H.R. 674: To amend the Internal Revenue Code of 1986 to repeal the imposition of 3 percent withholding on certain payments made to vendors by government entities

H.R. 674

To amend the Internal Revenue Code of 1986 to repeal the imposition of 3 percent withholding on certain payments made to vendors by government entities

Date
October 26, 2011 (112th Congress, 1st Session)

Staff Contact
Communications

Floor Situation

On Wednesday, October 26, 2011, the House is scheduled to consider H.R. 674, a bill to amend the Internal Revenue Code of 1986 to repeal the imposition of 3 percent withholding on certain payments made to vendors by government entities, under a rule. Under the rule, H.R. 674 and H.R. 2576 would be combined into one measure following passage. H.R. 674 was introduced by Rep. Wally Herger (R-CA) on February 11, 2011, and was referred to the House Committee on Ways and Means.  On October 13, 2011, the Ways and Means Committee held a mark-up and reported the bill by voice vote.

Bill Summary

H.R. 674 would amend the Internal Revenue Code of 1986 to permanently repeal the imposition of 3 percent withholding on certain payments made to vendors by government entities. Currently, the imposition of the 3 percent withholding is set to take effect on January 1, 2013. If the 3 percent withholding tax were implemented as scheduled, government entities would be required to withhold 3 percent of payments to persons providing property or services.  For example, on an invoice for $20,000 the government would pay the business $19,400 and withhold $600 as a preemptive tax. Government entities include the government of the United States, as well as every state and local government. However, local governments with less than $100 million of annual expenditures for property or services would be exempted from the requirement.

According to the Joint Committee on Taxation, repealing this requirement would reduce federal revenues by $11.2 billion over the 2012–2021 period.

Background

On May 17, 2006, the Tax Increase Prevention and Reconciliation Act of 2005 (P.L. 109-222) was enacted.  Among a number of other provisions, the bill included Section 511, titled, “Imposition of Withholding on Certain Payments Made by Government Entities.”  Section 511 required the imposition of a preemptive 3 percent withholding tax on payments for goods and services to contractors made by all branches of the federal government and its agencies and all units of state and local governments, including counties and parishes.  Traditionally, wages and certain other payments are already subject to withholding of income tax, which employers are required to collect and submit to the government. Generally, the withheld amount is held as a credit against the taxpayer’s tax liability and is refunded if the tax liability is less than the amount withheld, or additional taxes may be due if the amount withheld is less than the actual tax liability.  Prior to the passage of P.L. 109-222, a withholding tax was not required from payments made by government entities.  Under the law (and subsequent delays), the 3 percent withholding tax on payments by government entities will become effective on January 1, 2013.

According to the Congressional Research Service (CRS), the 3 percent withholding tax on payments by government entities was conceived of as a means for the IRS to improve tax compliance and lower its tax gap, which is the difference between the amount of money the IRS is legally due in a given year and the amount of money the IRS actually receives.  In addition, the provision served as means to increase revenue and offset other revenue reductions in the bill.  Under the legislation, the 3 percent withholding tax was scheduled to take effect on January 1, 2011.  According to the Joint Committee on Taxation’s (JCT) original estimate for 2006, this provision would have raised revenues by $6.97 billion over the FY 2011 – FY 2015 period.  However, the Democrat’s original $1.2 trillion “stimulus” (P.L. 111-5) was enacted on February 17, 2009, and it included a provision to delay implementation of the 3 percent withholding tax until after December 31, 2011.  On May 5, 2011, the IRS issued final regulations (T.D. 9524) that delayed the implementation of the 3 percent withholding tax on government contractors until January 1, 2013.  Thus, without the enactment of legislation to repeal the 3 percent withholding tax on government payments to vendors, the tax will go into effect on January 1, 2013.

