Final Regulations Defer Effective Date of 3% Withholding Requirement on Payments to Government Contractors

The IRS has issued final regulations that defer for one year the amended effective date of regs relating to the withholding from and reporting of certain payments made by government entities. These rules now generally apply to payments made after Dec. 31, 2012 [Preamble to Prop Reg 05/06/2011].

Background. Code Sec. 3402(t) provides that, once effective, the federal government and the government of every state, political subdivision of a state, and instrumentality of a state or state subdivision (including multi-state agencies) making certain payments to a person providing any property or services (e.g., payments from a political subdivision to a government contractor) will have to deduct and withhold tax from that payment in an amount equal to 3% of the payment. The withholding requirement will also apply to a payment made in connection with a government voucher or certificate program that functions as a payment for property or services [Code Sec. 3402(t)(3)].

The above rules do not apply to payments that are otherwise subject to withholding (e.g., wage income, and payments subject to backup withholding).

Reporting requirements. Once the withholding requirements are effective, each government entity that is required to withhold tax under Code Sec. 3402(t) will also be required to furnish the payee with a written statement on Form 1099-MISC containing: (i) the name, address, and the taxpayer identification number of the person receiving the payment subject to withholding; (ii) the amount of the payment subject to withholding; (iii) the amount of the tax deducted and withheld; (iv) the name, address, and TIN of the government entity filing the form; (v) a legend stating that such amount is being reported to IRS; and (vi) other information required on Form 1099-MISC. The entity must also file a duplicate of that statement with the IRS [Prop Reg §31.6051-5].

The final regulations reserve for future guidance the issue of whether Code Sec. 3402(t) withholding will apply to payment card transactions (including payments by credit, debit, stored value, and other payment cards).

There is an exception to the above rules for payments under existing contracts that have not been materially modified. The IRS has issued proposed regulations that would end this exception effective with payments made after Dec. 31, 2013. If adopted, payments made under all government contracts would be subject to Code Sec. 3402(t) withholding as of Jan. 1, 2014, unless they were otherwise excluded under the regulations.