[Federal Register Volume 76, Number 89 (Monday, May 9, 2011)]
[Rules and Regulations]
[Pages 26583-26603]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2011-10760]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 31
[TD 9524]
RIN 1545-BG45
Extension of Withholding to Certain Payments Made by Government
Entities
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final regulations.
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SUMMARY: This document contains final regulations relating to
withholding by government entities. These regulations reflect changes
in the law made by the Tax Increase Prevention and Reconciliation Act
of 2005 that require Federal, State, and local government entities to
withhold income tax when making payments to persons providing property
or services. These regulations affect Federal, State, and local
government entities that will be required to withhold and report tax
from payments to persons providing property or services and also affect
the persons receiving payments for property or services from the
government entities.
DATES: Effective Date: These regulations are effective on May 9, 2011.
Applicability Date: For dates of applicability, see Sec. Sec.
31.3402(t)-1(d), 31.3402(t)-2(i), 31.3402(t)-3(g), 31.3402(t)-4(u),
31.3402(t)-5(e), 31.3402(t)-6(d), 31.3402(t)-7(b), 31.3406(g)-2(i),
31.6011(a)-4(d), 31.6051-5(g), 31.6071(a)-1(g), 31.6302-1(n), and
31.6302-4(e).
FOR FURTHER INFORMATION CONTACT: A.G. Kelley, (202) 622-6040 (not a
toll-free number).
SUPPLEMENTARY INFORMATION:
Background
This document contains amendments to 26 CFR part 31 under section
3402(t) of the Internal Revenue Code (Code). This document also
contains amendments to 26 CFR part 31 under sections 3406, 6011, 6051,
6071, and 6302 of the Code.
Section 3402(t) of the Code was added by section 511 of the Tax
Increase Prevention and Reconciliation Act of 2005, Public Law 109-222
(TIPRA), 120 Stat. 345, which was enacted into law on May 17, 2006.
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. Section 3402(t)(2) provides
exceptions to withholding under section 3402(t).
Proposed regulations under sections 3402(t), 3406, 6011, 6051,
6071, and 6302 of the Code were published in the Federal Register on
December 5, 2008 (REG-158747-06, 73 FR 74082, 2009-4 IRB 362).
After the issuance of the proposed regulations, section 1511 of the
American Recovery and Reinvestment Act of 2009, Public Law 111-5
(ARRA), 123 Stat. 115, 355, extended the effective date of section
3402(t) withholding to payments made after December 31, 2011.
Notice 2010-91, 2010-52 IRB 915, provided interim guidance on the
application of section 3402(t) to payments by debit cards, credit
cards, stored value cards, and other payment cards.
Written comments were received in response to the proposed
regulations, and a public hearing was held on April 16, 2009. All
comments are available at http://www.regulations.gov or upon request.
After consideration of all the comments, the proposed regulations are
adopted as amended by this Treasury decision.
Summary of Comments and Explanation of Provisions
The Treasury Department and the IRS received numerous comments in
response to the proposed regulations, all of which were considered in
formulating the final regulations. Commenters generally expressed
concerns about the administrative burdens of compliance and the revenue
effect on persons subject to section 3402(t) withholding. The final
regulations are intended to balance the legislative intent to construct
a withholding and reporting regime for payments by government entities
for property and services (other than those specifically excepted under
section 3402(t)(2)) with the goal of alleviating administrative burdens
on both
[[Page 26584]]
government entities required to withhold and persons receiving payments
subject to withholding where appropriate.
As discussed in section IX of the preamble, these final regulations
provide an additional one-year extension from the revised statutory
effective date of payments made after December 31, 2011. Thus, under
the final regulations, section 3402(t) withholding and reporting
requirements 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 (but see section IX of this
preamble for discussion of accompanying proposed regulations that would
apply section 3402(t) withholding and reporting requirements to
payments made under all contracts after December 31, 2013, regardless
of whether the contract was existing on December 31, 2012, and had not
been materially modified).
I. Government Entities Subject to Section 3402(t)
A. Exception for Political Subdivisions and Instrumentalities Making
Total Payments Under $100,000,000 (Section 3402(t)(2)(G))
Section 3402(t)(2)(G) provides that section 3402(t) withholding
does not apply to payments by a political subdivision of a State (or
any instrumentality of that political subdivision) that makes less than
$100,000,000 of payments for property or services annually (other than
for payroll or of another type exempt from withholding under the
regulations). Consistent with the proposed regulations, the final
regulations provide as a general rule that eligibility for the
exception for each calendar year is determined based on payments made
during the accounting year ending with or within the second preceding
calendar year. All payments for property and services during that
accounting year, including payments that are less than the $10,000
payment threshold, must be considered except payments qualifying for
any of the exceptions under Sec. 31.3402(t)-4(a) through (q) of the
final regulations (for example, payments to the employees of the
government entity that are subject to income tax withholding and thus
excludable under Sec. 31.3402(t)-4(a) (such as salary payments) and
payments to employees of the government entity with respect to their
services as an employee that are excludable under Sec. 31.3402(t)-4(i)
(such as payments of nontaxable fringe benefits)).
Commenters stated that if the political subdivision's or
instrumentality's yearly payments generally are near $100,000,000, but
do not always equal or exceed $100,000,000, the entity could incur
considerable expense and difficulty administering withholding in some
years but not in others. In addition, providing for withholding in
contracts would be problematic and uncertain. Other commenters noted
that due to substantial unusual capital spending, a political
subdivision or instrumentality could exceed the $100,000,000 threshold
in one year, even though the entity usually makes annual total payments
well below the threshold. The burden of applying section 3402(t)
withholding for a single year because of one year of unusual spending
could be considerable.
In response to these comments, the final regulations provide an
optional rule under which a political subdivision or instrumentality
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. An entity applying this
optional rule must keep adequate records for each of the five years for
the period of limitations for assessment applicable to the calendar
year for which it claimed the exception. This rule is intended to
provide a reasonable alternative method of determining expenditures for
a political subdivision or instrumentality with an unusually high year
of expenditures.
This optional rule will give greater predictability for future
years and will allow political subdivisions and their instrumentalities
to moderate the effect of unusual years of expenditures. The entity may
apply the optional rule at its discretion for any given taxable year
and is not required to file a form or otherwise indicate to the IRS
that it is using the optional rule. Additionally, under the final
regulations, if a political subdivision or instrumentality withholds
under section 3402(t), pays (or deposits) the withheld tax, and reports
this withholding on payments in any calendar year for which it does not
qualify for the section 3402(t)(2)(G) exception under the general rule,
but could have qualified under the optional rule, it will be deemed to
have waived any right to use the optional rule for that year. Thus, an
affected entity should decide before the beginning of the calendar year
whether it will rely on the optional rule for that year.
One commenter requested a similar exception for Federal Government
entities and State entities with total annual payments of less than
$100,000,000. By its terms, section 3402(t)(2)(G) does not apply to the
United States Government, States, or instrumentalities of the United
States Government or States. Therefore, this comment was not adopted.
