Magazine article Government Finance Review

IRS Finalizes 3 Percent Withholding Regulations; Efforts to Repeal Law Still in Play

Magazine article Government Finance Review

IRS Finalizes 3 Percent Withholding Regulations; Efforts to Repeal Law Still in Play

Article excerpt

This spring, the Internal Revenue Service released final regulations--26 CFR Part 31.3402(t)--that provide state and local governments with a roadmap for implementing Section 511 of the Tax Increase Prevention and Reconciliation Act of 2005 (PL.109-222). The act requires federal, state, and local governments to deduct and withhold 3 percent of any payment for property or services. The final regulations are effective for payments beginning January 1, 2013, providing a one-year delay in implementation.


The 2005 Tax Increase Prevention and Reconciliation Act (TIPRA) requires all government entities that spend more than $100 million a year on property and services to withhold 3 percent of payments to contractors and vendors and remit the amount to the federal government. The law also enacts new annual reporting requirements.

This withholding requirement constitutes an unfunded mandate on state and local governments. In 2006, the Congressional Budget Office estimated the cost to state and local governments for administering the provision to be $62 million per year; however, the state and local government community believes this estimate is far too low. Section 511 requires that government entities capture and report a significant amount of data to the Internal Revenue Service (IRS), in addition to remitting the 3 percent for all payments. Most state and local entities currently do not have the resources, capacity, or staff to undertake the required withholding remittance processes. Additionally, vendors will likely pass along costs related to complying with the law by increasing fees to their public-sector clients, which means government will have to pay more for the goods and services than they do now.

Below is an overview of the final regulations. A link to the IRS regulations can be found on the GFOA's Web site at


Implementation Date. The IRS delayed the implementation date to January 1, 2013.

Payment Threshold. Individual payments of less than $10,000 are exempt from requirements. Specific anti-fraud provisions are included in the regulations to ensure that governments and contractors do not split up a larger invoice into multiple smaller invoices to avoid complying with the law. The regulations also state that the threshold amount will not be increased in future years for cost of living adjustments or other reasons.

Determining If Your Government Must Follow This Law. The regulations state that a government must tally all payments made for property or services (including those of less than $10,000) when determining if it meets the $100 million annual spending threshold. The government may use one of two methods to determine if it meets the $100 million amount, and it must choose an option before the beginning of the calendar year:

* An entity may use an average from four out of five consecutive accounting years, prior to 2011 (two years prior to the implementation date of 2013).

* An entity may determine if it meets the threshold amount based on payments made during the accounting year ending with or within 2011 (two years prior to implementation date of 2013).

Definition of Government Instrumentality. The word "instrumentality" is not defined in the guidance, and the IRS stated that further guidance may be issued in the future to clarify this point. The regulations reference numerous IRS Code and Revenue Rulings on this matter including S 31.3402(t)-2(e) and Rev. Ruling 57-128, 1957-1 CB 311.

Contracts. Contracts that exist as of December 31, 2012, do not need to adhere to the law so long as the contract is not materially modified after this date. However, the IRS has proposed new regulations requiring all contracts, whether or not they existed before the implementation date, to abide by the law, beginning January 1, 2014.

Penalties. A government entity will not be liable for interest and penalties for failure to withhold on payments made before January 1, 2014, so long as the government made a good faith effort to comply with the law. …

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