State and local taxes, including property, franchise and income taxes are allowable costs. However, if the taxes are paid late or in error, any penalty or interest assessed by the state or local government is unallowable unless the contractor followed direction from the contracting officer.

Sometimes disputes arise over applicability of state and local taxes levied on inventory in the contractor’s possession to which the government has legal title because state and local taxes cannot be levied on the federal government. However, the government’s title to property that is obviously in possession by the contractor may be disputed by the local taxing authority. In such cases, the contractor should not pay the tax before asking the CO’s advice.

Tax accruals arising from differences between state and local taxable income and the expense reported for financial purposes are not allowable. The government accepts only those taxes reflected on the tax return – taxes actually paid. In addition, a contractor cannot allocate state and local taxes to a government contracts in excess of taxes actually paid. In Physics International Company (ASBCA No 17700) the board held though the contractor paid a minimum tax of $100 due to losses at a commercial division, the taxes allocable to the profitable government division based on the taxes that would have been due had it been a separate entity were unallowable.

Some states like New Mexico and Washington impose on the seller revenue based state taxes that are computed by multiplying the total revenues received from doing business by the applicable rate. Unlike many state sales taxes, the seller is not exempt from paying these revenue based state taxes. Though allowable, DCAA has imposed certain allocation restrictions. Since the revenue-based state taxes are levied on the contractor’s revenue form doing business in the state, which generally comprise many contracts, these costs are not identifiable to specific contracts and hence not a direct charge. Even though these taxes are overall costs of doing business and hence akin to G&A expenses, DCAA asserts these taxes, if they are material, should not be included in the G&A pool. Because the usual base of allocation of overhead and G&A are normally costs rather than revenue, they should be allocated to contracts on a different base than cost. Furthermore, DCAA states these revenue based state taxes should be included in the total cost input base for G&A allocation.

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