B. Determining Whether an Organization Is an Instrumentality
The proposed regulations requested comments on how to determine
whether an organization is an instrumentality of a government entity.
Commenters did not request a definition. The final regulations do not
define the term instrumentality, but reserve the issue for future
guidance. See Sec. 31.3402(t)-2(e). Although the Code contains
multiple references to government instrumentalities, neither the Code
nor the regulations define the term instrumentality. Several revenue
rulings provide guidance on determining whether an organization will be
treated as an instrumentality of a government entity for purposes of
other Code provisions. See Rev. Rul. 57-128, 1957-1 CB 311 (adopting a
six-factor test for use in determining what is an instrumentality of a
State or a political subdivision thereof for purposes of an exception
from the requirement to pay tax under the Federal Insurance
Contributions Act (FICA)); Rev. Rul. 65-26, 1965-1 CB 444; Rev. Rul.
65-196, 1965-2 CB 388; and Rev. Rul. 69-453, 1969-2 CB 182. These
rulings may be applied by analogy to determine whether an entity is an
instrumentality for purposes of section 3402(t) withholding until final
guidance is issued defining the term instrumentality for purposes of
section 3402(t). See Sec. 601.601(d)(2)(ii)(b).
II. Payments Subject to Section 3402(t) Withholding
A. Payments by Credit Card or Other Payment Card
The final regulations reserve for future guidance the issue of the
potential application of section 3402(t) withholding to payment card
transactions (including payments by credit, debit, stored value, and
other payment cards). See Notice 2010-91 and Sec. 31.3402(t)-3(e). The
Treasury Department and the IRS continue to study whether payments by
payment card should be subject to section 3402(t) withholding and, if
so, in what manner the withholding should apply. As provided in Notice
2010-91, the section 3402(t) withholding requirements and the related
reporting requirements will not apply to any payment made by payment
card for any calendar year beginning earlier than at least 18
[[Page 26585]]
months from the date further guidance is finalized applying section
3402(t) withholding to payments by payment card. This relief does not
apply to convenience checks issued in connection with payment card
accounts.
B. The $10,000 Payment Threshold
Consistent with the proposed regulations, the final regulations
provide that a payment subject to withholding arises when the
government entity or its payment administrator pays a person for
providing property or services. The final regulations adopt the rule in
the proposed regulations that withholding will not apply to any payment
that is less than $10,000 (subject to the anti-abuse rule described in
section II.B.3 of this preamble).
1. Amount of Payment Threshold
Commenters generally approved of the concept of a threshold, and
many commenters approved of the proposed $10,000 threshold level.
However, numerous commenters requested that the threshold be raised,
and some commenters requested that the threshold be adjusted each year
based on changes in the cost of living.
The final regulations adopt the payment threshold of $10,000, which
corresponds to a minimum withholding of $300. This $10,000 threshold
level strikes a reasonable balance between alleviating administrative
burdens and preserving the legislative intent that the withholding
requirement apply broadly. The final regulations do not adopt an annual
cost-of-living adjustment to the threshold. Computer processing and
transaction systems are becoming increasingly cost-effective so that
increasing the threshold annually is not warranted.
2. Application of the Payment Threshold to Individual Payments
Some commenters requested that the payment threshold apply
cumulatively rather than to individual payments. Under this suggestion,
section 3402(t) withholding would begin to apply when the payee
receives payments totaling $10,000 in the aggregate from the government
entity during the calendar year, and then apply to all subsequent
payments to the payee during the remainder of the year. The final
regulations do not adopt this suggestion. As other commenters noted,
one section or division of a government entity may not be able to
coordinate its billing with another section's or division's billing on
a real-time basis. Thus, a requirement to withhold immediately upon
reaching an annual minimum payment threshold would require the
establishment of new systems to track and coordinate payments.
3. Application of the Payment Threshold to Multiple Payments to the
Same Recipient
The $10,000 threshold applies on a payment-by-payment basis;
therefore, if a government entity makes a single payment of $10,000 or
more for multiple items of property or services, the entity must
withhold on the payment. For example, if a person bills a government
entity $5,000 each day for seven days of daily services, but the entity
pays the bills by making one $35,000 payment, the payment threshold is
applied to the $35,000 payment.
Consistent with the proposed regulations, the final regulations
provide that multiple payments by a government entity to a payee
generally will not be aggregated in applying the $10,000 threshold. The
final regulations also adopt the anti-abuse rule in the proposed
regulations providing that if a payment is divided into multiple
payments primarily to avoid the payment threshold, the payments will be
treated as a single payment made on the date of the first payment for
purposes of applying the threshold. For example, if a government entity
is scheduled to make a contractual payment for landscaping services of
$15,000 on July 2, 2013, but divides the payment into payments of
$7,000 and $8,000 on July 1, 2013, and July 2, 2013, respectively, to
avoid withholding, the government entity will be treated as having made
a single payment of $15,000 on July 1, 2013. This anti-abuse rule will
not apply if the primary reason for making multiple payments is
unrelated to section 3402(t).
Some commenters expressed concerns about the anti-abuse rule. Some
argued that it was too subjective and would lead to conflicts between
government entities and payees. Commenters noted that in many cases,
the payee controls the billing and the government entity cannot
determine whether the payee manipulated the billing to avoid the
threshold or engaged in a normal business practice. Commenters also
requested guidance on which entity (the payor or the payee) determines
whether the anti-abuse rule applies. Commenters asserted that
theoretically every payment below $10,000 will need to be examined to
determine whether the anti-abuse rule applies.
An anti-abuse rule is necessary because the parties could
potentially avoid the threshold by manipulating the amount of each
payment. Because the government entity is responsible for withholding
and may not have sufficient information regarding the payee's billing
process, the final regulations provide that the anti-abuse rule applies
only if the government entity knew or should have known that the
payment had been divided (whether by the government entity or as a
result of divided billing) with the primary purpose of avoiding the
withholding requirements. The final regulations further provide that in
determining whether the anti-abuse rule applies, a significant factor
is whether the government entity has exhibited a pattern or practice of
intentionally dividing payments (or intentionally permitting divided
billing) to avoid withholding. Thus, the anti-abuse rule is intended to
apply only in a limited number of cases.
Additionally, the final regulations permit a government entity and
a person providing services or property to that government entity to
contractually agree that the government entity will or may withhold in
accordance with the rules governing withholding under section 3402(t),
on specified payments not subject to section 3402(t) withholding,
including payments below $10,000. Therefore, the parties could
contractually agree to permit the government entity to apply, in its
discretion as it deemed appropriate, the anti-abuse rule. This type of
contractual provision would enable the parties to avoid disputes about
whether the anti-abuse rule applies. This provision in the final
regulations permitting additional withholding does not apply to
payments already subject to section 3402(t) withholding notwithstanding
the contractual provision, including amounts subject to section 3402(t)
withholding solely due to the anti-abuse rule.
