Still Sore over 1099 Flap? Here's Next Gripe

The provision to withhold 3% from federal payments to contractors has been delayed a year, but companies are still irked by it.

If your firm sells to Uncle Sam, you can breathe a little easier. That’s because a provision to withhold 3% from any payments the federal government makes to its contractors has been delayed. The law now will not affect most payments until after Dec. 31, 2012. It had been scheduled to go into effect at the end of this year.

The withholding requirement was embedded within the Tax Increase Prevention and Reconciliation Act  or 2005. It required federal, state, and local government entities to withhold income tax when making payments to persons providing property or services, as this notice in the Federal Register outlines.

As nonsensical as the proposal might seem, the driver behind it made sense: The government has found that some contractors with which it does business haven’t paid all their taxes. Since 1990, the Government Accountability Office has periodically reported on high-risk federal programs that are vulnerable to fraud, waste, and abuse, according to a 2007 GAO report titled “Thousands of Federal Contractors Abuse the Federal Tax System.” One such area is the management of federal contracts. “Specifically, about 27,000 DOD contractors, 33,000 civilian agency contractors, and 3,800 GSA contractors owed about $3 billion, $3.3 billion, and $1.4 billion in unpaid taxes, respectively,” the report said. What’s more, the estimates likely were understated because they excluded federal contractors that understated their income or did not file their tax returns, according to the report.

Still, few in the business community were pleased with the proposal. The major concerns: The administrative burden it placed on both government agencies and those providing goods and services, and the impact it would have on contractors’ cash flow. In fact, a Governmnet Withholding Relief Coalition was formed -- no surprise -- to repeal the provision. It boasts 120-plus member organizations, including the American Bankers Association, the Association of School Business Officials International and the National Association of Wholesaler-Distributions.

In a letter dated March 30, 2011, the Coalition writes, “The administrative and capital investment costs that compliance with the three percent withholding will impose on business and governments will be substantial. And the mandate will be exceedingly complicated to implement.”

While the current delay is nice, most groups really would prefer that the requirement vanish completely. In fact, several bills have been introduced that would repeal the withholding requirement. One, H.R. 674, was introduced by Rep. Walter Herger (R-CA) and boasts 128 co-sponsors, according to www.govtrack.us. It was referred to the House Committee on Ways and Means in February. In the Senate, S. 89, sponsored by Senator David Vitter (R-LA) and with eight co-sponsors, was referred to the Senate Finance committee in January, 2011.

This proposal seems to be generating the same level of antipathy provoked by the provision requiring all businesses to issue 1099s for purchases totaling $600 or more in a year. A similar death likely would attract few mourners.