or provide that a business may claim a tax deduction for the diversion to a reserve of those amounts that would otherwise have been paid as executive compensation? These tax benefits may be coupled with the protection of such accounts from the claims of creditors. In addition, perhaps we can “reform” the purpose for captive insurance to serve as a kind of rainy day fund to which the insureds – a community of businesses – would make tax deductible contributions.

During the last financial crisis, we were told that certain banks were too big to fail. The same could be said, and with more justification, for the domestic manufacturers of many kinds of products that are vital to the health and well-being (both physical and economic) of our citizens. Again, the Code can be utilized to foster the establishment and growth of such businesses, whether through preferential rates, credits or otherwise.

Turning to not-for-profits, perhaps we should recognize that not all of them are created equal. Healthcare should be promoted over dance. (Sorry.) Why not grant a larger tax benefit for donations to a hospital or to a research facility than to a “cultural” charity?

I am certain that more creative people than me can think of many more ways to employ the Code as a vehicle for preparing us to respond to the next crisis. The point is that we should start considering our options right away.

Lou Vlahos is a partner and leads the Tax Practice Group at the law firm Farrell Fritz, P. C. He publishes weekly blog posts on the firm’s Tax Law for the Closely-Held Business blog, [email protected]