Fall 2009 issue of Horizons

Raise Your Expectations CERTIFIED PUBLIC ACCOUNTANTS AND BUSINESS CONSULTANTS

Current Tax and Financial Reporting Developments for the Construction Industry Beginning on January 1, 2012, federal, state and local governments are required to withhold 3 percent from all payments for goods and services as a guard against possible business tax evasion. The law mandates that federal, state and local governments with total annual expenditures of $100 million or more withhold 3 percent on all government payments for products and services. The Associated General Contractors of America and numerous other trade associations across the United States are supporting the total repeal of the 3 percent withholding requirements. The AGC’s comments supporting the repeal include: • 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 By Frank Hogg, CPA 3 Percent Withholding

complete a project, such as those necessary to pay for materials and suppliers. • Withholding is more than profit on most construction contracts. Most general con- tractors, especially those working as construction managers, do not make a 3 percent profit on a contract. For example, a small business contractor may hold one government contract that is estimated to be completed in one year for $10 million. This law requires withholding $300,000 on that contract. Meanwhile, the contractor expects to net approximately 2.5 percent, or $250,000, after paying for supplies, services, subcontractors and other ordinary business expenses. The tax on the revenue generated is at most 35 percent of the revenue, which means the maximum tax owed on the $10 million project is $87,500 (35 percent of $250,000). Ultimately, the government has withheld $300,000 for an $87,500 tax liability. • Tightened cash flow would lead to less economic investment. With companies facing narrower profit margins during rough economic times, the prospect of additional tax withholding diverts available resources away from business expansion activities, including workforce investment and equipment purchases. • Tightened cash flow would restrict bonding capacity. The federal law requires construction contractors to carry several types of bonds. Surety companies that provide these bonds look at cash flow when deciding whether to cover a contract. This withholding law will restrict cash flow, leading to higher costs for bonds or the denial of coverage, both of which drive up the cost of the construction. In addition, the increased costs and difficulty in bonding will drive small businesses out of the market. • Undue burden on S Corps and joint ventures. Withholding creates additional reporting burdens on S Corps and other pass-through entities, as those withholdings will need to be accounted for and reported to each stockholder in the corporation, thereby impacting their tax returns

28 u fall 2009 issue