There's an ironic twist in the Tax Increase Prevention and Reconciliation Act (TIPRA) of 2005, write Gregory T. Spalj and Ryan G. Miner in the December 2006 issue of “The Construction Law Briefing Paper.” According to Spalj and Miner, shareholder and consultant, respectively, at Minneapolis-based Fabyanske, Westra, Hart, & Thomson, P.A., what was supposed to be a bill containing a series of tax reduction provisions is actually a time bomb for the construction industry. Added to the bill during reconciliation between the House and Senate versions and before being sent to President Bush for signing, Section 511 — a provision that will require 3% of the total contract value on most public construction projects to be withheld from the contractor, or vendor, to ensure it pays its taxes — is predicted to have dire financial consequences on the entire construction industry, especially small contractors.
“What 511 does is retain the money the government anticipates should be paid in taxes in the future,” Miner explains. “But that's not necessarily the case because the amount isn't computed based on tax burden. It's computed based on contract value.”
That means that a contractor or vendor working on a gross profit of less than 3% would have its entire profit margin withheld until after it's been proven the firm has paid its taxes. This would deplete the contractor's much-needed operating capital. “Cash flow is so critical in this business,” Miner says. “It's a grossly overstated amount to take 3% of the contract value.”
Eventually, contractors and suppliers may be forced to raise their proposal prices to account for the additional withholding. “If you create these administrative burdens, the contractor or vendor has no choice but to pass those costs on to the taxpayer,” Miner says. “In effect, it just raises the cost of the end product.”
The provision is due to take effect in 2011, although there has been some speculation that Congressional advocates of the provision want to amend it to an effective date this year. Miner encourages electrical contractors to support lobbying efforts to repeal this measure.