Tax Problems LA’s Garment Industry

Tax Problems Faced by Garment Manufacturers in Los Angeles:

Los Angeles, a global hub for fashion and garment manufacturing, is home to approximately 40,000 garment workers and 1,400 manufacturers, primarily concentrated in the downtown Fashion District. This vibrant industry, responsible for about 83% of the nation’s cut-and-sew manufacturing, faces significant challenges related to taxation. These tax problems, compounded by regulatory complexities, labor violations, and economic pressures, create a precarious environment for garment manufacturers. This article explores the key tax-related issues impacting Los Angeles garment manufacturers, including customs duty evasion, unreported cash transactions, sales tax compliance, and the broader economic implications of these challenges.

1. Customs Duty Evasion and Tax Fraud

One of the most prominent tax-related issues for Los Angeles garment manufacturers involves the evasion of customs duties on imported clothing, often coupled with tax fraud. The U.S. Customs and Border Protection (CBP) imposes duties on imported garments, calculated based on the declared value of the goods. However, some manufacturers and wholesalers in the Los Angeles Fashion District have been found to deliberately undervalue imports to reduce these duties, leading to significant legal and financial consequences.

Case Study: Tax Fraud and Money Laundering C’est Toi Jeans, Inc. (CTJ)

In October 2024, C’est Toi Jeans, Inc., a wholesale clothing importer in the Fashion District, along with its executives Si Oh Rhew and Lance Rhew, were convicted of avoiding over $8 million in customs duties. The company imported apparel from China and other countries but submitted false information to CBP, understating the value of the goods. This scheme not only reduced import duties but also facilitated money laundering and tax evasion. CTJ and Si Oh Rhew failed to report over $17 million in cash transactions on their tax returns, concealing these receipts from their accountant. The defendants sent 515 wire transfers totaling $137 million to overseas suppliers, further complicating their tax obligations. The case, part of the Organized Crime Drug Enforcement Task Force’s “Operation Fashion Police,” highlights the severe penalties for such violations, with potential fines for CTJ reaching $100 million and decades-long prison sentences for the Rhews.

Case Study: Under Reported Income Ambiance Apparel

Similarly, in December 2021, Sang Bum “Ed” Noh, owner of Ambiance Apparel, was sentenced to over a year in federal prison for undervaluing imported garments, evading millions in customs duties. Noh’s companies, Ambiance U.S.A. Inc. and Apparel Line U.S.A. Inc., maintained two sets of books to conceal cash transactions, underreporting sales on their 2011 and 2012 tax returns. This resulted in Noh owing the IRS $16.8 million in unpaid taxes, penalties, and interest, in addition to $18.4 million to CBP. The case underscores the systemic issue of tax fraud within the industry, driven by the pressure to remain competitive in a low-margin market.

Implications of Customs Duty & Tax Fraud

Customs duty evasion and tax fraud expose manufacturers to severe legal risks, including criminal charges, hefty fines, and imprisonment. These practices also distort the market, giving non-compliant firms an unfair advantage over ethical manufacturers who pay full duties and taxes. The complexity of international trade regulations and the temptation to cut costs in a highly competitive industry often drive such behavior, but the long-term consequences—financial ruin and reputational damage—are significant.

2. Unreported Cash Transactions and Wage Theft

Another critical tax issue is the failure to report cash transactions, often linked to wage theft and labor violations. Many garment manufacturers in Los Angeles operate in a cash-heavy environment, particularly when paying workers or conducting transactions with suppliers. This practice enables some firms to underreport income, evade taxes, and bypass labor laws, but it creates significant tax compliance problems.

Labor Violations and Tax Evasion

A 2023 U.S. Department of Labor survey revealed that 80% of garment-sewing contractors and manufacturers in Southern California violated the Fair Labor Standards Act (FLSA). More than half of these employers illegally paid workers “off the books,” either partially or entirely, with payroll records deliberately forged or withheld. This practice not only deprives workers of fair wages but also allows manufacturers to underreport income to the IRS, reducing their tax liability. For example, some workers were paid as little as $1.58 per hour, far below California’s minimum wage, with no record of these payments.

Piece-Rate Compensation

Until January 1, 2022, many garment workers were paid via piece-rate compensation, a practice outlawed by California’s Senate Bill 62 (Garment Worker Protection Act). Workers earned cents per garment (e.g., $0.03 for a zipper, $0.15 for a dress), resulting in hourly wages as low as $3–$5, well below the state’s minimum wage. This system enabled manufacturers to avoid payroll taxes, workers’ compensation insurance, and overtime pay, further reducing their tax obligations. However, it also left workers vulnerable to wage theft, with no pay stubs to document their labor. A 2016 UCLA Labor Center study found that Los Angeles garment workers lost $26.2 million weekly due to unpaid wages, exacerbating the issue of unreported income.

Tax Problems from Cash Transactions.

Unreported cash transactions and off-the-books payments create a dual problem: manufacturers evade income and payroll taxes, while workers are denied social security contributions and other benefits. When audited, manufacturers face back taxes, penalties, and interest, which can cripple small businesses. For instance, the Department of Labor’s 2012 sweep of a Fashion District building recovered $326,200 in back wages for 185 employees, with manufacturers also facing state citations for failing to comply with minimum wage and overtime laws.

3. CDTFA Sales Tax Compliance Challenges

In California, clothing is subject to a state sales tax of 7.25%, plus local taxes, which in Los Angeles County can push the total rate to 8.25% or higher. Garment manufacturers, particularly those selling directly to retailers or consumers, must navigate complex sales tax regulations, but compliance is often inconsistent due to the industry’s fragmented structure and cash-based transactions.