4. Application of the Payment Threshold to a Single Payment Covering
Multiple Billing Items
Commenters objected to applying the threshold to the payment amount
where the government entity chooses for its convenience to make one
payment for different ``unrelated transactions'' (which they termed
``bundling'' the payment), causing the payment to meet the $10,000
threshold. Commenters suggested that if a single payment covers more
than one ``unrelated'' transaction, the threshold should apply
separately to each transaction, invoice, or billing item, rather than
to the full payment amount. According to these commenters, applying the
threshold to bundled payments makes the threshold difficult to program
into accounts payable systems because the threshold
[[Page 26586]]
amount cannot be applied at the time of the transaction but only at the
time the payment is processed.
The final regulations adopt the proposed rule applying the
threshold on a payment-by-payment basis rather than a billing item
basis. A billing item approach would require formulating a method for
identifying a billing item or a similar term, which may not be easily
identifiable in every case. As a result, disputes would likely arise
about the number and amount of valid billing items, raising both
compliance issues for government entities and enforcement issues for
the IRS. A billing item approach also would require the government
entity to maintain records of the items covered by a particular
payment, and the supporting documentation justifying the separate
billing item treatment, increasing the administrative burden. This
approach could also facilitate abuse by parties seeking to avoid the
threshold by dividing billing items.
C. Payments to Contractors, Subcontractors, and Payment Administrators
Consistent with the proposed regulations, the final regulations
provide that, if a government entity or its payment administrator makes
a payment to a person that is subject to section 3402(t) withholding,
no subsequent transfer of cash or property by that person to another
person is treated as a payment for section 3402(t) purposes. Therefore,
if the government entity contracts with a prime contractor for property
and services, and that prime contractor separately contracts with
subcontractors for delivery of certain property and services, section
3402(t) withholding applies only to payments by the government entity
or its payment administrator to the prime contractor, and does not
apply to successive payments by the prime contractor to its
subcontractors.
Also consistent with the proposed regulations, the final
regulations apply to payments made by the government entity or its
payment administrator. A payment administrator is any person that acts
with respect to a payment solely as an agent for a government entity by
making the payment on behalf of the government entity to a person
providing property or services to, or on behalf of, the government
entity. The government entity is liable for the required withholding
and responsible for all related reporting regardless of whether the
government entity or its payment administrator makes the payment.
Transfers of funds from a government entity to a payment administrator
to be used by the payment administrator, on the government entity's
behalf, to pay persons for providing property or services are not
payments subject to section 3402(t) withholding. However, if the
government entity pays the payment administrator a fee for its
services, the fee is a payment subject to withholding.
Many commenters requested additional guidance on the application of
section 3402(t) to prime contractors, subcontractors, and payment
administrators to specific factual situations. The final regulations
adopt the rules in proposed regulations without change. These rules
provide general guidance that can be applied to various specific
situations and it is not practicable to describe all those situations
explicitly in the regulations. However, the Treasury Department and the
IRS may issue other forms of guidance in the future if it is determined
that such guidance is necessary to assist with particularly problematic
situations.
D. Advance and Interim Payments
Commenters requested guidance on whether section 3402(t)
withholding applies to any of the following payments that are made
before the final delivery and acceptance of service by the government
entity: Contract financing payments, performance-based payments,
commercial advance payments, interim payments, progress payments based
on cost, progress payments based on a percentage or stage of
completion, or interim payments under a cost-reimbursement contract.
Commenters requested exceptions for these types of payments because
withholding would detrimentally affect the cash flows of contractors
and could result in price increases for government contracts.
Commenters also argued that in some cases withholding is unnecessary
because amounts are already withheld from contract payments until the
completion of a contract. Finally, commenters suggested that government
entities are protected from loss through other provisions such as the
Miller Act (40 U.S.C. 3131-3134, discussed in greater detail in section
IV.E.1 of this preamble).
Commenters specifically requested that section 3402(t) withholding
apply to contract financing payments on the date the government entity
accepts the services or property provided under the contract. Under
Federal Acquisition Regulations (FAR), a contractor is not entitled to
liquidate contract financing payments until the government entity has
accepted the property or services. On this basis, a commenter asserted
that contract financing payments are not payments for property or
services until the contract is settled and the property or services are
``accepted'' by the government entity. The commenter maintained that
the payment date for section 3402(t) purposes should be the acceptance
date because interest under the Prompt Payment Act (31 U.S.C. 3903) for
late payments under a contract does not begin to run until the
acceptance date.
The final regulations do not adopt these suggestions. Treating the
acceptance date as the payment date would add administrative complexity
to section 3402(t) withholding, as would any attempt to distinguish
between payments in advance of performance by the contractor, interim
payments for partial performance, and other designated payments for
property or services. Treating the date the funds are disbursed as the
payment date ensures that there will be funds upon which to withhold.
For these reasons, the final regulations provide that payment is made
and withholding applies when the funds are disbursed and not when the
contract is settled and the services or property accepted.
E. Utility Payments
The proposed regulations provided that, unless otherwise excepted,
utility payments are subject to section 3402(t) withholding on the same
basis as payments for other property and services. Commenters requested
that utility payments be exempted from the withholding requirement on
the ground that utilities are already subject to regulation and that
government entities might lose utility services if forced to withhold
on payment of the utility bill.
There is no statutory exception for utility payments. In addition,
all persons receiving payments subject to section 3402(t) withholding,
including utility companies, are paid the full amount charged, albeit
in the form of a combination of a cash payment and a deposit of tax
made to the IRS. Thus, unless otherwise excepted, utility payments are
subject to section 3402(t) withholding.
F. Other Payments
Commenters requested exemptions from withholding or lower rates of
withholding based on a particular industry's profit margin or a
particular payee's expectation that it will not have any income tax
liability (because, for example, the payee had net operating losses).
Commenters also requested exemptions for payees that are current in
their Federal tax payments. The final regulations do not adopt these
suggestions because differing rates for
[[Page 26587]]
differing industries or taxpayers are not contemplated by the statute
and would raise administrative complexities.
In addition, many commenters requested guidance on whether certain
types of payments or designated portions of payments are payments for
property or services subject to section 3402(t) withholding. The final
regulations do not adopt most of these suggestions because the general
rules provide sufficient guidance. For example, commenters requested
guidance on certain amounts that typically are part of a payment for a
specific service or property, but generally are stated separately in
invoices to government entities, such as fuel surcharges. The final
regulations do not except separately stated costs (other than the
optional rule permitting sales, excise, and value-added taxes to be
excepted from the amount subject to section 3402(t) withholding). In
general, separately stated items such as fuel surcharges are treated as
part of the payment for property or services by the government entity,
and therefore are subject to section 3402(t) withholding unless an
exception applies. For example, the amount subject to withholding
includes late payment fees (that are not interest) and shipping and
handling costs in connection with the purchase of property that is
subject to section 3402(t) withholding.
