Magazine article Business Credit

Gearing Up for the 3% Withholding Tax

Magazine article Business Credit

Gearing Up for the 3% Withholding Tax

Article excerpt

One of the cornerstones of NACM's advocacy program has been the full repeal of one particular provision enacted in 2006.

Tucked into the Tax Increase Prevention and Reconciliation Act (TIPRA), perhaps a bit ironically, was a provision that would impose a 3% withholding tax on most payments for products or services purchased by a government entity. The measure was 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. This was seen as a way to solve the problem without really solving the problem, and 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.

It became almost universally disliked on Capitol Hill upon passage, but the political will for a full repeal has been hard to come by, and only delays have been passed. The provision was set to go into effect on all contracts dated after December 31, 2010, but that deadline was delayed to contracts dated after December 31, 201 1 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 into two or more in order to make them exempt under the $10,000 threshold. Certain payments would be excluded, like those for real property, interest, 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 tbe 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, 201 1 effective date will not be subject to witholding.

Relief

While the provision's language and accompanying IRS guidance seem to pare down the withholding requirement's reach to exclude a number of government entities, one constituency receiving no relief would be small businesses. One of the most alarming things about the 3% withholding tax is that it's the same across the board, and offers no lower rate for taxpayers with lower profit margins or lower marginal income tax rates. All would be subject to the same 3% requirement, regardless of size.

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

The GWRC letter pointed out that governments and governmental entities themselves will scarcely have the resources to handle the implementation of the new requirement. …

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