Brief Summary of Proposed Treasury Regulations

Under Internal Revenue Code § 3402(t)

 

Prepared by Terry A.M. Mumford and Albert J. Lee, Ice Miller LLP, March 23, 2009

 

I.          Background

 

Section 3402(t) of the Internal Revenue Code (Code) was added by section 511 of the Tax Increase Prevention and Reconciliation Act of 2005, Public Law 109-222 (TIPRA).  Section 3402(t)(1) provides that the government of the United States, every state, every political subdivision thereof, and every instrumentality of the foregoing (including multi-state agencies) making any payment to any person providing any property or services (including any payment made in connection with a government voucher or certificate program which functions as a payment for property or services) shall deduct and withhold from such payment a tax in an amount equal to 3 percent of such payment.  On December 5, 2008, the Internal Revenue Service (IRS) published Proposed Regulations (Prop. Reg) §§ 31.3402(t)-0 to 31.3402(t)-7.  Section 1511 of the American Recovery and Reinvestment Act of 2009 delayed the application of Section 3402(t) by one year to payments made after December 31, 2011.  However, the proposed regulations currently reflect the previous effective dates.  See Prop. Reg. § 31.3402(t)-7 for effective dates and transition provisions.

 

II.        Summary

 

            A.        What Governmental Entities Will Be Subject to Code § 3402(t)?

The requirement to withhold applies to "the government of the United States and every state (and the District of Columbia), as well as instrumentalities of the foregoing."  Prop. Reg. § 31.3402(t)-2(a).  However, political subdivisions and instrumentalities are subject to the withholding requirement only if they make at least $100,000,000 in payments for property or services annually (see Prop. Reg. § 31.3402[t]-4[g]).  Indian tribal governments (Prop. Reg. § 31.3402[t]-2[c]) and U.S. possessions or territories (Prop. Reg. § 31.3402[t]-2[f]) are exempt.

 

B.        What Payments Will Be Subject to Withholding?

Generally, each payment of $10,000 or more (see Prop. Reg. § 31.3402[t]-3[b][1]) is subject to 3 percent tax withholding when paid by the governmental entity to any person (including corporations, partnerships, organizations, groups, etc.) for property or services.  See Prop. Reg. § 31.3402(t)-3(a). The withholding is made regardless of whether the payment is attributable to multiple transactions (see Prop. Reg. § 31.3402[t]-3[b][2]) or paid through a payment administrator of the governmental entity (see Prop. Reg. § 31.3402[t]-3[d][1]; but see Prop. Reg. § 31.3402[t]-3[d][2] [regarding contractors]).  Payment by credit card or payment card occurs when the credit card or payment card is tendered at the point of sale, and not when the credit card company is paid.  See Prop. Reg. § 31.3402(t)-3(e).  The payments subject to withholding are treated as payments from an employer to an employee for tax liability and reporting purposes related to wage withholding.  See Prop. Reg. § 31.3402(t)-3(a); Code § 3402(t)(3).

 

C.        What Payments Will Be Excepted from Withholding?

Payments under the following categories are generally excepted from withholding:

·        Payments subject to withholding under Code §§ 3401 through 3405 (other than section 3402[t]), including payments exempt from those sections due to a tax treaty (Prop. Reg. § 31.3402[t]-4[a][1]); 

·        Certain payments under elective withholding, including (i) unemployment compensation, (ii) Social Security benefits, (iii) certain insurance proceeds relating to certain disaster payments; (iv) amounts received as loans from the Commodity Credit Corporation; and (v) any payment of an annuity to an individual (Prop. Reg. § 31.3402[t]-4[a][3]);

·        Payments subject to backup withholding under Code § 3406, if backup withholding is actually being withheld (Prop. Reg. § 31.3402[t]-4[b]);

·        Payments of interest (Prop. Reg. § 31.3402[t]-4[c] [reserved]; Code § 3402[t][2][C]);

·        Payments for real property (purchase and leasing, but not construction) (Prop. Reg. § 31.3402[t]-4[d]);

·        Payments made to government entities (except for political subdivisions or instrumentalities under the small entity exception), tax-exempt organizations, and foreign governments are exempt (Prop. Reg. § 31.3402[t]-4[e]);

·        Payments under certain classified or confidential federal contracts are exempt (Prop. Reg. § 31.3402[t]-4[f]);

·        Payments subject to the small entity exception from political subdivisions or instrumentalities thereof making less than $100,000,000 of payments for property or services annually (Prop. Reg. § 31.3402[t]-4[g]);

·        Need-based or income-based public assistance or public welfare payments (Prop. Reg. § 31.3402[t]-4[h]);

·        Payments to governmental employees related to government service, including deferred compensation plan and employee benefit plan contributions on behalf of the employee; fringe benefits; and payments under accountable plans for individual travel expenses (including payments by the employee to travel, meal, or lodging providers in the course of governmental travel) (Prop. Reg. § 31.3402[t]-4[i]);

·        Payments received by a nonresident alien individual or foreign corporation (foreign person) for providing services or property if the payments are derived from sources outside the United States and are not effectively connected with the conduct of a trade or business within the United States by the foreign person (Prop. Reg. § 31.3402[t]-4[j]);

·        Payments to an Indian tribal government or its political subdivisions (Prop. Reg. § 31.3402[t]-4[k]);

·        Payments made in an emergency or disaster situation if the Secretary determines that withholding from the payments would impede a government entity's efforts to respond to the emergency or disaster (Prop. Reg. § 31.3402[t]-4[l]);

·        Payments from pass-through entities (i.e., partnerships or S corporations), except if at least 80 percent of the aggregate ownership of the entity is held, directly or indirectly, by government entities (Prop. Reg. § 31.3402[t]-5[c]); and

·        Payments to pass-through entities, except if at least 80 percent of the aggregate ownership of the entity is held, directly or indirectly, by government entities (Prop. Reg. § 31.3402[t]-5[d]).

 

This publication is intended for general information purposes only and does not and is not intended to constitute legal advice.  The reader must consult with legal counsel to determine how laws or decisions discussed herein apply to the reader's specific circumstances.