Repeal 3% Withholding on Government Contracts

Enacted into law on May 17, 2006, section 511 of the "Tax Increase Prevention and Reconciliation Act of 2005" (Public Law No. 109-222) requires all federal, state and local government entities and instrumentalities to withhold 3% of payments made for goods and services for federal income tax liabilities. This withholding requirement will become effective for payments made after calendar year 2010.

The 3% withholding requirement departs from the traditional scheme of federal tax payments, because the static 3% withholding rate bears no relation to anticipated taxable income. Indeed, a small business working under a government contract with a slim profit margin could actually experience a net loss for the tax year but still be subject to the 3% withholding. For small businesses, this provision would:

• Reduce federal procurement opportunities for small businesses that cannot carry the increased financing requirements;
• Cause cash flow problems for both prime and subcontractors, jeopardizing the smooth/timely execution of the contract;
• Increase interest costs to small businesses for operating funds needed to cover the 3% withholding;
• Cause higher contract costs for government