Doing Business with the Government? Get Ready for Withholding in 2013
The IRS has issued additional guidance, in the form of frequently asked questions (FAQs), on the requirement for government entities to withhold 3% from nearly all payments made to government contractors. The FAQs explain the nuts-and-bolts of the withholding requirement, such as which payments are and aren't subject to withholding, and how withholding applies to contract hold-backs.
Background. The new law provides that, beginning in 2013, the federal government and the government of every state, city and county making certain payments to a person providing any property or services (e.g., a government contractor) will have to deduct and withhold tax from that payment in an amount equal to 3% of the payment. Payments subject to withholding under this rule will also be subject to information reporting requirements (i.e., 1099 filings).
Withholding under the above rules won't apply to any payment: (1) of interest; (2) for real property; (3) to any other governmental entity (i.e., intra-governmental payments), any tax-exempt entity, or any foreign government; or (4) made by a political subdivision of a state (such as a city) that makes less than $100 million of these payments annually.
The withholding requirement won't apply to any payment less than $10,000.
Withholding where portion of payment is held back. The amount to withhold, and the application of the $10,000 payment threshold, are determined on a payment-by-payment basis and are based on the actual amount paid to a contractor. Thus, any amount of retainage (i.e., a hold-back of part of the payment as security to ensure contract completion), is excluded, regardless of the purpose of the payment or its relationship to other payments to that payee. If and when the retainage is paid to the contractor, withholding and the application of the $10,000 payment threshold applies separately to that payment. However, if payments are divided for the primary purpose of avoiding withholding, they will be treated as one payment for purposes of applying the $10,000 payment threshold. (FAQ 9)
Withholding on payments to passthroughs. The IRS says withholding is required with respect to payments to a passthrough entity, even though the entity is not actually a taxpayer. The IRS says it is currently are working on guidance that will address how the owners of a passthrough entity (such as an LLC or S corporation) will claim the credit for their allocation of amounts withheld from a payment to the passthrough entity. (FAQ 14)
Here is a link to the FAQs:
http://www.irs.gov/govt/fslg/article/0,,id=243336,00.html