Just one year ago, on May 17, 2006, America’s small businesses cheered as President George W. Bush signed into law a bill providing a number of vital small business tax relief measures, such as extended lower capital gains and dividend tax rates, Section 179 expensing and a one-year Alternative Minimum Tax fix.

However, many small business owners stopped cheering when they realized that the bill, the Tax Increase Prevention and Reconciliation Act of 2005 (P.L. 109-222), included a provision requiring that 3 percent be withheld on all payments for goods and services made to federal, state and local contractors starting in 2011. The withholding applies to the total contract, not to the net revenue generated from a project. For construction contractors, this means the government is withholding funds necessary to complete a project, including funds needed to pay subcontractors and suppliers.


The Section 511 provision was added during conference negotiations as a “revenue raiser,” and was not included in either the U.S. Senate or U.S. House of Representatives versions of the bill. The provision was slipped into the P.L. 109-222 conference report with the intention of increasing tax law compliance and helping to close the “tax gap”-the difference between the amount of tax that taxpayers should pay for a given year and the amount that is paid voluntarily and in a timely manner. According to a Government Accountability Office report released last year, more than 3,800 federal contractors had tax debts totaling $1.4 billion.

While this figure is troubling, the potential impact of the 3 percent withholding on small businesses-construction firms in particular-is devastating. The withholding is larger than the profit margins permitted under many government contracts and will significantly impede cash flow, hampering a firm’s ability to compete for business, or even complete projects. Companies with tight margins or irregular cash flows will lose critical funds for day-to-day operations and will be at a competitive disadvantage in the bidding process. Small businesses will be forced to raise their bids for federal contracts to offset cash-flow issues related to the withholding, making their offers more expensive and less attractive.

In addition, the withholding will create an enormous administrative burden for contractors and government alike. In fact, the Congressional Budget Office reported last May that the costs of administering the 3 percent withholding constitute an unfunded mandate on state and local governments because they exceed the $50-million annual threshold established in the Unfunded Mandates Reform Act.


Although the withholding does not kick in until 2011, my association, Associated Builders and Contractors (ABC) is already taking action to ensure that the provision is never enacted. ABC has formed the Construction Organizations for Sensible Taxation (COST) Coalition, a group of nine construction industry organizations led by ABC that support the repeal of Section 511. The coalition strongly supports legislative efforts to remove the provision, such as measures introduced in the last Congress by Sen. Larry Craig (R-Idaho) and Rep. Wally Herger (R-Calif.), that would have repealed Section 511. The coalition is currently working with lawmakers to ensure similar legislation is introduced in the 110th Congress.

Additionally, ABC and its industry partners are fighting to prevent Congress from using the 3 percent withholding to fund government programs in the short term. In the final days of the 109th Congress, lawmakers proposed accelerating the implementation date of the provision from 2011 to 2007 in order to pay for a rural schools initiative. ABC led the charge on Capitol Hill and within the contractor community to oppose the withholding offset, working closely with Reps. Kenny Hulshof (R-Mo.) and Lynn Westmoreland (R-Ga.) to successfully defeat the revised timetable. ABC anticipates that similar efforts will be made in the 110th Congress to use the 3 percent withholding as a means to fund government programs.

Until Section 511 is repealed, America’s small business contractors must remain on guard. The potential effects from this provision are staggering-reduced competitiveness, huge administrative headaches, increased debt and higher costs. And as the cost of doing business with all levels of government climbs, the added expense will be passed along to American taxpayers.