The U.S. House of Representatives Committee on Ways and Means voted on October 13 to approve H.R. 647, a legislative bill for repeal of Section 3402(t) of the Internal Revenue Code, the law which requires government entities to withhold 3% federal income tax from certain payments for services and for property. In the U.S. Senate, two bills containing repeal of Section 3402(t) have been introduced but neither of them has been reported out of committee.
The 3% withholding requirement has not yet gone into effect. Tax regulations for 3402(t) were issued in May of this year, but the effective date is currently set at January 1, 2013. The IRS has been doing a lot of education and outreach to help government payers understand the regulations and plan for implementation, and the IRS has been planning to revise Form 1099-MISC and Form 945 to accommodate the reportable data.
The 3% withholding requirement was created when Section 3402(t) was added to the tax code as part of the Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA). Postponements pushed the effective date of withholding to January 1, 2013, and payments under existing contracts could remain exempt from withholding until the beginning of 2014 if contracts were not materially modified.
Federal, state and local governments, and their agencies and instrumentalities are subject to the requirement to withhold. There are specific exclusions for certain specific types of payments or payees. An exception for political subdivisions of a state was created so those with annual payments (of the type subject to 3402(t) withholding) less than $100 million are not required to withhold.