The IRS has delayed, by one year, the implementation of a withholding tax requirement on government contracts.

 

The pending new rule, which would have gone into effect on January 1, 2012, requires all federal, state, and local government agencies that make payments of at least $100 million for goods and services in a year to withhold a tax of 3% of the contract value and report that information to the IRS.

On May 11, 2011 the IRS announced a delay of the effective date until January 1, 2013.

The tax withholding is due to a provision in the 2005 tax reconciliation bill (Section 511 of the Tax Increase Prevention and Reconciliation Act of 2005) and requires federal, state, and local governments to start withholding 3% of payments due to government service providers. Originally this provision had an effective date of January 1, 2011 but that was pushed back until 2012 by the Stimulus bill.

The withholding tax presents a particular problem for small businesses in a competitive market like the construction industry that already deals with retainage. This 3% could be used by contractors to compensate for material costs, supplies, and other operating expenses; instead, construction contractors will in essence be "floating" the government a 3% interest free loan.

This withholding provision unfairly penalizes construction contractors, because the 3% withholding amount would apply to the total gross contract amount, not to the net revenue generated from the project.

 

Lawmakers earlier this year proposed repealing the controversial provision, and Obama administration officials in March expressed support for delaying the requirement while agencies prepare to implement the change.

 

Critics have suggested that the provision is unnecessarily burdensome during an economic downturn, noting that other measures exist to ensure contractor tax compliance.

 

 

For more information please contact Joseph Rockwell at jrockwell@smf-cpa.com or you can reach him at 973-472-6250.