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Small Businesses Unite Against Withholding Tax

The 3 percent withholding tax due to take effect at year-end has unleashed a groundswell of opposition among business owners and advocates. Here's what they're fighting about.
Posted by Carol Tice | June 24, 2011
URL: http://www.entrepreneur.com/blog/219910

As if small business owners don't have enough on their plates.

There's a ticking tax time-bomb due to take effect in January 2013 -- a little-noticed provision of the 2005 Tax Increase Prevention and Reconciliation Act. It's a budget-balancer that adds a 3 percent withholding tax to any federal contract. In other words, you win a federal contract -- likely on a tight profit margin -- and then the Feds pocket 3 percent. If you're a small business subcontracting for a federal contractor, this will likely hit your bottom line, too.

Besides the obvious margin-killing problem, the provision constitutes double taxation for S Corporations, LLCs and other "pass-through" entities, say small-business advocates. Owners would essentially pay a new corporate tax up front for their government work, while they would continue to be taxed on their individual earnings from the business as well.

With everything else business owners are facing right this minute, the tax is even more onerous as a potential business- and job-killer, advocates claim. As a result, a groundswell of opponents is rising to repeal the provision.

The U.S. Chamber of Commerce is one of more than 120 organizations on the warpath to get the provision overturned. The flotilla of opponents to the provision even has a name: Government Withholding Relief

In one video of a small-business speak-out event that's posted on the U.S. Chamber's new RepealWithholdingNow website, longtime government contractor Buffalo Supply's CEO Harold Jackson explains its impact succinctly:

"In these uncertain times, it creates a situation where I'd have to go out and borrow money so I could loan it to the government for free," he says.

Talk about going in the wrong direction. The idea of the tax is to provide a hedge against tax underpayment by contractors -- something a small minority of unscrupulous businesses do. If this law takes effect, all businesses that work with the government will pay the price.

The government seems to have a sense that this tax is a hot potato -- implementation has already been delayed twice. Most recently, it was supposed to go into effect at the end of this year.

Despite these delays, bills have also been introduced in both the House and Senate to repeal the tax altogether. But it remains unclear if they can rise to the top of the agenda and see action given all the other crises lawmakers face.

Will you fight the 3 percent withholding tax? Tell us your views on the provision below.