The Tax Increase Prevention and Reconciliation Act of 2005, Section 511

The Tax Increase Prevention and Reconciliation Act of 2005, Section 511

December 1, 2006

By Gregory T. Spalj


They say that no one is safe when Congress is in session. Well, Congress is at it again. Buried deep within the Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA) [1] , signed by President Bush earlier this year is a provision that will require 3% of the total contract value on most public construction projects be withheld from the contractor to insure it pays its taxes. This tax withholding, which is in addition to retainage, is predicted to have dire financial consequences on the entire construction industry, and especially so for small contractors, if it is allowed to take effect. This month’s Briefing Paper will provide you with the knowledge that you need to take and support actions to repeal this provision, before its effects can be felt.

A History of Section 511

TIPRA, as passed by both the House of Representatives and the Senate, was a series of tax reduction provisions. The version Congress approved did not include section 511. Section 511 was slipped into the Act during reconciliation between the House and Senate versions of the bill, before being sent to the President for signing. [2]

Because this provision is not to take effect until the year 2011, there is plenty of time for the construction industry to lobby Congress to repeal this provision. The Section is applicable to all government entities with an annual procurement budget of at least $100 million. When it takes effect, Section 511 will require state, local, and the federal governments to apply a new 3% withholding tax on all contracts for goods and services, including construction. Hence, all federal entities, every state, and most cities and counties will be subject to this rule. According to a Joint Committee on Taxation report, when the Section becomes effective in 2011, it will generate over $6 billion in annual revenue. [3]

Immediately following the enactment of this provision, lobbyists for industry groups such as the Associated General Contractors, the Associated Builders and Contractors, and the National Electrical Contractors Association took action. Legislation was introduced in both the House and the Senate to repeal Section 511. However, at the close of the 109th Congress, the provision remains law and support is gathering on both sides of the issue.

Advocates of Section 511 support the provision for the purpose of funding the tax-gap, which is the shortfall between what taxpayers should pay and what they actually pay on a timely basis. However, there is no direct correlation between the amount of tax withholding and a government vendor’s tax liability or the probability that they might default.

Observing this newfound revenue stream and not wanting to wait until 2011 to cash-in, congressional advocates of Section 511 want to amend the provision to accelerate the effective date to 2007. As Congress reconvenes in 2007, new amendments seeking an early start date may resurface. Near the end of the 109th Congress, an amendment was proposed to accelerate the effective date of Section 511 and to use the additional revenue to fund the Rural Schools and Community Trust Fund. Through some quick defensive action by industry groups and lobbyists, the proposed amendment was defeated.

Effects on Construction

While Section 511 is applicable to all government contracts for goods and services, the adverse effects will be particularly acute on the construction industry. In the construction industry, it is common for general contractors, construction managers, and design professionals to work on low single digit profit margins. Furthermore, some of greatest challenges throughout the industry’s supply-chain stem from slow payment and retainage restricting cash-flow and project financing. On many projects, a new 3% withholding, in addition to retainage, will deplete not only the contractor’s profit, but reduce sorely needed operating capital. Undoubtedly, this will impact risk analysis by insurance underwriters, sureties, and financiers. Eventually, contractors and suppliers will be forced to raise their proposal price to account for this shifting burden of financing and the taxpayer’s cost of construction will increase.

Additionally, all governmental agencies that are required to withhold the tax will feel the burden. Accounting methods and financial software will need to be modified, requiring the expenditure of more money that local governments do not have.

Current Action

The 110th Congress will convene on January 4, 2007 and the advocates of Section 511 are expected to propose accelerating the effective date. Contractors, equipment manufacturers, material suppliers, labor unions, trade organizations, and professional service providers need to generate bi-lateral support to repeal Section 511 before it takes effect. If you want to join the effort to repeal this provision, contact your trade organization and make sure that they are informed and offer your support to repeal Section 511.

This discussion is generalized in nature and should not be considered a substitute for professional advice. © FWH&T

Fabyanske Westra Hart & Thomson