IRS Published Proposed Regulations to Implement Three Percent Withholding Law

On December 5, the IRS published in the Federal Register a notice of proposed rulemaking to implement the 3 percent withholding law enacted in 2005.  Effective January 1, 2011, federal, state and local governments with annual expenditures of $100 million or more are required to withhold 3 percent from payments for goods and services, including payments made under government contracts with construction companies.  The law was intended to reduce the so-called “tax gap” and tax evasion. IRS’ proposed rule clarifies that payments for the construction of a building or other public works projects are subject to 3 percent withholding.  Other key points of the proposed rule include:

• Only applies to payments over $10,000
• No flow down to subcontractors
• Political subdivisions: 2 prior fiscal years determine $100 million threshold
• Only impacts contracts entered into after 1/1/2011
• Credit can be taken against estimated income tax withholdings
• No credit against employment taxes (e.g., Medicare, Social Security)
• Government entities are liable even if money is not withheld

AGC has made full repeal of the 3 percent withholding law a top priority for the 111th Congress.  During the 110th Congress (2007-08), a bill to repeal the law enjoyed the bipartisan support of over 260 co-sponsors in the House and 15 co-sponsors in the Senate.  Proponents of the bill are ready to reintroduce the legislation early in 2009, and AGC will urge all members of Congress to support it. AGC has also made full repeal of the law a top priority for any economic stimulus package Congress may consider in early 2009.  Although the withholding does not go into effect until 2011, companies, as well as federal, state, and local governments are expending funds to prepare for implementation now.  These are needless preparation expenses in rough economic times.