REPEALED!  The President signed the law to repeal it on November 21, 2011.


A three percent withholding provision was imposed by the Tax Increase Prevention and Reconciliation Act of 2005. It imposed a requirement on Federal, state, and local governments to withhold taxes from government contractors beginning in 2011.

On February 17, 2009, President Obama signed into law the American Recovery and Reinvestment Act as Public Law 111-5. The law delayed the effective date of the withholding requirement by one year to 2012.

The Internal Revenue Service has just announced it is delaying implementation until 2013. Withholding and reporting requirements will apply to payments made after December 31, 2012. In addition, payments made under contracts existing on December 31, 2012, that are not materially modified, will be exempt until January 1, 2014.

The House bill  to repeal the requirement is H.R.674, introduced by Representative Wally Herger (R-CA). There are two Senate bills, S.89, introduced by Senator David Vitter (R-LA), and S.164, introduced by Senator Scott Brown (R-MA).


 The law applies to certain Federal, state, and local government payments made after December 31, 2011* and it basically imposes a flat rate of 3 percent withholding on all payments.

Payments subject to withholding under the provision include any payment made in connection with a government voucher or certificate program which functions as a payment for property or services (for example, payments to a commodity producer under a government commodity support program).

The provision does not apply to any of the following payments: 

  • Payments made through a Federal, state, or local government public assistance or public welfare program for which eligibility is determined by a needs or income test.
  • Wages or any other payment with respect to which mandatory or voluntary withholding applies under present law. (The provision does not exclude payments that are potentially subject to backup withholding under section 3406.  If, however, payments are actually being withheld under backup withholding, withholding under the new provision does not apply.)
  • Payments of interest.
  • Payments for real property.
  • Payments to tax-exempt entities or foreign governments.
  • Intra-governmental payments.
  • Payments made pursuant to a classified or confidential contract (as defined in section 6050M(e)(3)).
  • Payments to government employees that is not otherwise excludable from the new withholding provision with respect to the employees’ services as employees.

Political subdivisions of States (or any instrumentality thereof) with less than $100 million of annual expenditures for property or services that would otherwise be subject to withholding under this provision are exempt from the withholding requirement. 

*Now delayed until January 1, 2013 or later depending on the contract.


According to Senator Charles Grassley (R-IA), “Everybody has a duty to pay their fair share of taxes owed.  Those who are paid by the government should be held to a high degree of responsibility to pay taxes that are legally due. Failure to effectively enforce the tax laws against government contractors encourages noncompliance among other contractors.  Over time, the failure by government contractors to pay their tax debts could erode taxpayers’ confidence in the fairness of the nation’s tax system, leading to increased rates of noncompliance with the nation’s tax laws.”

In the 2004 Annual Report to Congress, the National Taxpayer Advocate stated that Federal contractor noncompliance is among the most serious problems facing taxpayers because it contributes to the growing Federal tax gap and thus forces law-abiding taxpayers to subsidize these contract awards by making up for the resulting revenue shortfall.  This noncompliance also places law-abiding contractors at an unfair competitive disadvantage because nonpaying contractors can use their “tax savings” to underbid compliant ones. The report notes that there is an inherent unfairness when those who “reap the benefits of Federal contracts” refuse to fulfill their Federal tax obligations.

According to the General Accounting Office (GAO), over 3,800 Government Service Administrator (GSA) contractors, or about 10 percent of all GSA contractors, had tax debts totaling about $1.4 billion as of June 30, 2005.  This follows on top of testimony to the same Subcommittee, provided less than one year before, that found that about 33,000 civilian agency contractors owed over $3 billion in unpaid Federal taxes as of September 30, 2004.  Also, GAO noted in a February 2004 report that over 27,000 Department of Defense contractors owed about $3 billion in unpaid taxes as of September 30, 2002.


The Government Withholding Relief Coalition is leading the effort to repeal the provision.  The coalition has noted these concerns:

  • Significant increases in private-sector administrative costs.  The administrative costs to companies – as well as governments – to comply with this withholding requirement will be substantial.  Companies’ internal systems are not set up to track the amounts withheld from invoice payments.  This will significantly complicate the estimating of tax liabilities on quarterly tax payments.  For companies receiving thousands of government payments per year, this will be administratively time consuming and costly.
  • Adverse effects on cash flows of companies. Compliance with Section 511 will reduce cash assets that are used to pay company employees and other day-to-day expenses. Start-up firms and some industries will be severely impacted by this reduction in cash receipts.  For instance, in many construction projects profits are not realized until the end of a multi-year contract.  Despite this, contractors will have had 3 percent withheld throughout the life of the contract.
  • Unfairly burdens honest taxpayers.  More efforts should be focused on identifying and prosecuting, if appropriate, the actual tax cheats rather than adding to the administrative burden placed on honest businesses.  This proposal treats tax-compliant businesses the same as those illegally avoiding the payment of their tax obligations.  The extra cost to implement the provision will, in our opinion, far exceed the additional tax gap revenues the Joint Committee on Taxation estimates it will raise.


 Perhaps Congress has learned its lesson that the tax gap closer initiatives may have sounded good in theory, but in the real world, they made no sense.



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