IRS delays contractor tax withholding

The Internal Revenue Service is pushing off an unpopular requirement that the government withhold a percentage of its payments to most contractors for tax purposes.

The final rule, published in Monday's Federal Register, delays a mandate that federal, state and local governments with expenditures of more than $100 million withhold 3 percent of payments for products and services worth more than $10,000, including nonconfidential or classified contracts, grants to for-profit companies, and farm and Medicare payments. The requirement, scheduled to take effect on Jan. 1, 2012, now will be delayed to apply to payments on new contracts made after Dec. 31, 2012. The rule will affect all contracts starting Dec. 31, 2013.

The requirement, included in the 2005 Tax Increase Prevention and Reconciliation Act to ensure that individuals and companies with outstanding tax debts do not receive new payments from the federal government, would closely mirror the withholding system on individual salaries and wages. The government would set aside 3 percent of the gross payments and the information and funds would then be transmitted to the IRS. At the end of the year, the amount withheld would be credited toward taxes owed.

Lawmakers earlier this year proposed repealing the controversial provision, and Obama administration officials in March expressed support for delaying the requirement while agencies prepare to implement the change.

Critics have suggested that the provision is unnecessarily burdensome during an economic downturn, noting that other measures exist to ensure contractor tax compliance.

"This is an 11th-hour quasi-reprieve from a temporary tax increase that would have eliminated jobs and helped only the IRS," said Phil Bond, president and chief executive officer of TechAmerica, a technology-based trade association. "It is a scheme to force companies to pay taxes in advance and then wait for the IRS to send them a refund a year later. A one-year extension of the withholding and reporting requirements is a significant, positive development but far from a solution."

Roger Jordan, vice president of government relations at the Professional Services Council, a contractor trade group, on Monday also applauded the delay but called the requirement itself "bad policy."

"The withholding requirement would significantly reduce companies' cash flow at a time when the current economic environment is already squeezing their ability to meet operating expenses," he said. "While it's appropriate to focus on how to ensure that any tax liabilities government contractors and other organizations owe are properly collected, other regulations have been implemented in recent years that effectively ensure contractors are meeting their tax obligations."