Commenters also requested guidance on determining the amount
subject to withholding when a portion of one payment is subject to
withholding, but the remainder of the payment is excepted from
withholding. Commenters asserted that it would be difficult to identify
which portion of the payment was excepted and to apply withholding only
to the remainder. In response to these administrative concerns, the
final regulations permit government entities to withhold on the full
amount of a payment that combines an amount subject to withholding and
an amount excepted from withholding, provided the payee has consented
to this additional withholding.
Commenters requested guidance on determining the amount of
withholding when a payment for property or services to a person is
subject to offsets for the person's outstanding debt or other amounts
owed to the government entity. Because there is no exclusion or other
provision under section 3402(t) for offsets, the payment to which the
section 3402(t) withholding applies is not reduced by offsets. Rather,
the amount of the payment subject to section 3402(t) withholding
includes any portion of the payment that is offset to pay debt owed to
the government entity or other offsets.
IV. Payments Excepted From the Section 3402(t) Withholding Requirements
A. Payments to Certain Exempt Payees (Section 3402(t)(2)(E))
Consistent with the proposed regulations, the final regulations
except from section 3402(t) withholding payments to other government
entities required to withhold, to foreign governments, and to tax-
exempt organizations as provided in section 3402(t)(2)(E). A commenter
asked whether the exception for payments to tax-exempt organizations
extends to payments that are included in determining the organization's
unrelated business income that is subject to income tax. A payment to a
tax-exempt organization is excepted from section 3402(t) withholding
regardless of whether it is treated as unrelated business income.
B. Payments to Indian Tribal Governments
Consistent with the proposed regulations, the final regulations
exempt payments to Indian Tribal governments. Because Indian Tribal
governments are not subject to United States income tax, subjecting
payments made by government entities to Indian Tribal governments to
section 3402(t) withholding would be unduly burdensome. In response to
comments, the final regulations also exempt payments to passthrough
entities that are owned 80 percent or more by one or more persons each
of which is an Indian Tribal government or a person described in
section 3402(t)(2)(E).
C. Identifying Exempt Payees
Commenters requested guidance on how to identify exempt payees.
Exempt payees include: (1) Government entities required to withhold
under section 3402(t), foreign governments, tax-exempt organizations,
and Indian Tribal governments; (2) passthrough entities that are 80
percent or more owned by those types of entities; and (3) nonresident
alien individuals and foreign corporations that receive certain types
of payments (and partnerships that receive certain types of payments
and that are 80 percent or more owned by nonresident alien individuals
and foreign corporations). The Treasury Department and the IRS expect
to issue additional guidance on how a payee can claim an exemption. The
guidance is expected to provide that if the government entity receives
a payee statement indicating under penalties of perjury that the payee
qualifies for an exemption from section 3402(t) withholding and
identifying the particular exemption, the entity will be able to rely
on that statement unless it knew or had reason to know that the payee
did not actually qualify for the exception. The guidance is also
expected to provide that a government entity need not obtain a payee
statement if the name of the payee reasonably indicates or the payor
knows the payee to be a government entity (including an Indian Tribal
government) or foreign government. However, it is not anticipated that
this ``eyeball'' test would apply to tax-exempt organizations, foreign
corporations, nonresident alien individuals, or passthrough entities.
D. Payments of Interest (Section 3402(t)(2)(C))
Section 3402(t)(2)(C) excepts payments of interest from section
3402(t) withholding. Two commenters requested that a definition of
interest be provided, and other commenters inquired whether certain
specific types of payments are payments of interest for purposes of
this exception.
The Code and the regulations do not provide a general definition of
interest. Rather, a definition of interest has arisen through case law.
Generally, under long-standing case law, interest is compensation paid
for the use or forbearance of money. See, for example, Old Colony R.R.
Co. v. Commissioner, 284 U.S. 552 (1932), 1932-1 CB 274; Deputy v.
DuPont, 308 U.S. 488 (1940), 1940-1 CB 118; see also Thompson v.
Commissioner, 73 T.C. 878, 887 (1980) (interest is the charge per unit
of time for the use of borrowed money); Dickman v. Commissioner, 465
U.S. 330, 337 (1984), 1984-1 CB 197 (interest is the equivalent of rent
for the use of funds). The general standard, as developed through the
case law, may be applied to particular facts and circumstances. Thus,
the final regulations do not provide a definition of interest. However,
the Treasury Department and the IRS continue to study whether any
particular guidance with respect to the application of section 3402(t)
to interest payments may assist taxpayers in complying with the section
3402(t) withholding and reporting requirements, and accordingly
continue to reserve that section. See Sec. 31.3402(t)-4(c).
[[Page 26588]]
E. Payments for Real Property (Section 3402(t)(2)(D))
1. Construction Payments
Section 3402(t)(2)(D) excepts payments for real property from
section 3402(t) withholding. Consistent with the proposed regulations,
the final regulations provide that the term payments for real property
includes payments for the purchase and the leasing of real property,
but does not include payments for the construction of buildings or
other public works projects, such as bridges or roads.
Commenters requested that payments for construction be treated as
payments for real property. One commenter interpreted 40 U.S.C. 3131-
3134 (the ``Miller Act'') as already protecting the Federal Government
for taxes owed by the contractor. The commenter stated that the Miller
Act mandates that the contractor provide a performance bond to protect
the Government, and a separate payment and performance bond to protect
all persons supplying labor and material in carrying out the work
provided for in the contract. According to the commenter, the
protection afforded by these bonds includes taxes due under the Code.
See 40 U.S.C. 3131(c)(1).
The tax protection afforded by these bonds relates to employment
taxes deducted from wages, not to income taxes which the contractor may
owe. Therefore, these performance bonds do not protect against a
contractor's failure to pay its correct income tax liability, and the
Miller Act does not provide the Federal Government protection for the
contracting entity's income tax liability.
Another commenter suggested that treating payments for construction
as payments for real property would be consistent with other tax
provisions, including section 460(e)(4) and Sec. 1.460-3(a) (defining
the term construction contract for purposes of determining whether an
exception from the required use of the percentage of completion method
in determining taxable income applies), and Sec. 1.263A-8 (defining
the term real property to include land, buildings, and inherently
permanent structures, and the structural components of both buildings
and inherently permanent structures for purposes of the requirement to
capitalize interest under section 263A). Another commenter cited other
Code sections and regulations, including: (1) Section 469 (relating to
passive activity losses and credits and providing that a ``real
property trade or business'' includes ``any real property development,
redevelopment, construction, reconstruction, acquisition, conversion,
rental, operation, management, leasing, or brokerage trade or
business''); (2) section 856 (defining ``interests in real property''
to include ``fee ownership and co-ownership of land or improvements
thereon, leaseholds of land or improvements thereon, options to acquire
land or improvements thereon, and options to acquire leaseholds of land
or improvements thereon''); and (3) Sec. 1.1031(a)-1(b) (relating to
like-kind exchanges and providing that the fact that any real estate
involved is improved or unimproved is not material, for that fact
relates only to the grade or quality of the property and not to its
kind or class).
