Gearing Up for the 3% Withholding Tax

As the clock continues to tick toward 2012, many credit professionals have been asking about the 3% withholding tax, which is still set to go into effect at the end of the year on most government contracts.

The provision was tucked into the Tax Increase Prevention and Reconciliation Act (TIPRA), enacted in 2006, originally included as a means to reduce the nation’s tax gap, which is the annual difference between taxes legally owed and taxes collected, totaling about $345 billion. Essentially, the idea was that since a number of contractors that did business with the government didn’t accurately pay their tax bills, a withholding requirement would offset the revenue lost from these contractors’ non-compliance. Observers quickly noted that merchants selling to the government that were forced to comply with this new requirement would simply raise their prices, meaning the whole provision would provide zero sum gain.

The provision was originally set to go into effect on all contracts dated after December 31, 2010, but that deadline was delayed to contracts dated after December 31, 2011 by a provision in the American Recovery and Reinvestment Act of 2009, popularly known as the stimulus bill.

The details of the provision are many, and more than a little beguiling.

According to the text, the withholding requirement would apply to government entities, including states, municipalities or any instrumentality thereof, with annual procurement budgets in excess of $100 million, which would exclude a lot of local agencies in many smaller towns. It would also only apply to purchases worth more than $10,000, and according to the Internal Revenue Service (IRS), entities and businesses would not be allowed to divide payments up into two or more in order to make them exempt under the $10,000 threshold. Certain payments would be excluded, like payments of interest, for real property, to tax-exempt entities and to foreign governments, although it should be noted that “real property” does not include payments for the construction of buildings or public works. This is a fairly vague definition, so establishing which of these payments would or would not be subject to the withholding requirement could prove challenging.

IRS guidance on the subject notes that the withholding would only apply to payments made by the government entity to the prime contractor, meaning there is no flow down to subcontractors. Payments made under contracts existing prior to the December 31, 2011 effective date will not be subject to withholding.

Advocacy

NACM has opposed the 3% withholding tax since its inception, and continues to hope that lawmakers come to their senses and repeal it.

Several bills and amendments have been proposed over the course of the provision’s life that would remove it from the record, and prevent it from ever damaging the cash flow of companies that do business with local, state and federal entities. The most recent of these is an amendment, still pending at the time of this writing, to S. 493, the Small Business Innovation Research (SBIR) and Small Business Technical Transfer (STTR) Reauthorization Act, introduced by Senators David Vitter (R-LA) and Scott Brown (R-MA). Vitter and Brown have previously introduced their own standalone repeal bills before combining them into this amendment, which would likewise eliminate the 3% withholding requirement and tell agencies and companies to act as though it were never enacted.

The issue with previous repeal efforts was that they weren’t attached to measures that would offset the revenue loss of repealing the 3% withholding; as expensive as it would be in the long run, the 3% tax would generate revenue for the government, and any repeal effort will have to include some commensurate form of spending cuts or revenue generators. Amendment 212 gets around this by rescinding $39 billion in funds appropriated but unspent by government agencies, excluding the Departments of Defense and Veterans Affairs.

“The withholding is a flat percentage of revenues from government payments, bears no relationship to companies’ taxable incomes and will restrict cash flow needed for day-to-day operations and investments,” said the Government Withholding Relief Coalition (GWRC) in a recent letter to lawmakers in support of Amendment 212. NACM is counted among the dozens of members of the Coalition, which was formed to repeal the requirement shortly after its enactment and the NACM Government Business Group (GBG) has been active in keeping its members informed of the implications and encouraging contact with respective representatives.

The letter continued, pointing out that governments and governmental entities themselves will scarcely have the resources to handle the implementation of the new requirement. “In addition, the administrative and capital investment costs that compliance with 3% withholding will impose on businesses and governments will be substantial, and the mandate will be exceedingly complicated to implement. Three percent withholding will be especially burdensome for small firms. With the withholding mandate scheduled to take effect on January 1, 2012, businesses and governments are expending limited resources now in order to make the major system and process changes needed to implement this provision. This is a particular challenge for cash-strapped state and local governments.”

For more information on the 3% withholding tax, stay tuned to NACM's Credit Real-Time blog, NACM's eNews, and Business Credit magazine.

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