2012 Mandatory Withholding on Government Contracts

Published:

Brandon Cook, CPA | Manager, Tax Services Group and Team Member of the Construction Services Group
317.241.2999 | bcook@greenwaltcpas.com

Back in March of 2009 I wrote my first article on this topic. At that time, not very many professionals or clients were aware of a tiny inclusion buried in the Tax Prevention and Reconciliation Act of 2005. Section 511 of this tax act will require Federal, State, and Local governments with total expenditures of $100 million or more to withhold 3% of a contract’s total payments for goods or services provided to the governmental body to guard against possible business tax evasion. This withholding provision originally was supposed to take effect on payments received on or after January 1, 2011, however, the American Recovery & Reinvestment Act of 2009 delayed the effective date until January 1, 2012.

This law could have adverse affects on many industries that conduct business with the government, but it could especially hinder the construction industry. As the law reads at the date of publishing, most contracts that are performed for a governmental body will be subject to the mandatory 3% withholding (there are a few exceptions). Given the current economic conditions, a 3% reduction in the amount of cash received from a project could have many adverse affects on general, or prime, contractors. The Government Withholding Relief Coalition (GWRC) was formed shortly after this tax act was signed into law in the hopes of eventually helping to repeal this section of the tax law. Some arguments the GWRC has against the new withholding tax include:

  • The withholding applies to the total contract price and not the net income associated with the contract
  • The law places an undue burden on S Corporations and LLC’s since those companies pay tax at the shareholder/partner level
  • Some construction contracts do not make a 3% profit, especially in today’s environment
  • It will put a burden on many companies’ cash flow and could ultimately affect their ability to receive bonding since the contractor’s cash flow will not be as attractive
  • Many companies already pay quarterly estimated tax payments, so an additional withholding requirement may be excessive
  • Since this only applies to those that have the contract with the government, the subcontractors are not being impacted in the same way, but the general contractor will likely want to pass on the burden to the subcontractors

Many of the construction industry associations already belong to the GWRC, including the American Subcontractors Association, the Associated Builders and Contractors, and the Plumbing-Heating-Cooling-Contractors. A complete listing of the GWRC’s members can be found at www.withholdingrelief.org. In addition to the items listed above, there are many additional unanswered questions as to how the withholding process would work.

Despite the lobbying efforts by the GWRC, not much has changed since my March 2009 article. The GWRC is still lobbying with Congress to get this law removed before the January 1, 2012 effective date, or at the very least push back the effective date so that more analysis can be done. Letters were sent by the GWRC to the House and Senate on September 16, 2010, as well as a follow up letter in November 2010. Unfortunately this particular issue wasn’t addressed in the 2010 Tax Relief Act, which was signed into law by the President on December 17, 2010.