The final regulations do not adopt these suggestions. None of these
authorities provides as a general rule that payments for construction
are payments for real property. Moreover, the Code and regulations
sections cited serve different purposes. The relevant distinction here
is between payment for a completed building (a payment for real
property), and payment for the services and materials used to construct
a building (not a payment for real property). There is no evidence that
Congress intended to exempt payments for construction. Additionally, an
exemption for construction would substantially reduce the scope of
payments subject to section 3402(t) withholding.
2. Lease Payments
The proposed regulations provided that the exemption for payments
for real property extends to payments for the leasing of real property.
A commenter asked whether payments for construction in leased buildings
are treated as payments for real property if the government entity pays
the person providing the property or services directly for facility
improvements rather than the lessor. Commenters also asked whether
payments to the lessor for services or property (such as for utilities
or insurance) or for services under the lease agreement (such as for
utilities provided at the lessor's expense) are considered payments for
the lease. In addition, commenters asked whether payments to third
parties required by the lease agreement (such as payments for utilities
and insurance) are considered payments for the lease.
The final regulations distinguish between payments to the lessor as
part of the lease and payments to a third party. Payments to the lessor
that are required under the lease agreement, such as payments for
utilities or insurance, are payments for leasing, and are not subject
to section 3402(t) withholding. In contrast, payments to third parties
for services or property are subject to section 3402(t) withholding,
even if required by the lease. Thus, under the final regulations, the
lease terms generally govern whether payments for leasehold
improvements and for services or property in connection with a lease
are subject to section 3402(t) withholding. However, because of the
potential to avoid the application of withholding to payments for
construction by temporarily leasing before purchasing, rather than
simply purchasing, the property on which the construction will occur,
payments for construction are subject to section 3402(t) withholding
even if required by a lease and paid to the lessor.
F. Payments Subject to Other Withholding (Section 3402(t)(2)(A) and
(B))
Section 3402(t)(2)(A) excepts from section 3402(t) withholding
amounts that are subject to withholding under another provision of
chapter 3 or chapter 24 (other than section 3406). Commenters asked
whether unpaid compensation paid to beneficiaries or the estates of
deceased employees is subject to section 3402(t) withholding. Although
such amounts generally are not subject to wage withholding under
section 3402(a) (see Rev. Rul. 86-109, 1986-2 CB 196), the final
regulations provide that these payments are excepted from section
3402(t) withholding under section 3402(t)(2)(I) as payments to an
employee.
G. Payments Made Pursuant to a Classified or Confidential Contract
(Section 3402(t)(2)(F))
Section 3402(t)(2)(F) excepts payments made pursuant to a
classified or confidential contract described in section 6050M(e)(3).
Commenters asked whether this exception applies to other government
operations not specifically covered by section 6050M(e)(3),
recommending that the exception apply to any contract whose subject
matter contains any scope of work subject to the National Industrial
Security Program Operating Manual (NISPOM). Because of the express
statutory language describing the confidential contracts to which the
exception applies, the final regulations do not extend the exception
beyond contracts described in section 6050M(e)(3).
H. Payments in Connection With a Public Welfare or Public Assistance
Plan (Section 3402(t)(2)(H))
Section 3402(t)(2)(H) excepts from section 3402(t) withholding any
payment in connection with a public
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assistance or public welfare program for which eligibility is
determined by a needs or income test. Consistent with the proposed
regulations, the final regulations adopt a broad definition of in
connection with to include payments made to third parties under a
public assistance or public welfare program for the benefit of the
recipient of benefits under the program. Consistent with the
legislative history, a program for which eligibility is determined
under a needs or income test does not include a program under which
eligibility is based on age only (for example, Medicare). For purposes
of this exception, a program providing disaster relief to victims of a
natural or other disaster is considered to be a program for which
eligibility is determined under a needs test.
Many commenters asked that the regulations address specific
benefits under various plans. Questions about specific plans can be
resolved by applying the statute and these final regulations, and
special rules are not needed. However, the Treasury Department and the
IRS may issue other guidance in the future, as necessary to address
arrangements to which it is particularly difficult to determine the
application of the statute and these final regulations.
Commenters asked how section 3402(t) applies when a government
office or portion of a government office is used to administer a public
welfare program. Commenters asked whether payments for expenses of that
office (utilities, property insurance, maintenance) that are
attributable to administering the public welfare program qualify as
payments made in connection with a public welfare program under section
3402(t)(2)(H). The final regulations provide that government entities
may determine the portion of any payment that is attributable to
expenses to administer the public welfare program using any reasonable
allocation method (including, for example, using prospective budget
allocations). To ease administration, the final regulations also
provide that, if a government entity makes a reasonable, good faith
determination that only an insignificant portion of the government
office's payments are attributable to administering a public welfare
program (or to functions other than administering a public welfare
program), that insignificant portion may be disregarded.
I. Payments to a Government Employee for Services as an Employee
(Section 3402(t)(2)(l))
Section 3402(t)(2)(I) excepts payments to a government employee for
the employee's services as an employee. Consistent with the proposed
regulations, the final regulations interpret this exception broadly to
exclude any form of compensation that is paid to the employee or on the
employee's behalf. For example, the final regulations exclude employer
and employee contributions to employee benefit and deferred
compensation plans, employer-provided fringe benefits, and employer
payments for insurance under the Federal Employees Health Benefits
Program.
The final regulations further provide that, consistent with the
proposed regulations, the section 3402(t)(2)(l) exception applies to
payments to employees under an accountable plan for the employee's
business travel expenses, and to payments made by the employee to
providers of the employee's travel, meals, and lodging when the
employee is traveling on government business and is reimbursed under
the accountable plan. Payments to an employee made under a
reimbursement or other expense allowance arrangement that do not exceed
the substantiated expenses are treated as paid under an accountable
plan and are not wages if the arrangement meets the requirements of
section 62(c) and the expenses are substantiated within a reasonable
period of time. See Sec. 31.3401(a)-4(a). In contrast, payments to an
employee under a nonaccountable plan are includible in wages subject to
income tax withholding under section 3402(a), and thus are excepted
from section 3402(t) withholding by section 3402(t)(2)(A).
Commenters requested that payments by a government entity to third
party providers (and not to an employee) for employee travel and
lodging also be excepted from section 3402(t) withholding, arguing that
these payments are another way to pay for employee business travel
expenses and should be excepted in the same manner as payments made
under accountable plans. Commenters argued that applying withholding in
this instance will complicate the travel arrangement process, reduce
the use of more efficient central billing accounts, and create
unjustified discrepancies in travel expense reimbursements based on the
employer method of payment.
The section 3402(t)(2)(I) exception by its terms applies only to
payments to employees (or their successors in interest). If the
government entity pays a provider directly for employee travel
expenses, there is no payment from the government entity to the
employee to invoke this exception. Payments to the provider by the
government entity are payments for property and services, and therefore
subject to section 3402(t) withholding unless another exception
applies. The exception for employee fringe benefits does not apply
where a payment is made directly to the provider because, while related
to the provision of a fringe benefit to the employee, the payment
itself is not a fringe benefit and is made to a third party rather than
to the employee. However, payments made by payment card are excepted
pending future guidance. See Notice 2010-91.
