Little known legislation takes federal contractors by surprise.

• Position: GOVERNMENT POLICY NOTES - Tax Reconciliation Act of 2006

Last May, during negotiations between the House and Senate on the Tax Reconciliation Act of 2006, a provision was "slipped in" the final legislation that was not part of the original House or Senate bill, nor was it ever debated in either chamber. The provision, Section 511 of Public Law 109-222, mandates that federal, state and local governments withhold 3 percent from all payments for goods and services beginning in 2011.

This provision will affect payments for government contracts as well as those to any person for a service or product provided to a government entity. This far-reaching new requirement was inserted as a last-minute $7 billion revenue-raiser in the bill that was signed into law by President Bush last May. There have been no committee hearings held on this idea and its appearance in the final bill surprised many on Capitol Hill, including Sen. Larry Craig, R-Idaho, who introduced legislation, S.2821, to repeal Section 511.

That bill died with the last Congress partly because the implementation date was not until 2011 and the crush of passing other legislation at the end of the year.

Unless repealed sooner, section 511 will not be effective until Jan. 1,2011. However, under new rules in Congress to pay for any additions to authorization and appropriations measures, there have already been efforts to accelerate the implementation date and talk of raising the 3 percent to 6 percent. If implemented, the requirement of Section 511 will have a significant impact on the defense industry, especially small businesses.

Currently, Section 511 is estimated to "increase" revenue by $7 billion from 2012 to 2015, but raises $6 billion of that amount due solely to accelerated tax receipts and not an actual revenue increase from improved tax compliance.

In addition, Section 511 is based on revenues from government payments with no relationship to a company's taxable income and therefore unrelated to any tax liability. Section 511 hurts honest taxpaying businesses without providing any additional enforcement mechanisms for tax delinquencies. Section 511 will also significantly impede the cash flow of small business.

Companies of all sizes--but particularly small businesses who are awarded large value government contracts--may see significant amounts of their operating funds become unavailable for periods that could exceed 16 months. For example, on a contract valued at $10 million, $300,000 would be withheld.

The cost to federal, state and...