Contractor tax provision forces agencies to change financial systems

A provision in a tax law passed last year would require agencies to revamp financial management systems unless federal contractors are successful in convincing Congress to repeal the provision.

Section 511 of the Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA) requires federal and state governments, and local governments with expenditures of $100 million or more, to begin in 2011 withholding a tax of 3 percent of all payments to government contractors. The 3 percent withholding would raise an estimated $7 billion between 2011 and 2015.

Congress added the provision to the law to make it more difficult for contractors to avoid paying income taxes, said Chris Braddock, director of procurement policy at the U.S. Chamber of Commerce's economic policy division. The provision has ties back to a 2004 Government Accountability Office report that found, after reviewing Defense Department and Internal Revenue Service records, that more than 27,000 Defense contractors owed about $3 billion in unpaid taxes as of Sept. 30, 2002. Congress acted quickly to find ways to collect the unpaid taxes.

Those opposed to the rule say it will require agencies to dip into already tight IT budgets to reprogram financial management systems to keep track of the 3 percent tax. Rules and contracts will need to be modified to address the withholding requirement, which could cause a number of logistical problems, said Andrea Wuebker, a spokeswoman for the Office of Management and Budget.

"We have specific concerns regarding implementation and have reached out to the [Chief Acquisition Officers Council] and [Chief Financial Officers Council] to identify payments for which this requirement may pose challenges," Wuebker said. "For example, we expect this requirement will be difficult to implement for purchase card transactions."

The IRS is developing regulations to implement the rule. But individual agencies will be required to comply, which means IT managers must consider what they have to do to revamp financial management systems. How much agencies will have to reprogram their systems will most likely vary, depending on the applications the agencies use and how easily they can be customized.

"We are still evaluating what it will take to comply with this legislation," said Boyd Rutherford, assistant secretary for administration at the Agriculture Department. "However, our initial view is that our financial and acquisition systems will require substantial modifications to accommodate the new requirement."

Glenn Perry, senior procurement executive at the Education Department, also expects adjustments will be needed to the Oracle program used by the department's procurement office for billing. "If this does come to fruition, details would have to be worked out on how to modify the terms and conditions within the system for withholding the amount, and also handling the money once it comes in," Perry said.

He suspects IT shops in larger agencies could manage the change with a significant investment of resources. Because Congress provided no funding to make the change, agencies will be forced to tap their existing IT budgets.

Sen. Larry Craig, R-Idaho, is leading efforts to repeal the provision. "Section 511 will . . . impose significant administrative costs on the federal, state and local governments," Craig said in a statement in March. "Congress never debated the merits of an expanded withholding requirement -- as a revenue-raiser or as a way to narrow the tax gap -- in a committee or on either chamber's floor. If it had, Congress would have realized that it does neither of these things well."