House-passed law would delay 3 percent withholding

The U.S. House of Representatives has passed a tax bill that would delay a mandate to government buyers to withhold part of their payments to contractors.

Section three of H.R. 3056, "The Tax Collection Responsibility Act of 2007," passed Oct. 10 by House lawmakers would delay the mandate by one year. It had been set to take effect Jan. 1, 2011. The rationale of the mandate, widely opposed by contractors and their advocates, is that it would give the government a way to collect taxes on unreported revenues.

The measure, which was signed into law as part of the Tax Increase Prevention and Reconciliation Act of 2005, galvanized the government contracting community. Led by the U.S. Chamber of Commerce, 75 businesses and groups formed a coalition that urged lawmakers to repeal what industry deemed was a particularly onerous measure.

Sources familiar with the legislation said the delay was granted to allow adequate time for a more complete study of how the measure would impact various types of businesses, grantees and government-aid recipients.

Section three of H.R. 3056 would not only delay implementation but require the secretary of the treasury to submit a report six months after the enactment of the law to the House Ways and Means Committee and the Senate Finance Committee that provides a detailed analysis of its impact.

The study would examine the challenges administering and complying with the withholding mandate, the burdens it would place on governments and businesses and the application of measure to small expenditures for services and goods by government entities.

Businesses both large and small would be hit hard by the provision, according to industry experts.

The Information Technology Association of America, one of the groups opposing the measure, views the mandate as an interest free loan from the contracting community to the government. It would have a profoundly negative impact on small and mid-size companies since the withholding requirement would far exceed their corporate income tax obligations, said Olga Grkavac, executive vice president for the public sector with the Arlington, Va.-based Information Technology Association of America.

"For the larger companies, it would seriously increase the cost of lending and have a very negative effect on their cash flows," she said.

Steve Charles, co-founder and executive vice president of the McLean, Va.-based consulting firm immixGroup Inc., said companies that supply products, rather than services, to the government would be particularly hard hit. Three percent "could be the entire margin between the supplier's cost and what the government pays," he said.

The Tax Increase Prevention and Reconciliation Act of 2005 included the provision requiring all federal, state and local entities to deduct and withhold payments made to any individual or business providing goods or services an amount equal to three percent of the total payment.

Section 511, as it was set forth, was included as a "revenue raiser" and was not in the original version of the bill passed by either chamber of Congress. Senate legislative staff inserted the withholding requirement during conference negotiations in an attempt to generate $7 billion to fund other tax cuts. Opponents of the measure point out that no hearings were held on the measure.

While some industry groups are optimistic that the study will eventually lead to a repeal, others are doubtful. But the battle isn't over yet.

"I certainly hope that the members of industry most dramatically affected will be able to mount an effective communications campaign to inform the study," Charles said.