By Larry Jones
May 16, 2011

The Internal Revenue Service issued final regulation on May 5 that would delay implementation of a burdensome, costly unfunded federal mandate until January 1, 2013 instead of next year. This is welcomed news for local and state governments who have expressed strong opposition to the so called three percent withholding requirement since it was enacted as part of the Tax Increase Prevention and Reconciliation Act.

Under current law, all federal, state and local government agencies are required to begin withholding three percent of payments made to suppliers and contractors, to remit the funds to the IRS and to maintain appropriate records. Congress passed the law in 2005 hoping it would help the federal government close a $300 billion annual tax gap by reducing the number of opportunities contractors and suppliers would have to avoid reporting income.

The new IRS regulation would also exempt any payment of less than $10,000; however, if a contractor issues a series of bills to a government agency that are each less than $10,000 but the government agency pays the contractor in a single lump sum payment that exceeds that amount, the agency would still be required to withhold three percent of the payment. The new rules also provide for a number of exemptions including payments made for wages, unemployment and social security benefits, interest and real property.

Acknowledging the burden that the 2005 law would impose on state and local governments, Congress and the Administration from the outset delayed implementation until January 2011. Later, the IRS took further action to delay implementation until January 2012 as it continued to seek public comment on the proposed rules. The latest IRS action further delays the effective date until January 2013.

The U.S. Conference of Mayors and other state and local groups have been working together since 2006 to urge members of Congress and the Administration to pass legislation repealing the three percent withholding requirement. As a result, there is bipartisan support in both houses of Congress for repealing the rule. Representative Wally Herger (CA) has introduced legislation (H.R. 674) in the House, which has 101 cosponsors, and Senator Scott Brown (MA) has introduced legislation (S. 164) in the Senate that has eight cosponsors. The Administration is backing a three-year extension of the three percent withholding exemption. The Conference of Mayors is hopeful repeal legislation will be enacted this year.