US Repeals Contractors Tax

by Mike Godfrey, Tax-News.com, Washington

21 November 2011

With the passage of the Senate-amended bill through the House of Representatives on a bipartisan vote, the United States Congress has finally approved legislation to repeal the 3% withholding tax on payments made to contractors providing services to government entities.

The repeal of Section 511 of the Tax Prevention and Reconciliation Act of 2005, which required federal, state and local governments to withhold 3% from nearly all of their contract, Medicare and farm payments, has taken a long time. When it was first enacted, Congress immediately delayed its implementation for five years until the end of 2011, and then the Internal Revenue Service further delayed payments until after January 1, 2013.

The original intention of the 3% withholding requirement was to help close the “tax gap”, but it was 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.

The repeal of the withholding received support from both the Democrat and Republican parties, and from President Barack Obama. The only problems were differences in opinion over the method of funding of the revenue shortfall that would be produced by the repeal.

The Joint Committee on Taxation (JCT) has estimated that it would reduce federal revenues by USD11.2bn in the ten years between 2011 and 2021. Democrats had originally proposed funding by means reductions to corporate tax breaks for the US oil and gas industry, but this was substituted in the Republican-controlled House by provisions aligning 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.

Those provisions will require taxpayers 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 tax credits. The JCT has estimated that such an alignment would save the federal government some USD13bn over ten years.

In the next phase of the repeal bill’s progress through Congress, in order to obtain Democrat support in the Senate where that party holds the majority, and counteract expected opposition to the proposed health care changes, the veterans tax provisions that were part of President Obama’s stalled American Jobs Act were tagged on to the legislation.

There will be a ‘Returning Heroes’ tax credit for veterans to encourage the hiring of unemployed veterans, and a ‘Wounded Warriors’ tax credit for hiring unemployed workers with service-connected disabilities, up to a total of USD9,600 and funded, among other measures, by applying a fee to veterans who apply for a mortgage.

The bill, comprising 3% withholding, health care changes and veterans credits, is being looked on as one of the few recent examples of Congress working on a bipartisan basis. President Barack Obama congratulated “Republicans and Democrats in Congress for coming together to pass these tax credits that will encourage businesses to hire America’s veterans. … This is a good first step, but it is only a step”.

The House Ways and Means Committee Chairman Dave Camp (R - Michigan) said that Congress had “demonstrated that when we work together, we can find bipartisan solutions to laws and regulations that stifle job creation. The permanent repeal of the 3% withholding law gives employers greater certainty that they will have resources to hire and invest in getting America back to work.”

The repeal of the withholding has also attracted support from a wide range of businesses. The US Chamber of Commerce’s executive vice president for Government Affairs, Bruce Josten, stated: “By repealing the 3% tax withholding provision that was scheduled to take effect in 2013, Congress took an important step in lifting a cloud of uncertainty hanging over the business community. With passage of this legislation, many small businesses that operate on tight margins will feel more comfortable making decisions to hire and invest in their companies knowing that the government won’t be allowed to hold 3% of their revenues.”

The Associated General Contractors of America’s chief executive officer, Stephen E. Sanderr, added that “the repeal of the 3% tax withholding mandate will provide a much-needed boost for construction employers across the country. The fact contractors won’t be forced into providing billions in interest-free loans to the federal government beginning in 2013 is welcome news for a hard hit industry and its struggling workers.”

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