House Approves Repeal of Tax Withholding on Government Contracts

Senate can permanently halt rule diverting 3 percent of invoice payments to IRS.

It may not sound like much, but for a small business, 3 percent on an invoice can mean the difference between making payroll or not. It can be the cash you need to pay a vendor or make a loan payment. For a small business, 3 percent can be the proverbial straw that breaks the camel’s back.

The 3 percent we’re talking about is the amount the IRS would withhold from payments on government contracts beginning in 2013. For example, on an invoice of $100,000, the government would pay the business $97,000 rather than the full amount, with the rest diverted to the IRS to cover the company’s tax liability.

The U.S. House last week provided some encouragement to opponents of the requirement, however, when it voted 405-16 vote to repeal the rule. The repeal measure now heads to the Senate for consideration.

The 3% Withholding Tax was part of the Tax Reconciliation Act of 2005 and was originally scheduled to be implemented Jan. 1, 2011. That date was pushed back a year by the 2009 economic stimulus law, and the IRS announced this summer that it would delay implementation until 2013.

“Compliance with this withholding tax will impose significant financial burdens on both the public and private sectors, adversely affecting job creation and economic growth at a time when we can least afford it,” said Rep. Sam Graves (MO-R), chair of the House Small Business Committee, in a statement. “It will also further limit the cash flow of small companies that operate with thin margins in a difficult economy. Startups and small firms with a high volume of government contracts will be particularly disadvantaged.”

The withholding mandate is intended to fight tax evasion by companies selling to government entities. A 2004 Government Accountability Office report found that more than 27,000 defense contractors owed about $3 billion in unpaid taxes. The 3 percent withholding mandate would help the IRS close that gap and raise an estimated $7 billion by 2015. The provision applies to Medicare payments to medical professionals and farm payments, as well as sales of other goods and services to governments by businesses of all sizes.

The U.S. Chamber of Commerce has said the 3 percent withholding would reduce capital that small businesses need for day-to-day operations, and companies would need to develop new internal accounting systems to track, handle, and reconcile these payments. The additional personnel and system costs will increase bids rates on government projects in order for businesses to maintain profit margins, the Chamber said.

The amount withheld also could exceed a company’s actual tax liability, according to the Chamber.

“The 3% Withholding Tax essentially provides the federal government with an interest-free loan and will especially have a negative impact on small businesses as resources are shifted to handle the administrative burden on tracking and reconciling transactions as well as securing capital for day-to-day operations, job creation and business expansion,” the Chamber said in a statement posted on a website it set up to oppose the mandate.

A coalition of more than 125 organizations is lobbying against the withholding requirement. In its statement to the House subcommittee earlier this summer, the coalition said the mandate is already causing problems despite the fact that implementation has been delayed. Because government contracts often cover five years or longer, companies entering into long-term contracts must be aware of the change now and consider additional administrative and financing costs of the 3 percent withholding in future years.

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About Smart Companies Thinking Bigger®

Kelly Scanlon is the owner and publisher of Thinking Bigger Business Media. She recently finished a term on the national board of directors of the National Association of Women Business Owners, and was the national chair from 2010-2011. An advocate for small business owners, Kelly sits on numerous boards and committees to advocate on behalf of small business owners. She has won several awards for her advocacy. Among them are the 2011 United Nations NGO Positive Peace Award on behalf of Kansas City area small business owners, the U.S. Small Business Administration's Region VII Women's Business Champion of the Year in 2009, and the Women in Business Advocate of the Year from the State of Kansas in 2006. In 2002, she won the SBA's Region VII Small Business Journalist of the Year Award (Missouri, Iowa, Nebraska, Kansas). Whatever your business stage—aspiring, startup, established, mature—Thinking Bigger Business Media has the resources you need to grow to the next level. We are a resource organization dedicated to providing the strategic, "how-to" information small business owners need to become more productive and more profitable. We also provide information that helps owners connect with resources within the business community that can help them grow. We deliver that information through a variety of media products and other channels easily accessible to business owners.
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