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Final Regulations Issued on TIPRA
Withholding and Reporting Requirements
The
Treasury Department and the Internal Revenue Service (IRS) have
issued final
regulations regarding the withholding and reporting requirements
under Section 3402(t) of the Internal Revenue Code (Code) . Code
Section 3402(t) was added by the Tax Increase Prevention and
Reconciliation Act of 2005 (TIPRA) to provide that the United States
government, every state and political subdivision thereof, and every
instrumentality of the foregoing making any payment to a person
providing property or services must deduct and withhold from such
payment a tax equal to three percent (3 %) of the payment.
Background
Proposed
regulations were published in 2008 and originally provided that Code
Section 3402(t) applied to payments made after December 31, 2010.
Once the American Recovery and Reinvestment Act of 2009 was enacted,
however, the effective date was extended so that the withholding
requirements applied only to payments made after December 31, 2011.
Most recently, the IRS provided interim guidance in Notice 2010-91 on
the application of the Code Section 3402(t) withholding requirements
to payments made by payment cards (such as credit, debit, and gift
cards), and further extended the effective date only for such
payment card transactions. The Notice provided that the requirements
of Code Section 3402(t) would not apply to any payment made by
payment card for any calendar year beginning earlier than at least 18
months from the date the Treasury Department and the IRS issued
future guidance. Read our summary of Notice 2010-91 here.
Final Regulation - Effective Date Extended
The final
regulations adopt the proposed regulations with a number of
amendments and clarifications. One significant change is that the
effective date has been extended again for an additional year so that
the Code Section 3402(t) withholding and reporting requirements now
apply to payments made after December 31, 2012, subject to an
exception for payments made under contracts existing on December 31,
2012 that are not materially modified. This means payments made under
written contracts in effect on December 31, 2012 are not subject
to 3402(t) withholding, but payments made after December 31, 2012,
under contracts entered into after December 31, 2012, are
subject to 3402(t) withholding unless otherwise excepted.
Additionally, if an existing contract is materially modified (i.e.,
the contract is changed such that it materially affects either the
payment terms of the contract or the services or property to be
provided under the contract) after December 31, 2012, payments under
the contract become subject to 3402(t) withholding.
Proposed Regulation for Contract Modifications
It is also
important to note that, in response to commenters' suggestions that
the material modification rule described in the preceding paragraph
be removed, the IRS and the Treasury Department have issued new
proposed regulations concurrently with these final regulations which
provide that the exemption from the 3402(t) withholding rules for
payments made under existing contracts will not apply to payments
made on or after January 1, 2014. In other words, under the new
proposed regulations, payments made on or after January 1, 2014 under
all existing and new contracts would be subject to the 3402(t)
withholding requirements unless another exception applies. You can
view the new proposed regulations here.
Payment Card Transactions - Further Extension
Consistent
with Notice 2010-91, the Treasury Department and the IRS continue to
consider for future guidance the issue of 3402(t) withholding on
payment card transactions. In any event, as noted above, the rules
under Code Section 3402(t) could not apply until a calendar year at
least 18 months after additional guidance is issued.
Key Guidance in Final Regulations
- Under TIPRA,
several types of payments are exempt from the 3402(t)
withholding rules, including payments made by a state or local
government if that entity makes annual payments of less than
$100 million.
The
final regulations provide an optional rule with respect to the $100
million exception that will help certain state or local governments
that have annual payments near the $100 million threshold without
reaching that limit or that experience an occasional year of
unusually high expenses. Generally, eligibility for the $100 million
exception for each year is determined based on payments the
government entity made during the accounting year ending with or
within the second preceding calendar year. Under the optional rule,
an entity may average the payments made during any four of the five
consecutive accounting years ending with the accounting year that
ends with or within the second preceding calendar year.
The
entity may use its discretion in applying the optional rule and it is
not required to file a form or notify the IRS that the optional rule
is being applied. Additionally, the entity should decide before the
beginning of the calendar year whether to use the optional rule,
because if the entity withholds payments in any calendar year for
which it does not qualify for the $100 million exception, but could
have qualified for the optional rule, it will be deemed to have
waived the right to use the optional rule for that year.
- Other payments
that are exempt from 3402(t) withholding under the final
regulations include payments for wages, retirement benefits, and
retirement plan contributions, as well as payments made to the
following: other government entities required to withhold,
foreign governments, tax-exempt organizations, Indian Tribal
governments, beneficiaries or the estates of deceased employees,
all grants, and loan guarantees.
- The final
regulations provide that a payment is subject to withholding if
it is $10,000 or more. Consistent with the 2008 proposed
regulations, the $10,000 threshold applies on a
payment-by-payment basis and multiple payments by a government
entity generally will not be aggregated in applying the $10,000
limit. However, anti-abuse rules provide that, if a payment is
divided into multiple payments to avoid withholding, the
payments will be treated as a single payment.
- The final
regulations adopt provisions consistent with the 2008 proposed
regulations regarding payments by government entities to prime
contractors and subsequent transfers of payments by prime
contractors to separate subcontractors. Under these provisions,
3402(t) withholding applies only to payments a government entity
makes to the prime contractor, and not to payments a prime
contractor makes to a subcontractor.
- The same
reporting and payment rules set forth in the 2008 proposed
regulations have been adopted in the final regulations. The
entity required to withhold must report the amounts withheld on
Form 945, "Annual Return of Withheld Federal Income
Tax," in the same manner as other non-payroll withheld
amounts, and must file information returns and furnish payee
statements on Form 1099-MISC, "Miscellaneous Income,"
to report such payments and the tax withheld.
- In response to
commenters' requests, the final regulations clarify the
procedures for correcting overwithholding and underwithholding
and the rules for adjustments of overpayments or underpayments
of income tax withholding.
- The transition
rule described under the 2008 proposed regulations regarding
payments made for property and services before January 1, 2014
still applies under the final regulations. Under this rule, a
government entity will not be liable for interest and penalties
for failing to withhold on payments for property or services
made before January 1, 2014 if the entity made a good faith
effort to comply with Code Section 3042(t).
For more
information regarding the final regulations under Code Section
3402(t) and how it may impact your government entity, please contact Mary Beth Braitman, Terry A.M. Mumford, Lisa E. Harrison or the Ice Miller Employee Benefits
attorney with whom you work.
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