Insurance, Bonds, and Taxes: Government Contracting Costs Explained
One of the biggest questions new government contractors ask is, "How much does it actually cost to get started?"
The answer depends on the type of work you're pursuing, but there are a handful of costs and requirements that come up repeatedly in federal contracting.
The good news is that you don't need to buy everything on day one. Many of these requirements only become necessary once you're preparing to perform a contract or after you've been selected for award.
Here are some of the most common questions I receive about the costs of government contracting.
What insurance does a government contractor actually need?
Insurance requirements vary by contract, but there are a few coverages you'll see over and over again.
A common requirement is:
- General Liability: $1 million per occurrence
- General Liability Aggregate: $2 million
- Workers' Compensation: $100,000 per accident or incident when required
Some contracts may also require commercial auto insurance, professional liability, cyber liability, or other specialized coverage depending on the work being performed.
The important thing is to read the solicitation carefully. The insurance requirements are usually listed in the contract documents.
Don't assume every opportunity requires the same coverage.
How much does bonding actually cost?
Not every government contract requires bonding.
When it does, you'll typically see one or more of the following:
- Bid Bond
- Payment Bond
- Performance Bond
As a general rule, performance and payment bonds often cost around 1 to 3 percent of the contract value, although the exact cost depends on factors such as the contract amount, your company's financial strength, and the surety underwriting the bond.
For example, a $250,000 contract might require a bond that falls somewhere within that range.
Understanding bonding requirements before bidding helps you avoid surprises if you're selected for award.
How do government contractors pay for a project before the government pays them?
Cash flow is one of the biggest challenges for growing contractors.
In many cases, you'll need to pay employees, purchase materials, or cover operating expenses before receiving payment from the government.
That's why it's important to think about financing before you win the contract.
Some common options include:
- A business line of credit
- A high limit business credit card
- A small business loan when appropriate
The goal isn't to borrow money unnecessarily.
The goal is to make sure your business has enough working capital to perform the contract without creating financial stress while you're waiting to be paid.
What taxes should government contractors expect to pay?
Every business is different, but there are several taxes that most contractors should expect.
These may include:
- Federal and state income taxes
- Sales tax when applicable
- Payroll taxes if you have employees, including Social Security, FICA, FUTA, and state unemployment taxes
The taxes you owe depend on your business structure, where you're operating, and the type of work you're performing.
As your business grows, it's worth working with a qualified accountant who understands both small businesses and government contracting.
How do you know what minimum wage you're required to pay?
Some government contracts include prevailing wage requirements.
Two of the most common are:
- The Service Contract Act (SCA) for many service contracts.
- The Davis Bacon Act for many construction contracts.
These wage determinations establish the minimum wages and fringe benefits that must be paid for covered labor categories.
Before submitting a proposal, make sure you understand whether prevailing wage requirements apply because they'll directly affect your labor pricing.
Ignoring them can quickly turn a profitable contract into a costly mistake.
Should you start as a sole proprietor, LLC, or S Corporation?
There isn't one answer that's right for everyone.
Many contractors begin as a sole proprietor or LLC because they're relatively simple to establish.
As the business grows and becomes more profitable, many owners eventually elect S Corporation tax treatment to take advantage of potential tax benefits.
The right decision depends on your specific situation, your long term goals, and your tax strategy.
The important thing is not to let the perfect business structure delay you from getting started.
You can always adjust your business as it grows.
Final Thoughts
Government contracting doesn't require enormous upfront costs, but it does require planning.
Understand your insurance requirements, know when bonding applies, prepare for cash flow, budget for taxes, understand prevailing wage laws, and choose a business structure that fits where your company is today.
As your business grows, those systems can grow with it.
About Derek James
Derek James is the founder of GovKidMethod. By age 30, he had won 32 federal contracts worth more than $15 million. Since then, he's helped small businesses win more than $75 million in government contracts by teaching practical proposal writing, positioning, and bidding strategies that contractors can actually apply.
Ready to Go Further?
Reading about government contracting is one thing. Knowing exactly how to write winning proposals is another.
That's why I've made the first modules of my GovRFP Proposal Writing System available for free. They'll walk you through the foundation every contractor should understand before submitting bids.
Access the free GovRFP Proposal Writing System here:
www.govkidmethod.com/govrfp