Taxable Transactions

Manufacturers must collect and remit sales tax on retail sales, including online sales, unless exemptions apply (e.g., sales of children’s clothing to qualifying nonprofits or certain thrift store transactions). However, the prevalence of cash transactions in the Fashion District makes it tempting for some firms to underreport sales, reducing their sales tax liability. This practice is particularly risky given California’s robust tax enforcement mechanisms, such as audits by the California Department of Tax and Fee Administration (CDTFA).

Impact on Small Businesses

For small-batch manufacturers, such as those producing 50–300 pieces per style, sales tax compliance adds to operational costs. These firms, often startups or emerging designers, may lack the accounting expertise to navigate California’s tax code, leading to errors or intentional non-compliance. The risk of owing back taxes out of pocket—especially if sales tax is not collected on taxable transactions—can be financially devastating.

4. Economic Pressures and Tax Policy Impacts

Beyond specific tax violations, broader economic pressures and tax policies exacerbate the challenges faced by Los Angeles garment manufacturers. Rising labor costs, minimum wage hikes, and proposed regulations create a high-tax, high-cost environment that drives some firms to cut corners or relocate.

Minimum Wage Increases

California’s minimum wage, set to reach $16.50 per hour by 2025, significantly impacted the garment industry, which relies on low-wage workers. A 2016 Los Angeles Times article noted that this hike accelerated the outsourcing of manufacturing to cheaper locales like Mexico, China, and Southeast Asia. For example, American Apparel, once the largest clothing maker in Los Angeles, cut 500 local jobs and considered outsourcing to the U.S. South to offset costs. The increased labor costs translate to higher payroll taxes, further straining manufacturers’ budgets.

Proposed Textile Waste Regulations

In 2022, the Los Angeles Department of Sanitation proposed regulations to ban the disposal of unsold apparel and textiles, aiming to reduce landfill waste. While environmentally motivated, these rules were criticized as an additional “tax” on manufacturers, who would face fees for waste collection services. Industry leaders argued that the policy overlooks existing recycling practices (e.g., repurposing fabric scraps for linings or donating defective garments) and could increase operational costs, indirectly affecting tax compliance by squeezing profit margins.

Gentrification and Zoning Changes

The DTLA 2040 plan, a zoning initiative to add 100,000 residential units downtown, initially threatened to displace garment manufacturers by allowing residential development in the Fashion District. This raised concerns about increased property taxes and rent, which could force manufacturers to relocate or close. After advocacy from the Garment Worker Center, amendments were made to protect 20,000 garment jobs, but the uncertainty surrounding such policies adds to the industry’s tax and financial burdens.

5. Ethical Manufacturers and Compliance Costs

While some manufacturers engage in tax evasion, others strive to operate ethically, prioritizing fair labor practices and tax compliance. However, these firms face higher costs, making it difficult to compete with non-compliant competitors.

Example: The Evans Group (TEG)

TEG, a Los Angeles-based manufacturer, emphasizes ethical and sustainable production, offering small-batch and high-end garment manufacturing. By adhering to labor laws, paying fair wages, and maintaining proper tax records, TEG incurs higher operational costs than firms that evade taxes or underpay workers. These costs are passed on to clients, making it challenging to compete with low-cost, non-compliant manufacturers.

Competitive Disadvantage

Ethical manufacturers face a competitive disadvantage in an industry where price points are driven down by fast fashion giants like Forever 21 and Fashion Nova. The pressure to remain cost-competitive tempts some firms to skirt tax obligations, perpetuating a cycle of non-compliance that undermines the industry’s integrity.

6. Solutions and Recommendations

Addressing the tax problems faced by Los Angeles garment manufacturers requires a multifaceted approach, balancing enforcement, education, and economic support. Below are key recommendations:

Enhanced Tax Education and Support

• Workshops and Training: The California Department of Tax and Fee Administration and the Labor Commissioner’s Office should expand outreach programs, offering free tax compliance workshops tailored to small manufacturers. These could cover sales tax, payroll tax, and customs duty regulations.
• Subsidized Accounting Services: Provide grants or subsidies for small manufacturers to access professional accounting services, reducing errors and improving compliance.

Stronger Enforcement and Penalties

• Audits and Inspections: Increase audits of cash-heavy businesses in the Fashion District to deter unreported transactions and wage theft. The IRS and CDTFA should collaborate with CBP to target customs duty evasion.
• Licensing Revocations: As demonstrated in the case of VRP Fashion, Inc., whose license was revoked in 2021 for labor and tax violations, the Labor Commissioner’s Office should continue to penalize non-compliant manufacturers by revoking licenses and seizing goods.

Policy Reforms

• Tax Incentives: Offer tax credits for manufacturers who demonstrate ethical practices, such as paying hourly wages, maintaining workers’ compensation insurance, and recycling textile waste. These incentives could offset the costs of compliance.
• Streamlined Regulations: Simplify sales tax rules for small manufacturers, particularly regarding exemptions for alterations and embroidery, to reduce administrative burdens.

Conclusion

The garment manufacturing industry in Los Angeles is a vital economic engine, but its tax problems—customs duty evasion, unreported cash transactions, sales tax non-compliance, and the economic fallout of labor violations—threaten its sustainability. These issues stem from intense competitive pressures, complex regulations, and a legacy of exploitation in the industry. High-profile cases like C’est Toi Jeans and Ambiance Apparel highlight the risks of tax fraud, while ethical manufacturers like TEG and Euphoric Colors struggle to compete in a low-margin market. Addressing these challenges requires robust enforcement, targeted tax education, and policy reforms that reward compliance and protect workers. By fostering a fair and transparent tax environment, Los Angeles can preserve its status as a global fashion hub while ensuring economic justice for its garment manufacturers and workers.