AICPA Urges Repeal of 3 Percent Withholding on Payments to Small Business Government Contractors

May 26, 2011

Congress should repeal a 3 percent tax withholding rule facing government contractors and individuals such as farmers and medical professionals, Patricia Thompson, chair of the Tax Executive Committee of the American Institute of Certified Public Accountants, said in Congressional testimony today. The provision would subject the contractors to 3 percent withholding on payments they receive for goods and services provided to federal, state and local governments.


“The AICPA strongly urges Congress to repeal the 3 percent withholding on payments made to government contractors, and for Medicare, farm and certain other payments,” Thompson said in testimony submitted to the House Small Business Subcommittee on Contracting and Workforce for the hearing record.  The subcommittee’s hearing examined the need to repeal the provision.


Thompson said AICPA members are reporting that state and local governments are concerned about the cost to reprogram their systems to comply with the law and that their clients are concerned about the law’s potential impact on cash flow.


Thompson noted that Congress delayed the effective date of the provision in 2009 from Jan. 1, 2011 to Jan. 1, 2012.  The Internal Revenue Service issued final regulations on May 9 that included a further one-year delay in the effective date until Jan. 1, 2013.  The 3 percent withholding provision was approved by Congress as part of the Tax Prevention and Reconciliation Act of 2005.


“Without compelling evidence of non-compliance by these persons and business entities in terms of non-payment of their federal tax liabilities, the additional burden may not be necessary,” Thompson said.  The IRS already has a number of tools it uses to thwart nonpayment of federal taxes by government contractors and granting of contracts to businesses that have unpaid federal taxes.


A copy of the testimony is below.


For more information or to talk with someone about this issue, please contact Shirley Twillman, AICPA senior manager of media relations, at 202.434.9220 or by e-mail at

Good morning Chairman Mick Mulvaney, Ranking Member Judy Chu, and the Members of the Subcommittee.  My name is Patricia A. Thompson.  I am a CPA and am submitting this statement as Chair of the American Institute of Certified Public Accountants ("AICPA") Tax Executive Committee.  I am the tax partner with Piccerelli, Gilstein & Company, LLP, Providence, Rhode Island; and my clients include many closely held businesses in the manufacturing, service and real estate industries.  The AIPCA thanks this Subcommittee for the opportunity to submit this written statement today for the hearing on the need to repeal section 3402(t) of the Internal Revenue Code, requiring federal, state and local governments generally to withhold 3 percent on certain payments. 


The AICPA strongly urges Congress to repeal the 3 percent withholding on payments made to government contractors, and for Medicare, farm, and certain other payments.  The original effective date for the provision was set for January 1, 2011, but was delayed until January 1, 2012 as a result of the 2009 signing into law of the American Recovery and Reinvestment Act.  On May 9, 2011, the Internal Revenue Service issued the final regulations on 3 percent withholding which included a further one-year delay in the effective date until January 1, 2013. 


While we welcome the IRS’s action to further delay the provision’s effective date, we continue to urge Congress to repeal the 3 percent withholding law because compliance will likely remain extremely burdensome for state and local governments, government contractors, medical service providers, farmers, and others concerned.  Without compelling evidence of non-compliance by these persons and business entities in terms of non-payment of their federal tax liabilities, the additional burden may not be necessary.  In fact, the IRS already has a number of tools in place to address taxpayers with federal tax liabilities without the need for governments to resort to 3 percent withholding on payments.  Some of these tools include (among others): (1) the Federal Awardee Performance and Integrity Information System, involving a federal (legal and tax compliance) database that government employees and grant officials are required to review before awarding a federal prime contract; and (2) tax compliance certifications, requiring government contractors to certify that the offeror and its principals have no delinquent federal taxes with a delinquency grounds for suspension and disbarment.


Our CPA members who provide services to state and local governments are hearing that these governmental entities consider the 3 percent withholding law to be an unfunded mandate, causing significant challenges for governmental accounting and procurement systems.  Similarly, state and local governments are also informing our members that this need to reprogram systems (to comply with the law) will likely prove a costly task, particularly during a period of budgetary imbalances and difficult economic times.


We also support repeal of 3 percent withholding because of the potentially harmful impact that the law will have on businesses engaged in government contracting.  For example, should a company have 3 percent withholding imposed on the services it provides as a government prime contractor, the company might find it extremely difficult to adjust subcontractor arrangements to pass the timing and cost of withholding on to the subcontractors.  This issue alone represents the potential for notable impact on contractor cash flows and financing and administrative costs.  The impact of the withholding law could be even more pronounced for a government contractor with low profit margins, potentially threatening their operations through a tightening of its cash flow.


Our members have also heard from clients that the withholding law will likely have a negative impact from a Medicare payment perspective.  Over the last decade the operating costs of medical service professionals, such as physicians, nurses, medical support staff, and administrators, have increased significantly while Medicare payments have only been increasing slightly in excess of 1 percent per year on average.  With the additional prospects of further tightening in Medicare payments to medical providers in the coming years, the 3 percent withholding law may only exacerbate the cash flow problems facing medical professionals.  We emphasize this point, particularly since we are not aware of any data suggesting that medical professionals (in general) are a compliance risk with respect to their payment of federal income taxes, considered the fundamental reason for imposing a withholding regime.


The 3 percent withholding law will notably alter the cash support accorded to efforts of American farmers.  Farmers will be subject to 3 percent withholding because they receive certain payments through the U.S. Department of Agriculture.  Under Internal Revenue Code section 6654(i), acknowledging the importance of cash employed in targeted activities, individual farmers and individual fishermen are required only to make one estimated tax payment as opposed to quarterly estimated payments; and such individuals are not required to make that one estimated payment until January of the following year.  Also, that individual is not required to make an estimated payment if the taxpayer files his or her return by March 1.  Imposition of 3 percent withholding on such farmers and fishermen will result in an acceleration of the tax payments to the government, something that would be in contradiction to the underlying policy reasons for enactment of section 6654(i).  For the remaining taxpayers contracting with the government, the 3% withholding will unnecessarily complicate calculations of their estimated tax obligations.


In conclusion, the AICPA commends the subcommittee for holding today’s hearing on the 3 percent withholding provision.  We welcome the opportunity to discuss our views with your informally or at any future public hearing.


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The AICPA (, founded in 1887, is the national professional organization of certified public accountants comprised of approximately 370,000 members in 128 countries.  Our members advise clients on federal, state, and international tax matters and prepare income and other tax returns for millions of Americans.  They provide services to individuals, tax-exempt organizations, small and medium-sized businesses, as well as America’s largest businesses.