Government contractor payments are about to get more complex, thanks to new reporting and withholding requirements taking effect in 2012.
The Tax Increase Prevention and Reconciliation Act of 2005 includes a provision requiring government entities to withhold 3 percent from specific payments to contractors for products and services. While these new requirements were originally supposed to apply to all payments after Dec. 31, 2010, The American Recovery and Reinvestment Act of 2009 pushed the implementation date back to Dec. 31, 2011.
With more than a year to go before the requirements, called section 3402(t), take effect, the IRS has released a set of proposed regulations. The 3 percent withholding rules affect all U.S. local, state, and federal government entities. Whenever they make payments of $10,000 or more to a vendor for products or services, the government entity must report the payment and withhold 3 percent.
The only government entities exempt from 3402(t) are state government instruments that make less than $100 million worth of purchases for property and services during the year. This exception removes the reporting requirements for smaller government entities.
Withholding must be performed at the time of the payment - regardless of payment method. If a government entity fails to withhold 3 percent from an applicable payment, then they will be liable for the tax. Governments should report any amounts withheld on a Form 1099-MISC provided to the payee.
In addition to exempting certain government entities from reporting and withholding, the proposed provisions also exempt certain payments. Section 3402(t) applies to payments to individuals, trusts, estates, partnerships, associations, and corporations. However, the following types of payments are exempt:
- Payments otherwise subject to withholding, such as wages.
- Payments for retirement benefits, unemployment compensation, or social security.
- Payments subject to backup withholding, if the required backup withholding is actually performed.
- Payments for real property.
- Payment of interest.
- Payments to other government entities, foreign governments, tax exempt organizations, or Indian tribes.
- Payments made under confidential or classified contracts, as described in IRC 6050M(e)(3).
- Payments made by a political subdivision of a state, or instrumentalities of a political subdivision of a state that make annual payments for property of services of less than $100 million.
- Public assistance payments made on the basis of need or income. However, assistance programs based solely on age, such as Medicare, are subject to the requirements.
- Payments to employees in connection with service, such as retirement plan contributions, fringe benefits, and expense reimbursements under an accountable plan.
- Payments received by nonresident aliens and foreign corporations.
- Payments made by Indian tribal governments.
- Payments in emergency or disaster situations.
Section 3402(t)'s withholding requirements apply only to single payments of $10,000 or more. This differs from traditional 1099 reporting, which aggregates all payments to a vendor over the course of the year. If a government entity makes several payments, each less than $10,000, to a vendor, then there is no requirement to withhold 3 percent, even if the aggregate amount exceeds $10,000.
Some vendors may attempt to break up their payments so that a reportable payment becomes several non-reportable payments. To combat this, section 3402(t) includes an anti-abuse rule that prevents vendors some breaking up these payments.
The regulations described are only proposed. There could be significant additions or deletions when the law takes effect after Dec. 31, 2011. A representative of the IRS says that final regulations shall be available before the end of 2010. Once the regulations are available, we will update this page to reflect any changes.