Opposition to the imposition of the 3 percent withholding tax began relatively soon after the passage of P.L. 109-222.  As early as March 22, 2007, the House Small Business Committee held a hearing on the “Potential Effects on Small Businesses of 3 Percent Withholding Provisions on Government Contracts.”  When the provision was delayed by the first stimulus bill, JCT explained the delay by saying, “The Congress believes that the three-percent withholding requirement was not appropriately targeted to the noncompliant taxpayers for whom it was originally intended and may impose significant and costly administrative burdens on state and local governments.”  Indeed, the cost of complying with the withholding tax could adversely affect many businesses, especially those businesses with relatively small profits and tax liabilities. Overwithholding will occur if a business has a low profit margin or an income tax liability that is relatively low. Thus, some businesses would effectively provide the federal government with an interest-free loan.  In addition, compliance costs would impose new burdens on financially strapped small businesses and impede necessary cash flow during an unemployment crisis.  These added costs would almost certainly translate into fewer private-sector jobs and higher costs for the government and taxpayers.

A number of outside organizations and employer advocates have publicly opposed the imposition of the 3 percent withholding tax and have called for its permanent repeal.  Notably, the Chamber of Commerce has repeatedly called for the repeal of the 3 percent withholding tax.  According to the Chamber, which represents the interests of more than 3 million businesses, “The 3% Withholding Tax will mandate that federal, state, and local governments withhold 3% from payments for goods and services, not only causing an unprecedented paperwork burden for the government and companies who provide goods or services to them, but forcing firms to increase costs to offset the impact of delayed payments and disrupting businesses’ cash flows.”  Calls for the total repeal of the withholding tax from job creators have prompted bipartisan support for H.R. 674, which as of October 25, 2011, had 269 co-sponsors, 62 of whom were Democrats.

Cost

According to the Joint Committee on Taxation, repealing this requirement would reduce federal revenues by $11.2 billion over the 2012–2021 period.  To offset the revenue reduction caused by H.R. 674, the House will also consider H.R. 2576, a bill to modify how eligibility for certain healthcare programs is calculated.  According to JCT, H.R. 2576 would increase revenue over the same period by $12.9 billion.

Additional Information

The following information was provided by the House Ways and Means Committee on October 11, 2011.

 

Background

  • In 2006, Congress enacted a 3 percent withholding requirement on certain payments made to contractors doing business with the federal, state, and local governments.  This provision—which was originally enacted as part of a larger package featuring numerous other significant tax changes—was purportedly intended to improve tax compliance.
  • The 3 percent withholding rule was originally scheduled to take effect on January 1, 2011, but because of strong concerns raised by employers and government entities alike about  the potentially significant burdens it could create, the rule’s effective date has been subsequently been delayed until January 1, 2013.

 

Proposal:

  • Reps. Wally Herger (R-CA) and Earl Blumenauer (D-OR) have introduced legislation (H.R. 647) that would permanently repeal the 3 percent withholding rule.  This bill has received strong, bipartisan support from 269 cosponsors as well as from the Government Withholding Relief Coalition, a 143-member coalition featuring many well-known trade associations and groups representing various state and local governments.  According to the Joint Committee on Taxation, repealing this requirement would reduce federal revenues by $11.2 billion over the 2011 – 2021 period.

  • President Obama has recently acknowledged the need to address this issue, calling the 3 percent withholding rules “burdensome withholding requirements that keep capital out of the hands of job creators.”  He has proposed another one-year delay of the implementation of the 3 percent withholding rule, until January 1, 2014.

  • Much like the costly “Form 1099” requirements that Congress repealed earlier this year, the 3 percent withholding rule would impose substantial new burdens on cash-strapped employers, impeding cash flows and further undermining job creation.

  • Repealing the 3 percent withholding requirement would also relieve federal, state, and local governments of the need to comply with the significant, unfunded administrative burdens that the rule would impose.

  • While Chairman Camp and the Ways and Means Committee continue to pursue comprehensive tax reform as a critical means of promoting economic growth and job creation, permanently repealing the 3 percent withholding rule is a common-sense, bipartisan step that Congress and the President can take right away.