J. Grants
The proposed regulations did not provide an explicit exception for
grant payments. Commenters requested that all grant payments be
excluded from section 3402(t) withholding because they are ``non-
exchange'' transactions in which the government entity is not making a
payment for property or services for the direct benefit or use of the
government entity. According to commenters, grant payments are
distinguishable from payments in a transaction with a vendor in which a
government entity is directly purchasing property or services for its
own benefit or use.
Commenters also recommended that section 3402(t) withholding not
apply to the use of grant funds by grant recipients that are complying
with the grant eligibility and award process. One commenter cited the
example of a city or county fire department that receives a grant from
a government entity specifically for the purchase of an emergency
response vehicle. If the purchase of an emergency response vehicle by
the local fire department were subject to section 3402(t) withholding,
the commenter maintained the withholding would divert Federal grant
money from the authorized acquisition use into the three percent
withholding process.
In cases where the grant recipient is another government entity or
a tax-exempt organization, the grant payment will be excepted from
section 3402(t) withholding under section 3402(t)(2)(E). In addition,
grant payments may qualify as payments made in connection with a public
assistance or public welfare program for which eligibility is
determined by a needs or income test, and thus be excepted from
withholding under section 3402(t)(2)(H). Thus, it seems likely that
many grant payments
[[Page 26590]]
will qualify for these statutory exceptions.
In light of the administrative difficulty and potential frustration
to the intended use of the grant proceeds that may arise, the final
regulations explicitly except all grants from section 3402(t)
withholding. For this purpose, the final regulations define a grant as
a transfer of funds by a government entity to a recipient (which may be
a state government, local government, or other recipient) pursuant to
an agreement reflecting a relationship between the government entity
and the recipient when (1) the principal purpose of the relationship is
to transfer a thing of value to the recipient to carry out a public
purpose of support or stimulation authorized by law instead of
acquiring (by purchase, lease, or barter) property or services for the
direct benefit or use of the government entity; and (2) substantial
involvement is not expected between the government entity and the
recipient when carrying out the activity contemplated in the agreement.
The exception from section 3402(t) withholding for grants does not
apply to the distribution of grant proceeds by a government entity.
Commenters' suggestions that grant proceeds be permanently excepted
from withholding if the grant recipient is using the proceeds for the
purposes specified in the grant is not supported by the statute and
would be difficult to administer. Tracing would be required to
determine which government entity purchases had been made with grant
proceeds. Tracing would be particularly difficult if the grant
agreement does not identify specific uses for the proceeds (for
example, to purchase items necessary to improve emergency response
time, which may include an additional emergency response vehicle) or if
only a portion of a payment consists of grant proceeds. Accordingly,
the final regulations do not adopt this suggestion.
K. Sales Tax, Excise Tax, and Value-Added Tax
Commenters requested guidance on whether the payment subject to
withholding includes the amount of any sales tax, excise tax, or value-
added tax. Sales taxes are generally paid by the purchaser, collected
by the vendor, and remitted to the state. The sales tax amount
generally is not included in the vendor's gross income.
By comparison, information reporting under section 6041 and related
backup withholding under section 3406 apply only to payments that are
includible in the payee's income. Therefore, if the payee is liable for
sales tax and the payor includes the amount of sales tax in the total
payment to the payee, the payor includes the amount of sales tax on
Form 1099-MISC, ``Miscellaneous Income,'' as part of the reportable
payment. In contrast, if (as is generally the case) the payor is liable
for any sales tax and the payee merely collects sales tax from the
payor, the payor does not include sales tax in the total amount
reported on Form 1099-MISC.
A different reporting rule applies to reportable payment card
transactions under section 6050W. Section 1.6050W-1(a)(6) provides that
the gross amount reportable on Form 1099-K, ``Merchant Card and Third
Party Network Payments,'' is the total dollar amount of aggregate
reportable payment transactions for each participating payee without
regard to any adjustments for credit, cash equivalents, discount
amounts, fees, refunded amount or any other amounts. Thus, the gross
amount reported on Form 1099-K includes the amount of sales tax, excise
tax, or value-added tax paid as part of a payment transaction.
Similar to reporting under section 6050W, but in contrast to
reporting under section 6041, section 3402(t) withholding does not
depend on whether an amount is includible in gross income. The entire
amount paid for property or services is subject to withholding
regardless of whether the vendor realizes a profit on transactions
covered by the payments. Accordingly, the final regulations provide
that the amount subject to withholding and reporting includes any
sales, excise or value-added tax. However, the final regulations also
permit government entities to exclude the amount of any sales, value-
added, or excise tax, for purposes of section 3402(t) withholding,
provided the exclusion is applied consistently to all payments to a
given payee during the calendar year. This rule is similar to the rules
permitting payors to exclude the amount of the wager from gambling
winnings for reporting and withholding purposes under Sec. 31.3406(g)-
2(d)(2) or to exclude commissions and option premiums in determining
gross proceeds from securities sales for reporting purposes under Sec.
1.6045-1(d)(5).
L. Loan Guarantees
Commenters requested guidance on whether loan guarantees provided
by government entities and payments on loan guarantees are subject to
section 3402(t) withholding. The final regulations provide that the
loan guarantee itself (meaning a guarantee provided by a government
entity on a loan by a lender) is not a payment subject to section
3402(t). The underlying amounts are still loans and guaranteeing a loan
or making a loan that is expected to be repaid through the payment of
principal and interest is not a payment for property or services.
Payments of principal and interest by the government entity as
guarantor of the loan so that the borrower can continue performing
services under the contract are also not subject to withholding under
section 3402(t). The government entity is making these payments as
guarantor of the loan, and the payments are being made to the lender,
not to a third party contractor that is performing services or
transferring property. Thus, the final regulations provide that
government entity payments of principal and interest on a loan pursuant
to a loan guarantee are not subject to section 3402(t) withholding.
Under some circumstances, borrowers use the funds from guaranteed
loans to fund a specific project. As part of a loan guarantee, the
government has the right to assume the operation of the underlying
project if the borrower ceases making payments on the loan. If the
government entity (through a right of subrogation) assumes the
operation of the underlying project, the government entity as the
operator of the project makes payments to the contractors providing
services and property for the project. In that case, payments by the
government entity to third party contractors are payments for property
or services. Although the government exercised its right of subrogation
pursuant to the loan guarantee or the underlying loan, and not as a
party to the underlying contract between the borrower and the third
party contractors, the government is stepping into the borrower's shoes
and making payments for property or services directly to the third
party contractors. Accordingly, the final regulations provide that
section 3402(t) withholding applies in that case.
