AEC groups battle new 3% withholding rule

January 01, 2007 |

AEC industry groups are mounting a fight against a new law that will require government entities, including school districts, to withhold 3% of payments to construction, engineering, and design firms that perform work for federal, state, or local governments. The withholding rule is scheduled to take effect in 2011.

“Contractors aren't making much money on these contracts, and the assumed tax gap is way out of balance,” said Heidi Blumenthal, AGC's director of congressional relations, tax, and fiscal affairs. “Three percent withholding on the entire contract is akin to more than 100% of a constructor's earnings after costs, which is then much more than the tax liability actually owed on those earnings.”

Last May, a Senate-House conference committee inserted a package of revenue-raising measures into the Tax Increase Prevention and Reconciliation Act (TIPRA). One of these was the 3% withholding measure, which was added just before the bill was passed, so there was no time for debate.

The new rule, called Section 511 of the U.S. tax code, would place new burdens on almost all government contractors and vendors. Small businesses of less than 50 employees would be exempt, but lobbyists for the AEC industries say they would take the worst hit from the change.

An impact study by the 32,000-member Associated General Contractors of America, based in Arlington, Va., found that the 3% withholding would drive operating profit and net income before taxes into negative numbers for the typical heavy construction project. It would also limit cash flow and increase the cost of construction insurance bonds. AGC estimated that two-thirds of the money withheld would be in excess of the actual taxes due to the government.

Last month, Sen. Ron Wyden (D-Ore.) and Rep. Joe Barton (R-Texas) introduced an amendment to another tax bill that would have moved up the Section 511 implementation date to Dec. 31, 2006, for federal projects. With support from Reps. Kenny Hulshof (R-Mo.) and Sam Johnson (R-Texas), the AGC, the National Electrical Contractors Association (Bethesda, Md.), and small-business lobbying groups were able to get the amendment defeated before the last Congress adjourned.

Advocates of Section 511 say that government vendors are among the most egregious abusers of tax filing and payment obligations. For example, Pentagon contractors owe more than $3 billion in taxes to the federal government, according to congressional findings. Those who support the 3% withholding to contractors say it is an equitable way to close the gap between what taxpayers should pay and what they actually pay on a timely basis.

“Supporters like to claim this is like payroll withholding, but payroll withholding is fairly close to real liability, it's not an employee's complete paycheck,” said the AGC's Blumenthal.

“It's not increasing the amount of money going to the federal government at all,” said Tom Wolfe, senior director of federal affairs for the American Institute of Architects, Washington, D.C. “It's like claiming no exemptions on your W-2 form. It just means the government's holding onto large amounts of your money until you file your taxes at the end of the year.”

Wolfe says payments on government projects often are doled out in dribs and drabs. “In many cases, the payments aren't even sufficient to pay the cash flow of the architecture or engineering firm that's doing the work,” he says. “It's an increase on the burden for architects and engineers for no tax reason at all.”

Sen. Larry Craig (R-Idaho) says he will resubmit a bill to repeal Section 511 that he introduced in the last Congress. The original bill never made it to the floor for a vote.

The AGC, the AIA, NECA, the National Roofing Contractors Association, the Mason Contractors Association of America, and other industry groups are focusing much of their lobbying efforts on repealing the 3% rule before it takes effect in 2011. If it's not repealed, they said they would advise their members to seek professional help from tax lawyers or CPAs about how to comply.

“We're not sure the people who introduced it or any member of Congress for that matter has thought about implementation,” said Jessica Johnson Bennett, director of government affairs for the MCAA, based in Schaumburg, Ill.

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