IRS Delays 3% Withholding Rule Until 2013, AGC Still Demands Full Repeal

The IRS published final regulations May 9 on the implementation of 3% withholding, or section 3402(t) of the IRS Code. The regulations considered many of the points AGC made in its comments to the draft regulations two years ago but the final regulations gave no ground.  In short, the good news is confined to a delayed imposition of the rule because government entities will have to “adopt the systems and process necessary to comply with section 3402(t)”…and will also need to “formulate acquisition rules that are consistent with the final regulations, as well as the infrastructure needed to apply those rules, some commenters stated that government entities would need at least 18 months from the final regulations … to comply.” AGC has learned that “government entities” mentioned above include the Department of Defense. The final regulations provide no relief from concerns AGC has expressed about the 3% withholding. AGC’s comments to the IRS in 2009 laid out a number of concerns and urged reforms to reduce the burden.  The IRS rejected AGC recommendations that would have reduced the impact on the construction industry.  For instance, AGC recommended that: the withholding amount be modified to a closer match tax owed; the withholding law exclude construction as it does real estate purchases; 3% be withheld from the final payment rather than every payment;  overwithholding be refundable on a quarterly rather than an annual basis; the construction industry use payment bonds to ensure taxes are covered; subchapter S corps, ESOPs, JVs and other pass through entities be exempted as they owe no tax at the entity level;  and construction managers be exempted like “agents (payment administrators)” under the regulations.  In each case the IRS rejected the request for a modification, saying that they lacked the statutory authority to create specific exemptions or that the modifications could create opportunities for bypassing the withholding requirement. Major Change Included for Existing Contracts In addition to beginning the withholding on 1/1/2013, the regulations also modify the law’s impact on existing contracts.  The draft regulation included an exemption from 3 percent withholding for “existing contracts.”  In the final rule, existing contracts are exempted only for one year beyond 1/1/2013.  All payments under all contracts will be subject to withholding beginning 1/1/2014.  Also, existing contracts that are “substantially modified” after 1/1/2013 may become subject to the withholding requirement. Regulation Costs at $20 Billion, Only Collects $12 Billion AGC is a member of the Government Withholding Relief Coalition.  Earlier this year the coalition produced a detailed estimate of the cost of compliance and enforcement of the section 3402(t) 3% withholding requirement.  The coalition estimates that the combined costs of software upgrades, compliance, enforcement and administrative and interest expenses exceeds $20 billion over the first five years.  About $10 billion of those costs will be one-time costs. Recurring annual costs include about $597 million in interest expenses, $662 million in costs to administer withholding by government entities, and $622 million for government contractors to comply, report and recover the massive overwithholding contemplated by the legislation. It is important to note that the government estimates of new “income” generated by the provision will be about $12 billion, so about 60 percent of the costs inflicted by the rule.  Also, on an annual basis the rule is expected to bring in far less than 50 percent of the annual cost to comply with the rule.  Because of the negative short and long-term impacts of the rule, the number of cosponsors for both the House and Senate repeal bills continues to grow. House Cosponsors for 3 Percent Repeal Exceed 100 AGC has made repeal of 3 percent withholding a priority since it was originally enacted.  The three repeal bills introduced this Congress continue to add cosponsors.  H.R. 674 had only 42 cosponsors during the AGC convention in Las Vegas in March. During and after the convention, AGC members made a push to get cosponsors for the legislation, sending thousands of letters to Congress. In addition, there have been hundreds of personal meetings with Congress, including many during Federal Contractors Conference last week in Washington, D.C. As a result there are now 107 cosponsors of the House bill and we are having similar results in the Senate.   There are still 129 members of the House and six members of the Senate who have cosponsored the bill in previous years but have yet to do so this Congress. To see if your Member of Congress has cosponsored, click here. To send a letter to your member of Congress and Senators, click here. For more information, contact Jeff Shoaf at shoafj@agc.org.