M. Debt Repayments and Stock and Bond Purchases
Commenters requested clarification that a government entity's
repayments of principal on a loan are not subject to section 3402(t)
withholding. Generally, repayments of principal on a loan will not be
subject to section 3402(t) withholding because they are not payments
for property or services. However, if a government entity issues a debt
obligation to a person providing services as part of the purchase
price, the debt's fair market value is subject to section 3402(t)
withholding when the obligation becomes effective, unless an exception
applies. If a government
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entity issues a debt obligation to a person providing property as part
of the purchase price, the debt's issue price as determined under
section 1273 or 1274, as applicable, is subject to section 3402(t)
withholding unless an exception applies (for example, the exception for
payments for real property will apply to a debt obligation issued as
part of a government entity's purchase of real property). For
administrative convenience, the regulations allow the government entity
and the person providing property to agree to use the stated principal
amount of the debt obligation in lieu of the issue price as the amount
of the payment attributable to the debt obligation that is subject to
section 3402(t) withholding. Thus, for example under these rules, if a
government entity pays a person in 2013 for the performance of services
with $50,000 cash and a 5-year note valued at $50,000, then the note's
fair market value would be subject to section 3402(t) withholding in
2013 along with the cash payment, but the repayment of the principal
after the note matured in 2018 would not be subject to section 3402(t)
withholding. If a government entity uses a third party debt obligation
(a debt obligation issued by another government entity or by an entity
other than a government entity) to pay for property or services, the
fair market value of the debt obligation is subject to section 3402(t)
withholding, unless an exception applies.
The final regulations also except payments to purchase stock,
bonds, and other negotiable instruments primarily for investment
purposes. Although these payments are for intangible property,
withholding on purchases in stock and bond markets is not practicable
given the functioning of the investment markets in which buyers and
sellers are paired on a virtually anonymous basis. However, a
government entity's payment of investment advisory fees to investment
advisors (including a payment from the government entity's account) is
a payment for services subject to section 3402(t) withholding. In
contrast, investment advisory fees paid, for example, by a mutual fund
in which a government entity owns shares are not subject to section
3402(t) withholding, since these payments are not made by the
government entity.
V. Application of Section 3402(t) to Passthrough Entities
The final regulations generally adopt the same basic rules as the
proposed regulations on applying section 3402(t) where either the payor
or the payee is a partnership or S corporation (a passthrough entity).
Payments from a passthrough entity generally are not subject to section
3402(t) withholding unless 80 percent or more of the passthrough entity
is owned in the aggregate by government entities required to withhold
under section 3402(t)(1). Similarly, payments to a passthrough entity
generally are subject to section 3402(t) withholding unless 80 percent
or more of the passthrough entity is owned in the aggregate by persons
described in section 3402(t)(2)(E) (government entities required to
withhold under section 3402(t)(1), tax-exempt entities, and foreign
governments) and Indian Tribal governments. Expanding on the exceptions
in the proposed regulations, the final regulations additionally provide
that certain payments to a partnership that is 80 percent or more owned
by foreign corporations or nonresident alien individuals are not
subject to section 3402(t) withholding. This exception does not apply
to S corporations because nonresident alien individuals and foreign
corporations are not permissible shareholders of an S corporation under
section 1361(b)(1). The regulations also provide that, as a general
rule, whether a passthrough entity is subject to section 3402(t) is
determined on the first day of the passthrough entity's taxable year.
However, any manipulation of the ownership percentage with intent to
avoid application of section 3402(t) will be recharacterized as
appropriate to reflect the actual ownership percentage. Because the
government entity is responsible for withholding and may not have
sufficient information regarding the payee's ownership structure, the
final regulations provide that this rule applies only if the government
entity knew or should have known that the payee's ownership percentage
had been manipulated with intent to avoid application of section
3402(t).
Commenters requested that payments to all passthrough entities be
excepted from section 3402(t) withholding. The final regulations do not
adopt this suggestion. A passthrough entity exemption would create
opportunities for payees to circumvent section 3402(t) by using
passthrough entities to receive government payments.
VI. Deposits and Reporting of Amounts Withheld Under Section 3402(t)
The final regulations adopt the same reporting and payment rules
for section 3402(t) withholding purposes as the proposed regulations.
Final regulations under section 6011 provide that the payor required to
withhold under section 3402(t) must file Form 945, ``Annual Return of
Withheld Federal Income Tax,'' reporting the amounts withheld. Final
regulations under section 6302 provide that the amounts withheld under
section 3402(t) must be deposited and reported in the same manner as
other nonpayroll withheld amounts, such as withholding on gambling
winnings and pensions. Pursuant to existing regulations, these amounts
are treated as if they were employment taxes for purposes of the
deposit rules, but are subject to special rules for determining the
payor's deposit schedule. See Sec. 31.6302-4. Additionally, final
regulations under section 6051 provide that payors required to withhold
amounts under section 3402(t) must file information returns and furnish
payee statements on Form 1099-MISC, ``Miscellaneous Income'' (or any
successor form), reporting such payments and tax withheld. Because this
reporting is pursuant to regulations under section 6051, the exceptions
provided in the regulations under section 6041 relating to Form 1099 do
not apply.
VII. Crediting of Amounts Withheld
A. Credit Against Income Tax
Commenters requested that the regulations permit fiscal year
taxpayers to credit amounts withheld against their income tax liability
for the fiscal year in which the tax is withheld. The final regulations
do not adopt this suggestion because it is inconsistent with the
statute. Section 31 governs the taxable year against which a taxpayer
may credit income tax. Section 31(a)(1) provides that ``[t]he amount
withheld as tax under chapter 24 shall be allowed to the recipient of
the income as a credit against the tax imposed by this subtitle.''
Chapter 24 includes section 3402(t), and section 31(a)(1) is in
subtitle A, income taxes. Thus, by its terms, section 31(a)(1) applies
to persons who have had income tax withheld from a payment pursuant to
section 3402(t). Section 31(a)(2) provides the general rule on the
timing of the allowance of the credit allowed under section 31(a)(1):
``The amount so withheld during any calendar year shall be allowed as a
credit for the taxable year beginning in such calendar year. If more
than one taxable year begins in a calendar year, such amount shall be
allowed as a credit for the last taxable year so beginning.'' Thus,
absent a special rule, section 31(a)(2) generally applies for purposes
of withholdings required under chapter 24, which includes section
3402(t).
Section 31(c) provides a special rule solely for backup
withholding. Under
[[Page 26592]]
section 31(c), any credit allowed by section 31(a) for backup
withholding under section 3406 must be allowed for the taxable year of
the recipient of the income in which the income is received. Section
31(c) is limited by its terms to section 3406 withholding only, and
thus does not apply to section 3402(t) withholding.
Practical considerations also support the section 31(a)(2)
crediting rule. Taxpayers generally will have received Forms 1099-MISC
reporting the withholding prior to filing income tax returns crediting
the income tax withheld, promoting accuracy in return filing.
B. Credit Against Estimated Income Tax Liability
Commenters requested that taxpayers be permitted to credit the
income tax withheld against the estimated tax liability for the
specific tax quarter in which the income tax is withheld. However, the
Code specifically provides that crediting for estimated tax purposes
occurs in the taxable year in which the tax withheld may be taken as a
credit against income tax liability. See sections 6654(g)(1) and
6655(g)(1)(B). Thus, the final regulations do not adopt this comment.
