US House Committee Backs Contractors Tax Repeal

by Mike Godfrey, Tax-News.com, Washington

17 October 2011

The Republican-led Committee on Ways and Means of the United States House of Representatives has favourably reported out, on a bipartisan basis, a bill to repeal the 3% withholding tax on payments made to government contractors, and another bill, on a not-so-bipartisan basis, to provide for its funding through changes to health programmes.

Section 511 of the Tax Prevention and Reconciliation Act of 2005 requires federal, state and local governments to withhold 3% from nearly all of their contract, Medicare and farm payments. When it was first enacted, Congress immediately delayed its implementation for five years until the end of 2011. Subsequently, the IRS further delayed payments of the withholding requirement until after January 1, 2013 because implementation would be too difficult.

The original intention of the 3% withholding requirement was to help close the “tax gap”, but it has been pointed out that, while it would place an increased burden on businesses of all types, small businesses working on thin profit margins would be hurt the most by being forced to wait until the end of the tax year to recoup the withholding.

Before the Committee decision, Patricia Thompson, chair of the American Institute of Certified Public Accountants’ Tax Executive Committee, had emphasized that “our CPA members who provide services to state and local governments are hearing that these governmental entities consider the 3% withholding law to be an unfunded mandate, forcing them to incur a costly reprogramming of their accounting and procurement systems during difficult economic times”.

“Moreover, in the absence of repeal,” she added, “the withholding law will likely have a pronounced (but negative) impact on government contractors with low profit margins, potentially threatening their operations due to a tightening of cash flow.”

It has been estimated by the Joint Committee on Taxation (JCT) that the bill to repeal the withholding rule, which was passed through the Committee on a voice vote, would reduce federal revenues by USD11.2bn over the 2011-21 period.

To fund that reduction, the Committee also passed a bill, although this time on only a 23-12 vote, to align the income definition for certain health programmes to reflect more closely how it is measured in other federal means tested programmes, such as public housing assistance.

Sponsored by Representative Diane Black (R - Tennessee), taxpayers would be required to count all of their Social Security benefits, rather than just the portion that is taxable for income tax purposes, as income for determining eligibility under the health care subsidies. The JCT has estimated that such an alignment would save the federal government some USD13bn over ten years.

"This common sense solution would bring Medicaid back into line with other federal assistance programs and ensure the programme is there for those in most need,” Black stated.

However, it is not certain if both bills will be taken together when they are considered by a full session of the House. There could be further Democrat opposition to the proposed health-care changes, but its sponsors hope that the legislation to repeal the 3% contractors withholding can be approved later this month.

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