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Senate OK's bill barring contractors from avoiding tax

Some had hired via offshore firms

Email|Print|Single Page| Text size + By Farah Stockman
Globe Staff / May 23, 2008

WASHINGTON - The Senate yesterday passed by unanimous consent a bill prohibiting federal contractors from avoiding Social Security and Medicare taxes by hiring workers through offshore shell companies.

Earlier this week, the House of Representatives also voted unanimously to ban the practice, used by former Halliburton subsidiary KBR to avoid payroll taxes for more than 10,000 American workers in Iraq.

The bill, which appears to have veto-proof support, now goes to President Bush. The White House has not indicated whether he supports it.

Senator John F. Kerry, a Massachusetts Democrat who cosponsored the bill with Senator Barack Obama of Illinois, said the money gained by closing the payroll tax loophole will help pay the cost of a tax relief package for veterans that was also included in yesterday's bill.

"Now thousands of military families in Massachusetts will receive the benefits they deserve, and big companies will pay their fair share of taxes, rather than leaving hard-working Americans with the bill," Kerry said in a statement.

"We cannot allow federal contractors to set up shell corporations in tax shelters and shirk their responsibility to pay payroll taxes for their American employees," Obama said in a statement.

Kerry drafted the payroll tax provision after The Boston Globe reported in March that Houston-based KBR had avoided hundreds of millions of dollars in payroll taxes for 10,000 American employees in Iraq by hiring them through shell companies based in the Cayman Islands.

Under federal law, companies and their employees split the cost of Social Security and Medicare taxes, which amount to 15.3 percent of an employee's wages. But some US defense contractors working overseas sought to avoid that tax by setting up offshore entities to hire the workers.

The practice prevented those workers from being able to collect unemployment benefits and resulted in losses for Social Security and Medicare.

KBR appears to be the largest offender in Iraq, but others also use the practice. In March, one other major defense contractor in Iraq surveyed by the Globe acknowledged using the practice. But subsequent investigations found that MPRI, a Virginia-based contractor, hires about 400 Americans through a subsidiary based in Bermuda.

DynCorp International, a defense giant, employs 750 to 1,000 American police trainers in Iraq through a wholly owned subsidiary based in a tax-free zone in the United Arab Emirates.

A DynCorp recruitment advertisement for those police training positions states that "no federal income or Social Security taxes are withheld" from their $134,110 annual salaries.

In a recent interview, DynCorp spokesman Douglas Ebner defended the practice as "integral to being competitive in the current contracting environment."

"This is a legal way of reducing costs," he said.

But that would change under the new law, which would oblige foreign subsidiaries of US federal contractors to pay Social Security and Medicare taxes for their American employees. The law would give companies 30 days to comply.

"I'm very pleased," said Representative Richard Neal, a Massachusetts Democrat who championed the measure in the House, alongside Representative Rahm Emanuel, an Illinois Democrat, and Representative Brad Ellsworth, an Indiana Democrat. "This whole issue now of closing tax loopholes in the search for revenues is very important. I think there is a sense that you can't argue for tax havens and two-and-a-half billion a week for the war in Iraq and be consistent."

"While honest taxpayers played by the rules, KBR . . . exploited a tax loophole that weakens Social Security and Medicare," Emanuel said. "The president has ignored these abuses of the tax code for too long. I sincerely hope he will sign this legislation and close this egregious loophole. "

The bill, the Heroes Earnings Assistance and Relief Tax Act of 2008, was also pushed in Congress by a coalition of consumer, labor, church, and taxpayer groups, including AARP, a national nonprofit organization of people 50 and older, the American Federation of State and Municipal Employees, and US PIRG, a federation of state Public Interest Research Groups.

John Krieger, tax and budget attorney at US PIRG, said he expects the bill to be signed into law in the coming days.

"There has been no threat of veto issued by the White House, and it looks like it would definitely withstand a veto anyway, since it was unanimous in both chambers," he said. Still, he said, he believes contractors will search for ways to avoid paying Social Security and Medicare taxes for employees overseas, predicting that once the bill is signed into law, some companies will try to classify the employees as independent contractors, a move that would place the sole responsibility for paying those taxes on the worker.

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