Capitol Hill

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.

The 3 percent

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 government an interest-free loan for $21,000.

Effects on construction

Section 511 is seriously flawed. It hits honest taxpayers in an attempt to get at those underreporting income. Fewer firms will be able to bid on government contracts as companies with tight margins or irregular cash flows would lose vital funds for day-to-day operations and be at a competitive disadvantage in the bidding process.

In addition, as the cost of doing business with all levels of government is raised, many contractors will have to assume higher levels of debt or equity to ensure regular cash flows necessary for operations. The cost of this increase in capital structure will be passed on to the government through increased prices of goods and services and ultimately will be borne by taxpayers. This is the first time federal law has required withholding a portion of revenues from a sales transaction between any entity and its customers for potential future tax liability.

Although all industries are subject to withholding, construction is squarely in the crosshairs. Three percent may not sound steep, but with price increases the industry has witnessed in recent years, many firms simply will choose, or be forced, to withdraw from public sector work. Another concern is the effect this will have on contractors' ability to secure bonding. To suddenly strip a contractor of 3 percent of his working capital increases the risk of performance failure and potentially jeopardizes performance bonding. Payment bonds also are likely to be affected.

Outlook

Upon learning about the provision, Sen. Larry Craig (R-Idaho) introduced S 2821, the Withholding Tax Relief Act of 2006, on May 17. S 2821 would repeal section 511 outright. Because of the disproportionate effect on the construction industry, NRCA is leading an effort to get Section 511 repealed and has written Craig to commend him for introducing the legislation. Also, Kent Tolley, vice president of Boise, Idaho-based Quality Tile Roofing Inc., has visited with Craig's staff to see how the roofing industry can assist his effort.

The 3 percent withholding isn't scheduled to go into effect until 2011. But even though time remains, no contractor should harbor any illusions that repeal is a foregone conclusion. Since TIPRA was signed into law, some legislators have attempted to increase the withholding percentage and speed up implementation, showing how difficult it will be to rescind Section 511. It is incumbent upon everyone in the roofing industry to speak with their representatives and senators to address the negative effects Section 511 will have on the roofing industry.

R. Craig Silvertooth is NRCA's director of federal affairs.