New Legislation Closes Tax Loophole for Federal Contractors

A new law will bring an end to a tax loophole that allowed some federal contractors to evade federal taxes even while technically following the law. Part of the Heroes Earnings Assistance and Relief Tax Act of 2008, signed into law on Tuesday by President Bush, requires foreign subsidiaries of federal contractors to be treated as American companies for tax purposes. In May, POGO co-signed a letter to the leaders of the Senate Finance Committee expressing support for this legislation.

Some contractors have been creating subsidiary companies in jurisdictions with advantageous tax laws, such as the Cayman Islands, without even conducting any operations there. American workers are technically employed by these subsidiaries, allowing the contractor to avoid paying payroll taxes. These taxes are used to fund programs such as Social Security and Medicare, so other taxpayers end up assuming the burden. The Joint Committee on Taxation estimated that closing this loophole will bring in about $850 million in tax revenues over the next 10 years.

While this law is a step in the right direction, there is still room for improvement. A 2007 GAO report found that regulations for awarding contracts do not take into account contractors' tax debt even though federal contractors as a whole owe billions of dollars in taxes. Current policy is fair to neither American taxpayers nor honest contractors who have lost bids to companies that are able to offer lower prices thanks to delinquent tax debts.

And while no federal contractor will be able to evade taxes through suspicious foreign subsidiaries, private corporations still can and do engage in similar practices; the Senate Finance Committee estimates that thousands of companies have registered in the Cayman Islands to avoid taxes. In one particularly suspicious case, 12,748 companies are registered in one five-story building in the Caymans.