Tax & Accounting Blog

2013 Is the New Starting Date for 3% Tax Withholding by Government Payers

ONESOURCE, Tax Information Reporting, Trust Tax June 16, 2011

A one-year postponement will make January 1, 2013 the applicability date for governments and government-owned entities to start withholding 3% from payments for services and property under tax regulations published in May.  These final tax regulations (TD 9524) provide guidance for administering the new withholding requirement, and a proposed regulation published simultaneously pushes back the starting date to the beginning of 2013.

Federal, state and local governments are all included in this withholding mandate, and also their agencies and instrumentalities, except for political subdivisions (local governments within states) with non-payroll payments totaling less than $100 million annually. The new withholding requirement applies to payments for services and for property (such as supplies, merchandise and materials, but not real estate) and includes payments to corporations. These new withholding requirements were enacted years ago but the applicability date has been postponed a couple of times.  Bills to repeal the requirement have been introduced in Congress, but the IRS has issued regulations for guidance under the law currently in effect.

Payments under $10,000 are exempt from this 3% withholding requirement but anti-abuse provisions of the regulations prohibit dividing payments to reduce them under the $10,000 threshold. Also exempt from this 3% withholding are payments to 501(c)(3) not-for-profit entities, to nonresident aliens, payments by Indian tribal governments, and payments through a public assistance or disaster relief program.

There is a limited exception to withholding that applies to payments made under contracts existing on December 31, 2012 that are not materially modified. Mere contract renewals are not considered substantial modifications; however, the proposed regulations published similtaneously with the final regulations would limit this grandfather exception to only one year.

Procedural and systems changes will be needed to comply with the new requirements.  Vendors will have to be coded. Remember, corporations and vendors of merchandise will not be exempt. Systems will have to provide for withholding the 3% federal tax, and procedures will be needed to cover the timely deposit of withheld tax with the IRS throughout the year as well as filing of the annual reconciliation Form 945.