If you’re a small business owner interested in government contracting, it’s essential to understand the unique accounting and tax considerations that can come with those types of arrangements. Be mindful of deadlines, for instance, and what taxes you are and aren’t responsible for paying. Your accounting system matters more than ever, too. Below are some areas to think about:
Cost Accounting Compliance
A recent and abrupt cancellation of the General Services Administration (GSA) $15 billion Alliant 2 Small Business (A2SB) contract was caused, in part, by inconsistencies with the evaluation of bidder cost accounting systems. Cost accounting standards were set up in 1970—first for defense contractors and now for all civilian contractors working with federal government and education agencies—to ensure costs are charged appropriately.
The standards are currently under review to simplify them and ensure that they don’t deter new contractors from doing business with the federal government. In the meantime, it remains vital that even small businesses have an accounting system in place that meets the often-confusing current standards on how federal contracting costs are measured, accumulated, assigned and allocated. How you determine profit rates, account for direct versus indirect costs, finance contracts, allocate home office expenses, and even pay for employee perks could lose you the bid.
State and Local Tax Obligations
While federal government entities are exempt from paying taxes, their civilian contractors are not. These factors come into play with state and local income taxes, sales and use taxes, and licensing:
- If you’re a Texas business, state income tax may not be on your radar. But a federal government contract could mean your work spans multiple states and, therefore, may be subject to the income tax rules. The laws vary state-by-state and depend on factors such as physical presence, the amount of money made within each state, and whether you are a prime contractor or subcontractor for the contract.
- Long before purchasing, leasing, or using any property or materials under a federal contract, be sure to work out your state and local taxes (SALT) responsibilities. In many cases, you won’t be able to take advantage of the government agency’s tax exemption. You may even be subject to SALT taxes on government equipment or property you use or possess. However, you might find provisions within state and local laws that can help reduce those taxes.
- Spreading your wings on a federal contract could also necessitate additional state and local business and occupational license and permit expenses. For instance, the State of Texas requires all businesses operating within the state to register for Texas-specific tax registrations for income tax withholding, sales and use tax, and unemployment insurance tax. General and specific business licenses and local permits may also be required.
Timing: It’s Everything
If there’s one thing that all successful federal government contractors get right, it’s their timing. It’s important in every aspect of the work. For example, when it comes to bidding and proposals, a U.S. Court of Federal Claims (COFC) agreed with the decision to deny a government IT contractor’s revised quote because it was submitted 90 seconds past the deadline. Even claims of latency issues and unfamiliarity with using the online portal were rejected.
Price adjustments for long-term contracts are highly sensitive to timing as well. “…There are procedural traps that can force the contractor to carry the increased costs on its own until the next option or anniversary. The key to the price adjustment is to time the increase correctly and to give the Contracting Officer timely notice,” notes boutique law firm Abrahams Wolf-Rodda, LLC.
Research & Development
Since federal government contractors aren’t exempt from tax obligations, they can take advantage of the same tax deductions and credits that other small businesses can. One special consideration that might slip by—but could save thousands—is the research and development (R&D) tax credit. Many contractors are unaware that R&D qualifying activities can still be tax-deductible when performed for government contracts. In fact, less than 33% of companies that qualify for the federal R&D tax credit utilize it.
Anytime you develop, design, or improve products, processes, formulas or software, you may be able to take an R&D tax credit. The definition has expanded over the years to the point now that the credit can be claimed for current and past years and, for pass-through business owners, it may even help offset an Alternative Minimum Tax (AMT).
Government contracting can be a significant recurring revenue source, but it’s not for the faint of heart or the ill-prepared. Set yourself up for success with reliable, industry-standard accounting practices, respect deadlines, and don’t overlook both tax obligations and tax opportunities. Feel free to contact us for more information.