IRS Further Delays Three-Percent Withholding

May 24, 2011

On May 9, the Internal Revenue Service (IRS) published final regulations requiring federal, state and local government entities to automatically deduct and withhold three-percent of the value of payments to contractors for the purchase of property or services. The final rule delays the new withholding requirement for an additional year from Dec. 31, 2011 to Dec. 21, 2012.

The three-percent withholding law, which was enacted in Section 511 of the Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA) mandates that federal, state, and local governments withhold three-percent of nearly all of their contract payments, Medicare payments, farm payments, and certain grants. Compliance with this law will impose significant, unnecessary financial burdens on both the public and private sectors, with a disproportionate impact on small businesses.

In the American Recovery and Reinvestment Act (ARRA) Congress delayed for one year—until Dec. 31, 2011—the implementation of this mandate in recognition of the exorbitant expenditures that will be necessary to implement accounting systems and hire new compliance employees at a time when those resources were desperately needed for productive uses. However, in response to public comment regarding administrative implementation burdens, the final IRS rule now provides for an additional one-year extension from the ARRA implementation date.

The most recent congressional estimate, in 2009, pegged the ten-year cost of repeal at $10.9 billion. Most of the revenue would be generated in the first year, when withheld funds would flow to the government before being credited to contractors.

These compliance costs will far exceed projected tax collections. For instance, just one federal agency, the Department of Defense, estimated that it would cost over $17 billion in the first five years to comply, and the original revenue estimate from TIPRA projected that only $6.977 billion would be collected over a 10 year window. This is a case of spending a dollar to collect a dime, which is counter-productive for addressing the nation’s deficits.

At the start of the 112th Congress, action was taken to repeal this onerous provision. The Withholding Tax Relief Act (S. 164) has been introduced by Sens. Scott Brown (R-Mass.), Olympia Snowe (R-Maine) and Sen. Amy Klobuchar (D-Minn.) which repeals Section 511, and includes spending rescission language that is identical to the spending rescission language in Sen. Debbie Stabenow’s (D-Mich.) 1099 repeal amendment.

S. 89, the Withholding Tax Relief Act of 2011 was introduced by Sens. David Vitter (R-La.), Richard Burr (R-N.C.), James Inhofe (Okla.), Johnny Isakson (R-Ga.), and Roger Wicker (R-Miss.), is a simple repeal bill that repeals Section 511. It is similar to bills from previous years. The House companion bill (H.R. 674) has been introduced by Reps. Wally Herger (R-Calif.) and Earl Blumenauer (D-Ore.) and currently has 116 cosponsors.

On Thursday, May 26, the House Small Business Committee Subcommittee on Contracting and Workforce will hold a hearing entitled, “Defer No More: The Need to Repeal the Three-Percent Withholding Provision.”

Please click here to contact your members of Congress to encourage their support for full repeal.