3% Tax Witholding on A/E Fees

3% Withholding on Government contracts

The Stimulus Bill has extended the requirement for governmental agencies to withhold 3% of the payments to contractors has been pushed back to 2012.

This “tax compliance” measure may still undergo some changes, delays (or even repeal) but here is what is in the draft regulations currently contain

All governmental entities (which is basically every government except tribal governments) that has more than $100 million in qualified purchases must implement the withholding. Qualifying payments are virtually everything a government buys except for their own payroll and benefits and real property.

All payments in excess of $10,000 must be withheld on. Note that payments are defined as the contact, and not individual payments. A $20,000 contract that is invoiced in 4 monthly invoices of $5,000 would still be a covered purchase, subject to the withholding even though non of the individual payments were in excess of $10,000.

The 3% will be applied at the time of payment, as of the date of payment.

The governmental entity will withhold the 3% unless the receiving party can demonstrate it is a qualified non-profit entity for tax purposes.

The government will report the amounts withheld via an annual 1099 form to persons or firms that the government has applied the 3% withholding to.

Contracts in force prior to the implementation date are not subject to the withholding

Of special interest to A/E firms, this 3% withholding can only be applied to federal income tax payments, and can not be applied to other federal liabilities, such as payroll taxes.

This amount is to be applied to the prime contractor and can not be passed on to subconsultants. Thus if you have a state law, or contractual requirement to “pay when paid, you will need to remit 100% of the money due to the sub (thus creating a gap in your firm’s cash flow)

As a practical matter, this means almost every substantial government entity will have to implement this withholding on A/E contracts. Given the current cost of construction, all it will take is a single capital project to throw even medium size agencies into the high dollar value needed to qualify for this withholding plan. Since virtually all of the government spending except payroll and benefits counts towards the $100 million threshold, we estimate this any agency with a total annual budget in excess of $250 million is likely to qualify.

There are still comments being gathered on this, so we can expect further changes or delays, but you should be aware of this potential impact on your future cash flow.