Navigating the Tariff Tightrope: How Can Government Contractors Keep Their Balance

On February 1, 2025, President Trump issued Executive Order 14193, Imposing Duties to Address the Flow of Illicit Drugs Across Our Northern Border under a 1977 statute (International Emergency Economic Powers Act, or “IEEPA”) that has never been used for this purpose. Together with many subsequent executive orders imposing sweeping new tariffs on imports from key trading partners - including new “national security” tariffs under Section 232 of the Trade Expansion Act of 1962.  These actions allow very few exemptions and have sent ripples through the global economy, particularly affecting the U.S. government contracting landscape. With new tariffs already in effect for Canada, Mexico, and China, and looming for the European Union, Australia, Brazil, India, Japan, South Korea, Russia, and Vietnam (on top of any existing Normal Trade Relations duties), contractors may face a significant challenge: absorbing or recovering potentially substantial cost increases for raw materials and component parts. 

Understanding the available tools and navigating the complex web of Federal Acquisition Regulation (FAR) clauses is now more critical than ever. This article delves into the strategies contractors can employ to mitigate the financial impact of these cumulative tariffs.

For an up-to-date timeline of tariff activity, please visit the Peterson Institute for International Economics (PIIE) site.

Cost Recovery: A Clause-by-Clause Breakdown

For contractors operating under fixed-price contracts, two key FAR clauses offer potential avenues for cost recovery:

• FAR 52.229-3, Federal, State, and Local Taxes: This clause allows for an upward adjustment of the contract price for "After-imposed Federal taxes", meaning any new or increased Federal excise tax or duty (including tariffs), not initially included in the contract, excluding employment taxes. This means that contractors may be able to recoup the added tariff costs, provided they were not factored into the original bid.
• FAR 52.216-4, Economic Price Adjustment—Labor and Material: This clause mandates negotiation with the Contracting Officer (CO) for price adjustments due to changes in labor rates or material costs. Crucially, contractors must notify the CO within 60 days of any price fluctuation and provide supporting documentation.
  
  

For cost-reimbursable or flexibly-priced contracts, the path to recovery is slightly different:

• FAR 31.201-2, Determining Allowability: This general cost principle dictates that costs must be reasonable, allocable, and compliant with relevant standards. While no specific tariff clause exists, FAR 31.205-41, Taxes (which generally allows for tax reimbursement unless explicitly prohibited) becomes the most relevant.
• It is possible to negotiate the inclusion of FAR 52.229-3, Federal, State, and Local Taxes into cost reimbursable contracts.
• FAR 52.232-20, Limitation of Cost, and FAR 52.232-22, Limitation of Funds, are also important for managing and reporting costs.

Seeking Exemptions: A Potential Alternative

When cost recovery proves challenging, contractors may explore duty exemptions under FAR Subpart 25.9 and DFARS Subpart 225.9. These regulations outline categories of foreign supplies eligible for exemption, including:

• Supplies under specific chapters of the Harmonized Tariff Schedule of the United States (HTSUS).
• Supplies for government-operated vessels or aircraft (FAR 25.903).
• Qualifying country supplies and eligible products under trade agreements (DFARS).
• Foreign supplies where estimated duties exceed $300 per shipment (DFARS 225.901).
  
  

Be aware the HTSUS is subject to change due to the Executive Orders, impacting HTSUS-based exemptions. Contractors must meticulously review their contracts for relevant FAR/DFARS clauses (such as FAR 52.225-8 and DFARS 252.225-7013) to determine eligibility and notification deadlines. Contractors should keep in mind that exemptions are not retroactive, so prompt action is vital.

The Road Ahead

The barrage of Executive Orders has created a complex landscape for government contractors. Proactive engagement with contracting officers, meticulous documentation, and a thorough understanding of applicable FAR and DFARS clauses are essential for mitigating the financial impact of these tariffs. As the trade environment continues to evolve, contractors must remain vigilant and adaptable to navigate these challenging times.