Following the active engagement of the U.S. Chamber of Commerce and 125 other trade associations in a grassroots effort to repeal the 3% withholding tax, now scheduled to take effect on January 1, 2013, there now appears to be a good chance that Congress might finally do away with the burdensome requirement. According to the Chamber, a private-sector study has estimated that the 3% withholding requirement could cost Federal, state and local governments as much as $75.2 billion in implementation costs during the first five years after it takes effect and NCTR, NASRA and other public sector groups have been fighting for years to obtain repeal. However, the potential impact of the provision on small business cash flows and their ability to finance new jobs seems to have finally done the trick. A repeal amendment is currently pending in the Senate, and repeal legislation in the House of representatives has 176 cosponsors.
The 3% withholding requirement was a last-minute provision (Section 511) added to raise revenue during the 11th hour of conference negotiations on the “Tax Increase Prevention and Reconciliation Act” of 2006. It requires Federal, state, and local governments and their instrumentalities to deduct and withhold 3% of any payment for property or services. There is a small entity exception for political subdivisions and their instrumentalities that make less than $100,000,000 in payments annually.
The withholding requirement was originally to take effect January 1, 2011, but was delayed for one year in the 2009 American Recovery and Reinvestment Act, and then was once again pushed out a year (until January 1, 2013) in the final Internal Revenue Service (IRS) regulations issued in May of this year.
Implementation of Section 511 presents a number of significant challenges to State and local governments. For example, the sophistication of systems necessary to capture and report the required data vary greatly between governmental entities, and many may not have the resources, capacity or staff to undertake the required withholding and remittance. In addition, there are costs to purchase or retrofit existing payment and procurement systems, which are particularly unwelcome given state and local government fiscal situations at present.
Repeal efforts in the past have run afoul of the revenues that would be lost as a result. For example, in 2009, the Congressional Research Service reported that eliminating the provision would cost close to $11 billion over 10 years. However, the costs of implementation to businesses and governments are estimated to be much higher. For example, the Department of Defense (DOD) prepared a report for Senate and House Armed Services Committees that anticipates DOD costs to comply will be over $17 billion for the first five years alone, presenting a net revenue loss for the Federal government based on just this one agency’s expected costs. The Chamber of Commerce claims that a private-sector study has estimated that the 3% withholding requirement could cost Federal, state and local governments as much as $75.2 billion during those first five years.
Legislation has once again been introduced in the Congress to eliminate the provision. For example, H.R. 674 has been offered by Congressman Wally Herger (R-CA), and currently has 176 cosponsors in the House of Representatives. In the Senate, Senator Scott Brown (R-MA) has introduced S. 164, which is cosponsored by 17 other Senators and seems to be the Senate bill garnering the most attention.
House Ways and Means Chairman Dave Camp (R-MI) has also said that he wants to explore a repeal , and that it could possibly be included as part of a larger tax bill that he said could be moving later this year. In addition, on May 26th, the House Small Business Committee’s Subcommittee on Contracting and Workforce held a hearing entitled “Defer No More: The Need to Repeal the 3% Withholding Provision.” No one testifying, nor any Member of Congress attending the hearing, opposed the repeal of the 3% withholding requirement.
The House Small Business Committee Chairman, Congressmen Sam Graves (R-MO), and Mick Mulvaney (R-SC), chairman of the House Small Business Subcommittee on Contracting and Workforce, also have written an op-ed entitled “Stop Withholding Small-Business Payments” that was published in the June 20th issue of Politico. In it, they stressed that many small-business government contractors work for less than a 3 percent profit margin. “Withholding 3 percent of their payments may force some of these companies out of the public-sector market - or out of business entirely,” they warned. This would result in “a loss of jobs, a loss of competition and higher costs to taxpayers,” the two pointed out.
Currently, there is an effort underway on the Senate floor to pass repeal of the provision. Senator Brown, along with Senators Olympia Snowe (R-ME), James Inhofe (R-OK), and David Vitter (R-LA), filed an amendment (No. 405) to S. 782, the Economic Development Revitalization Act of 2011, to repeal the 3% withholding provision of the IRC on June 9th. Since then, Senators Ayotte (R-NH), Barrasso (R-WY), Begich (D-AK), Enzi (R-WY), and Moran (R-KS) have cosponsored the amendment. The amendment is still pending, as the Senate has yet to complete business of the underlying bill. It would pay for repeal using “unobligated funds” as the offset.
NCTR and NASRA have joined with other governmental organizations, spearheaded by the National Association of State Auditors, Comptrollers and Treasurers (NASACT), in sending a letter to Chairman Camp urging prompt action. In addition, NCTR has signed onto a statement of support submitted for the record on the Small Business Committee hearing. The Chamber and more than 1,000 organizations, individuals and business from all across the country have also written a letter to all members of Congress, calling the 3 percent withholding provision onerous and asking them to support the Brown amendment.
Although repeal is finally looking like a real possibility, the IRS’s Office of Federal, State and Local Governments will hold a free, one-hour webcast on July 14th that will address a number of questions concerning implementation of Section 3402(t), the section of the Internal Revenue Code implementing repeal,
• Who must perform Section 3402(t) withholding?
• What payments are subject to Section 3402(t) withholding?
• What are the exceptions to Section 3402(t) withholding.
So for you pessimists (realists?) out there, registration instructions for the webcast can be found here.
• NASACT Summary of IRS Final Regulations
• IRS Final Regulations
• House Small Business Committee Hearing
• NCTR, National Organizations Statement for Record
• Graves/Mulvaney Op-Ed
• Chamber Letter
