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GOVERNMENT CONTRACTOR WITHHOLDING
STATUS
REPEALED! The
President signed the law to repeal it on November 21, 2011.
PAST HISTORY:
A three percent
withholding provision was imposed by the Tax Increase
Prevention and Reconciliation Act of 2005. It imposed a
requirement on Federal, state, and local governments to
withhold taxes from government contractors beginning in
2011.
On February 17,
2009, President Obama signed into law the American Recovery
and Reinvestment Act as Public Law 111-5. The law delayed
the effective date of the withholding requirement by one
year to 2012.
The Internal
Revenue Service has just announced it is delaying
implementation until 2013. Withholding and reporting
requirements will apply to payments made after December 31,
2012. In addition, payments made under contracts existing on
December 31, 2012, that are not materially modified, will be
exempt until January 1, 2014.
The House bill
to repeal the requirement is H.R.674, introduced by
Representative Wally Herger (R-CA). There are two Senate
bills, S.89, introduced by Senator David Vitter (R-LA), and
S.164, introduced by Senator Scott Brown (R-MA).
THE LAW
The law applies to certain Federal, state, and local
government payments made after December 31, 2011* and it
basically imposes a flat rate of 3 percent withholding on
all payments.
Payments subject to withholding under the provision include
any payment made in connection with a government voucher or
certificate program which functions as a payment for
property or services (for example, payments to a commodity
producer under a government commodity support program).
The provision does not apply to any of the following
payments:
- Payments made through a Federal,
state, or local government public assistance or public
welfare program for which eligibility is determined by a
needs or income test.
- Wages or any other payment with
respect to which mandatory or voluntary withholding
applies under present law. (The provision does not
exclude payments that are potentially subject to backup
withholding under section 3406. If, however, payments
are actually being withheld under backup withholding,
withholding under the new provision does not apply.)
- Payments of interest.
- Payments for real property.
- Payments to tax-exempt entities or
foreign governments.
- Intra-governmental payments.
- Payments made pursuant to a
classified or confidential contract (as defined in
section 6050M(e)(3)).
- Payments to government employees
that is not otherwise excludable from the new
withholding provision with respect to the employees’
services as employees.
Political subdivisions of States (or any instrumentality
thereof) with less than $100 million of annual expenditures
for property or services that would otherwise be subject to
withholding under this provision are exempt from the
withholding requirement.
*Now delayed until January 1, 2013 or later depending on the
contract.
RATIONALE
According to Senator Charles Grassley (R-IA), “Everybody has
a duty to pay their fair share of taxes owed. Those who are
paid by the government should be held to a high degree of
responsibility to pay taxes that are legally due. Failure to
effectively enforce the tax laws against government
contractors encourages noncompliance among other
contractors. Over time, the failure by government
contractors to pay their tax debts could erode taxpayers’
confidence in the fairness of the nation’s tax system,
leading to increased rates of noncompliance with the
nation’s tax laws.”
In the 2004 Annual Report to Congress, the National Taxpayer
Advocate stated that Federal contractor noncompliance is
among the most serious problems facing taxpayers because it
contributes to the growing Federal tax gap and thus forces
law-abiding taxpayers to subsidize these contract awards by
making up for the resulting revenue shortfall. This
noncompliance also places law-abiding contractors at an
unfair competitive disadvantage because nonpaying
contractors can use their “tax savings” to underbid
compliant ones. The report notes that there is an inherent
unfairness when those who “reap the benefits of Federal
contracts” refuse to fulfill their Federal tax obligations.
According to the General Accounting Office (GAO), over 3,800
Government Service Administrator (GSA) contractors, or about
10 percent of all GSA contractors, had tax debts totaling
about $1.4 billion as of June 30, 2005. This follows on top
of testimony to the same Subcommittee, provided less than
one year before, that found that about 33,000 civilian
agency contractors owed over $3 billion in unpaid Federal
taxes as of September 30, 2004. Also, GAO noted in a
February 2004 report that over 27,000 Department of Defense
contractors owed about $3 billion in unpaid taxes as of
September 30, 2002.
REPEAL EFFORT
The Government Withholding Relief Coalition is leading the
effort to repeal the provision. The coalition has noted
these concerns:
- Significant increases in
private-sector administrative costs. The
administrative costs to companies – as well as
governments – to comply with this withholding
requirement will be substantial. Companies’ internal
systems are not set up to track the amounts withheld
from invoice payments. This will significantly
complicate the estimating of tax liabilities on
quarterly tax payments. For companies receiving
thousands of government payments per year, this will be
administratively time consuming and costly.
- Adverse effects on cash
flows of companies. Compliance with Section 511
will reduce cash assets that are used to pay company
employees and other day-to-day expenses. Start-up firms
and some industries will be severely impacted by this
reduction in cash receipts. For instance, in many
construction projects profits are not realized until the
end of a multi-year contract. Despite this, contractors
will have had 3 percent withheld throughout the life of
the contract.
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- Unfairly burdens honest
taxpayers. More efforts should be focused on
identifying and prosecuting, if appropriate, the actual
tax cheats rather than adding to the administrative
burden placed on honest businesses. This proposal
treats tax-compliant businesses the same as those
illegally avoiding the payment of their tax
obligations. The extra cost to implement the provision
will, in our opinion, far exceed the additional tax gap
revenues the Joint Committee on Taxation estimates it
will raise.
OUTLOOK
Perhaps Congress has learned its lesson that the tax
gap closer initiatives may have sounded good in theory, but
in the real world, they made no sense.
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