On May 17, President Bush signed into law the Tax Increase
Prevention and Reconciliation Act of 2005 (TIPRA), which extends
various tax provisions scheduled to expire, including alternative
minimum tax relief and lower capital gains and dividend tax rates.
But the new law isn't good news for the contracting community.
Hidden in the fine print is a provision (Section 511) that would
require all government entities—federal, state and
local—to deduct and withhold from all payments made to any
individual or business providing goods or services an amount equal
to 3 percent of the total payment.
Advocates of Section 511 argue that withholding payments to
contractors is one way of closing the "tax gap"—the
difference between what taxpayers should pay and what they actually
pay on a timely basis. And because these advocates allege
government vendors are among the most egregious abusers of tax
filing and payment obligations, they reason it's only fair to
impose this new requirement.
The problem is this argument wrongly assumes 3 percent of the
gross payment on a contract will match a contractor's tax liability
on a particular project. Consider a contractor who signs a $1
million contract with the city of Chicago to reroof a municipal
property. Section 511 would require Chicago to withhold 3 percent,
or $30,000, of the $1 million payment. Then, assume the contractor
earns a 3 percent profit—the national average in construction
contracts—on the project. That means the contractor would
expect a profit of $30,000, or 100 percent of the amount withheld.
If the contractor qualifies as a small business and falls in the 30
percent corporate income tax bracket and because businesses are
taxed only on their profits, the tax liability on the $1 million
project would be $9,000. So the contractor would float the federal
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