The Chamber

In an effort to increase tax compliance by contractors working with the federal government, a 2005 tax cut included a last minute provision to implement a 3% withholding starting in January 1, 2012.  Section 511 of the Tax Increase Prevention and Reconciliation Act of 2005 (P.L. 109-222) requires any local government entity, with annual revenues in excess of $100 million, to withhold three percent of total contract payments until contractors have proven that their taxes are paid in full.  This move could be crippling to smaller business that typically operate on smaller profit margins. 

While this provision will not take effect until 2012, the issue was accelerated by some in Congress who would like to move the effective date up to fund other congressional initiatives.  The 3% withholding law, which was enacted in Section 511 of the Tax Increase Prevention and Reconciliation Act of 2005 (P.L. 109-222) as Section 3402(t) of the Internal Revenue Code, mandates that federal agencies, states, and certain local governments withhold 3% 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.

The withholding is a flat percentage of revenues from government payments and will restrict cash flow needed for day-to-day operations and investments. 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 businesses that might not have the resources needed to comply with this provision.

Status of Legislation: S.89, S. 164, and H.R. 674 have been introduced in order to repeal the 3% withholding tax on federal contracts.  On May 26 the Contracting and Workforce Subcommittee of the House Small Business Committee held a hearing on H.R. 674.  Click here to watch the hearing video.

IEC Position: IEC supports efforts to repeal this provision, including S. 89, S. 164 and H.R. 674.

Update:  On May6,  2011, the IRS issued a final rule delaying implimentation of the 3% withholding until 2013.  Here is the IRS release on the rule.