Tax Guide for Government Contractors: What You Need to Know
Navigate the unique tax requirements for federal, state, and local government contracts. Compliance is critical.
This article is provided for general informational purposes by Eugene Solutions LLC. For personalized tax advice specific to your situation, please schedule a consultation with one of our licensed tax professionals.
In This Article
- 1. The Unique Tax Landscape for Government Contractors
- 2. Contract Types and Their Tax Implications
- 3. Cost Accounting Standards (CAS) Compliance
- 4. SAM.gov Registration and Tax ID Requirements
- 5. Tax Deductions Specific to Government Contractors
- 6. Avoiding Common Compliance Pitfalls
- 7. State and Local Tax Considerations
The Unique Tax Landscape for Government Contractors
Government contracting presents unique tax challenges that differ significantly from standard business operations. Whether you hold a federal, state, or local contract, the tax implications touch everything from revenue recognition to cost accounting, contract classification, and compliance reporting. The Federal Acquisition Regulation (FAR) imposes specific requirements on how costs are tracked, allocated, and reported. Failure to comply can result in contract termination, financial penalties, or even debarment from future government work. Eugene Solutions specializes in helping government contractors navigate this complex landscape while maximizing legitimate tax benefits.
Contract Types and Their Tax Implications
The type of government contract you hold directly affects how income and expenses are recognized for tax purposes. Fixed-Price Contracts require you to deliver goods or services at a predetermined price — you recognize revenue as work is completed (typically using the percentage-of-completion method under IRC Section 460). Cost-Reimbursement Contracts reimburse your allowable costs plus a fee — revenue recognition follows the costs incurred. Time-and-Materials Contracts pay for labor hours at fixed rates plus materials at cost — each invoice is recognized as income when billed. Indefinite Delivery/Indefinite Quantity (IDIQ) contracts present additional complexity as revenue depends on task order issuance. Each type requires different accounting treatment, and getting it wrong can trigger IRS scrutiny.
Cost Accounting Standards (CAS) Compliance
Contractors with government contracts exceeding certain thresholds must comply with Cost Accounting Standards (CAS). These standards govern how costs are measured, assigned, and allocated. Key CAS requirements include: consistent treatment of direct and indirect costs, proper allocation of overhead and G&A expenses, disclosure of accounting practices via the DS-2 (Disclosure Statement), and adjustment of contract prices when accounting changes occur. Even if your contracts fall below CAS thresholds, following these principles demonstrates fiscal responsibility and can prevent disputes during audits. Eugene Solutions sets up CAS-compliant accounting systems for our contractor clients from day one.
SAM.gov Registration and Tax ID Requirements
Every government contractor must be registered in the System for Award Management (SAM.gov). Registration requires your Employer Identification Number (EIN), DUNS number (now UEI — Unique Entity Identifier), NAICS codes for your service categories, your Taxpayer Identification Number, and banking information for electronic fund transfers. Your SAM registration must be renewed annually. Letting it lapse can delay payments and make you ineligible for new awards. Eugene Solutions assists with initial SAM registration and annual renewals, ensuring your tax and entity information is always current.
Tax Deductions Specific to Government Contractors
Government contractors have access to several industry-specific deductions and credits: Bid and Proposal (B&P) Costs — expenses incurred in preparing contract proposals are generally deductible as ordinary business expenses. Independent Research and Development (IR&D) costs may qualify for the R&D Tax Credit (IRC Section 41). Performance bond premiums are deductible. Travel expenses for contract performance at government sites are deductible. Security clearance costs, including investigation fees and secure facility expenses, are deductible. Small Business Set-Aside compliance costs are deductible. Our tax team ensures every allowable cost is properly captured and deducted.
Avoiding Common Compliance Pitfalls
The most frequent tax and compliance mistakes we see from government contractors include: commingling personal and business expenses (especially dangerous for sole proprietors), failing to segregate costs by contract (required for multi-contract operations), incorrectly classifying subcontractors as employees (triggers significant payroll tax liability), missing the 1099-NEC filing deadline for subcontractors (penalty: $60–$310 per form), and failing to maintain adequate documentation for claimed costs. During a DCAA (Defense Contract Audit Agency) audit, every cost must be backed by documentation. If it's not documented, it didn't happen — and the cost will be disallowed.
State and Local Tax Considerations
Performing government contracts across state lines creates nexus — the obligation to file tax returns in each state where you have a physical presence or significant economic activity. Many contractors unknowingly create nexus in states where they perform on-site work. This can trigger state income tax, franchise tax, sales tax, and even local business license requirements. Eugene Solutions tracks our contractor clients' multi-state activity and ensures they're compliant in every jurisdiction — avoiding costly assessments and penalties from state revenue departments.
Key Takeaways
- Contract type (fixed-price, cost-reimbursement, T&M) determines revenue recognition method
- Cost Accounting Standards (CAS) apply to contracts above certain thresholds
- SAM.gov registration must be renewed annually — lapse delays payments
- Bid & proposal costs, security clearance costs, and bond premiums are deductible
- Properly classify workers — subcontractor vs. employee misclassification is high-risk
- Multi-state contract work creates tax filing obligations in each state
- DCAA audits require documentation for every claimed cost
Ready to Take Action?
Government contractor? Eugene Solutions navigates procurement and tax compliance across all 50 states. Let's talk.
Our team of PTIN-verified, IRS-authorized tax professionals publishes weekly insights to help individuals and businesses navigate the tax code. Serving all 50 states virtually with physical offices in the Southeast.
IRS Circular 230 Disclosure: Eugene Solutions LLC provides this content for general informational purposes. It does not constitute tax, legal, or accounting advice. Individual tax situations vary. Consult a qualified tax professional for advice specific to your circumstances. Eugene Solutions LLC is subject to IRS Circular 230 professional standards.
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