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It’s Time Congress Says No to Withholding Rule

Two architects accountants CPAIf there are any lessons to be learned from the 1099 reporting controversy, it’s that hitting the proverbial fly with the hammer is not the best way to go after tax cheats.  The fly still lives but everything around the fly gets whacked.

What is shaping up to be Lesson #2 is a rule that will force many federal, state and local agencies to withhold 3 percent of payments to contractors for goods and services that cost over $10,000.  It covers governments with total yearly contract expenditures over $100 million, which means most states and large cities.  The rule was enacted in 2006 but its implementation has been delayed – but barring congressional intervention, it will take effect Jan. 1, 2013.  Three bills have been introduced in Congress so far to abolish it - H.R. 674 and S. 89, which would simply repeal the rule, and S. 164, which would offset the cost of the repeal with unobligated funds. 

Why is the 3 percent withholding a bad idea and why is the AICPA opposing it?

We recognize that the “tax gap” (the gap between what the feds should receive in taxes and what they actually get) is a serious problem. But we also recognize, as explained in our letter to Congress, that other tools can and are being used to ensure that contractors are paying their share - tools that will not squeeze cash flow for businesses that are tax compliant and may already be operating on small profit margins.  The Associated General Contractors of America, in a 2009 letter to the IRS, warned that the rule “will result in overwithholding on every construction contract” and could jeopardize a company’s ability to complete work or drive up the cost of government projects.

The law will also mean lower Medicare payments to doctors and other providers who already face cash flow problems.  We are not aware of any special tax compliance problems among medical professionals to warrant withholding.

Additionally, state and local governments will face significant expenses to reconfigure their accounting systems and are liable for any amounts not withheld.  To give you a sense of the size of the impact this law will have on them, the Congressional Budget Office has been scrutinizing laws for 15 years to see what qualifies as an unfunded intergovernmental mandate, meaning it imposes over $70 million of costs without compensation on state, local and tribal governments. Only 13 made the cut. Guess which law is among the 13?

Federal agencies will also be hit.  The U.S. Department of Defense (DOD) testified before a congressional subcommittee that the withholding requirement would cost the agency and its contractors billions of dollars to implement. DOD also expressed concern that fewer companies, particularly small businesses, will compete for contracts, thus limiting government access to new technologies that would be developed by companies now shut out of the process. What is the cost of that, I wonder?

Footnote:  If you have questions about the 3 percent rule, you can visit the Government Withholding Relief Coalition, of which the AICPA is a member. 

Jina Etienne, CPA, Director of Taxation, American Institute of CPAs. Jina started her career in 1989 in the tax department of Touche Ross and, in 1993, started her own practice to focus on the needs of small businesses and their owners.  She recently joined the AICPA after 17 years in private practice.

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