Don't celebrate withholding tax repeal just yet

Congress and the president ended the system of withholding 3 percent of payments to contractors in 2011, but one expert says something else may take its place this year.

President Barack Obama signed the 3% Withholding Repeal and Job Creation Act into law Nov. 21, after it moved through Congress with ease. The legislation amended the tax law to cancel the withholding requirement on payments due to vendors providing goods and services to federal, state, and local government agencies.

The withholding system may be gone, but David Gallacher, associate at the Sheppard Mullin law firm, wrote in a Jan. 11 blog post that government and industry should watch for something just as “dysfunctional” that could take its place.

The bill requires the Treasury Department and the Office of Management and Budget to study ways to reduce the amount of federal taxes owed but not paid by contractors. For the study, officials must figure an estimated amount of delinquent taxes and whether having companies certify in bid proposals that their taxes are up to date has helped in compliance. Officials also will have to delve into various aspects of contracts awarded to tax-delinquent companies. The study doesn't apply to grantees.

The study is due this coming November.

Larry Allen, president of the Allen Federal Business Partners, said the possibility is real. The question is whether there's a way for the government to recover tax money before paying contractors, or only after.

"Clearly, both federal agencies and industry believed that a pre-payment withholding program was unworkable and more expensive than it was worth," he said.

As officials look for other possible options, Allen said there's no need or reason to make everyone pay because of a few problem contractors.

"Today we have smart munitions that can take out a mailbox while leaving everything else intact. Can't we do the same here?" he said.

The government is in a budget crunch and is seeking pools of resources to fund its operations. Under such scrutiny and in need, Gallacher predicts Congress will come up with other ways to get more money from contractors. He warned of broad approaches to get at delinquent tax dollars.

“Do not be surprised if Treasury identifies a number of solutions that are as overly broad and dysfunctional as the 3-percent withhold,” he wrote.

Congress passed the legislation by overwhelming majorities in both chambers, after hundreds of industry groups had attempted to change minds for five years.

But the lawmakers have not really adjusted their stance, Gallacher warned.

“Congress’ change of heart on the withholding issue in 2011 should give industry absolutely no assurances that Congress cannot (or will not) again be persuaded by equally bad ideas based on unrealistically rosy revenue projections,” he wrote.