The taxman cometh, and he bringeth unfair burdens

Buylines | Policies, strategies and trends to watch

Steve Charles

The Government Accountability Office contends some Defense Department contractors abuse the federal tax system with little consequence. DOD and Internal Revenue Service records indicate that some 60,000 government contractors (27,000 DOD, 33,000 civilian) owe nearly $3 billion in unpaid federal taxes.

Most are unpaid payroll taxes ? money that businesses withhold from an employee's wages for federal income taxes, Social Security and Medicare ? and the employer's matching contributions for Social Security and Medicare. A much smaller group of contractors failed to pay income taxes on their business profits or individual income, GAO reported.

GAO reported on the DOD portion of this phenomenon in 2002 and the civilian portion in 2005. The watchdog agency provided ample guidance for remedying the situation.

Yet a solution proposed by an IRS official found its way into law as Section 515 of the Tax Increase and Prevention and Reconciliation Act of 2005 that requires the government to deduct and withhold 3 percent of practically everything it owes anyone.

This provision goes into effect Jan. 1, 2011, and would include pass-through item invoices, grants, aid to farmers, construction contracts and even Medicare payments to hospitals and other health care providers. Section 515 also requires government entities at the state and local levels ? except those that spend less than $100 million per year ? to deduct and withhold 3 percent of what they owe. Policy-makers say Section 515 will net the government $7 billion, and they are already factoring this revenue into their budget planning.

A movement to repeal Section 515 of Public Law 109-222 is slowly building, spearheaded by the Government Withholding Relief Coalition, a group of 59 industry associations.

There is hope that this blunt instrument will be replaced by a policy that penalizes only those who abuse the system, not those who already pay their payroll and income taxes.

The coalition is collecting information on how this automatic 3 percent deducting and withholding would affect the many kinds of government contractors. Among the questions being raised: How would the withholding work for credit card orders? What about contracts for which 3 percent of the gross amount far exceeds any possible tax liability? What are the costs to maintain this method of tax accounting?

As for these 60,000 contractors, who are they? Are they among the 80 percent of contractors who do 20 percent of the business? Won't the tax evaders just go underground as subcontractors and provide better-than-competitive rates to prime contractors without penalty?

The GAO report that apparently got Congress fired up over this issue didn't recommend a universal 3 percent withholding. Rather, it recommended that the government prohibit contract awards to tax evaders and fix the accounting and finance systems that apparently allow this kind of thing to go undetected.

It's hard to believe that a simplistic suggestion by an IRS official can become law in the absence of any discussion about how withholding could be implemented without penalizing law abiders. Such a law would not address the real problem
if the lawbreakers simply become subcontractors.

What's more, I'm amazed how many resources it takes to collect facts and marshal the arguments necessary to lay the groundwork for legislation to undo this mistake.
It may seem like a long time until Jan. 1, 2011, but many contracts have a five-year base period, so we need to think about the extra costs associated with this law and plan accordingly. Better yet, help get it repealed by supporting your industry association and the Government Withholding Relief Coalition. We need to punish the abusers, not all taxpayers.

Steve Charles is co-founder of immixGroup Inc., a consulting firm in McLean, Va. E-mail him at steve_charles@immixgroup.com.

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