C. Credit Against Employment Taxes or Other Taxes
Many commenters requested that taxpayers be permitted to credit
their section 3402(t) withholding against employment taxes on wages or
other taxes. The final regulations do not adopt this suggestion.
Section 3402(t)(3) directs that crediting occur under the rules in
section 31(a), which provides for crediting against income tax. As
noted in the preamble to the proposed regulations, if a statute permits
income tax payments to be treated as employment tax payments, or vice
versa, it makes specific provision for that treatment. See, for
example, section 3510(b) (providing that domestic employment taxes are
treated as taxes due for estimated tax purposes under section 6654);
and section 31(b) (providing for the crediting against income tax of
the special refund of social security tax under section 6413(c)
applicable when an employee receives wages from two or more employers
in excess of the social security contribution and benefit base). The
Code does not provide for section 3402(t) withholding to be treated as
payments of the taxpayer's employment tax liability. In addition,
payments of income tax and employment taxes occur under different
processes, using different forms, and are subject to different
procedures for corrections of underpayments and overpayments, as well
as different audit procedures and potential penalties. Therefore, the
crediting of an amount withheld for income tax against an employment
tax obligation is not administratively feasible.
D. Credits for Amounts Withheld on Payments to Passthrough Entities
Amounts withheld on payments to passthrough entities are subject to
the same crediting rules as payments made to other entities. Thus, a
passthrough entity with a fiscal year may only claim the credit for its
fiscal year beginning in the calendar year during which the amount was
withheld pursuant to section 31(a)(2). The timing of when the owners of
the passthrough entity take into account the credit would then be
determined under the rules applicable to that type of passthrough
entity (for example, section 706 for a partnership). Commenters
specifically asked how the credit would be allocated by a partnership.
This allocation is governed by the rules set forth in Sec. 1.704-
1(b)(4)(ii), with appropriate adjustments under section 705.
VIII. Correction of Errors and Liability of Government Entity
Commenters requested clarification that a government entity is
liable for tax that the entity was required to withhold under section
3402(t) but did not withhold, unless the entity can demonstrate that
the payee has paid its income tax liability. Commenters also requested
clarification of the rules applicable to corrections of overwithholding
and underwithholding, and guidance on the effect of repayments,
underpayments, or overpayments for services or property on the
determination of section 3402(t) liability.
A. Corrections of Overwithholding and Underwithholding
Section 3402(t)(3) provides that, for purposes of sections 3403 and
3404 and for purposes of so much of subtitle F (except section 7205) as
relates to Chapter 24, Collection of Income Tax at Source, payments to
any person for property or services that are subject to withholding are
treated as if the payments were wages paid by an employer to an
employee. If a government entity fails to withhold the tax imposed by
section 3402(t), section 3403 applies to determine the government
entity's liability.
Section 3403 provides that the employer is liable for the payment
of tax required to be deducted and withheld under Chapter 24, and is
not liable to any person for the amount of that payment. Section
31.3403-1 of the Employment Tax Regulations provides that every
employer required to deduct and withhold the tax under section 3402
from an employee's wages is liable for the payment of the tax whether
or not the employer collects the tax from the employee. If the employer
fails to withhold all or part of the amount required to be withheld,
and thereafter the employee pays the tax, section 3402(d) provides that
the tax will not be collected from the employer. Thus, for purposes of
section 3402(t), the government entity generally will be liable if it
fails to withhold unless under section 3402(d) it can demonstrate that
the contractor reported the amount subject to section 3402(t)
withholding on its return and paid the income tax due (which may
include payment through an amended return or settlement of an audit).
Pursuant to section 3402(t)(3), the rules for adjustments of
overpayments or underpayments of income tax withholding on wages also
apply to section 3402(t) withholding. See section 6413, Sec.
31.6413(a)-2(c)(1), and Sec. 31.6413(a)-1(b)(1)(i) (repayments and
reimbursements to employees of overwithholding, and correction of
overpayments of income tax withholding); section 6205 and Sec.
31.6205-1 (corrections of underpayments of income tax withholding). If
an error is discovered before a return is filed, the payor must report
on the return and pay to the IRS the correct amount of income tax
withholding. Corrections of overwithholding or underwithholding of
income tax before the return is filed are not adjustments, and a payor
that discovers an error before a return is filed but does not report
and pay the correct amount of tax to the IRS may not later correct the
error through an adjustment.
For purposes of correcting overpayments of income tax withholding,
a payor must repay or reimburse the overwithheld income tax to the
payee in the same calendar year as the original payment in order to
make an adjustment. The payor can then make that adjustment on its
return at any time before the period of limitations on credit or refund
under section 6511 expires for that calendar year. If the amount of the
overwithheld income tax is not repaid or reimbursed to the payee in the
same calendar year as the original payment, there is no overpayment to
be adjusted; rather the amount withheld will be credited to the payee
and subject to a potential tax refund. However, an adjustment may be
made to correct an
[[Page 26593]]
administrative error (that is, an inaccurate reporting of the amount
actually withheld).
For purposes of correcting underpayments of income tax withholding,
an adjustment can generally only be made in the same calendar year as
the original payment. An exception to this general rule applies to
corrections for administrative errors (that is, an inaccurate reporting
of the amount actually withheld).
Pursuant to section 3402(t)(3), the rules for claims for refund of
income tax withholding on wages also apply to section 3402(t)
withholding. See section 6414 and Sec. 31.6414-1. Section 6414 permits
refunds of income tax withholding only to the extent the amount of the
overpayment was not actually deducted and withheld from the payee.
Amounts withheld under section 3402(t) are reported on an annual
Form 945.
Accordingly, any corrections of overwithholding or underwithholding
during the calendar year are not adjustments; the government entity
must report and pay to the IRS the correct amount of tax on Form 945.
For example, if a government entity pays an amount subject to section
3402(t) withholding in error to a contractor and the contractor repays
the net amount to the government entity within the same calendar year,
the government entity should not report the amount and the related
withholding on the annual Form 945 (that is, the government entity
should report and pay the correct amount of tax on Form 945). Because
the correction is made before the return is filed, the correction does
not constitute an adjustment. The government entity may reduce its
deposit of other withholding reportable on Form 945 for that calendar
year to account for the deposit of section 3402(t) withholding on the
amount repaid by the contractor. If the contractor repays the
government entity an amount in a later calendar year, no adjustment can
be made because an adjustment is permitted only in the case of an
administrative error (an inaccurate reporting of the amount actually
withheld) discovered after the filing of the Form 945. The contractor
already received a credit for the amount withheld under the general
rules for crediting income tax withholding.
Similarly, the government entity can collect underwithholding only
during the same calendar year as the payment (except corrections made
in the case of administrative errors). If the underpayment is
discovered in a later calendar year, the government entity is liable
under section 3403 for any amount that should have been withheld,
unless under section 3402(d) it can demonstrate that the contractor
reported the amount subject to section 3402(t) withholding on its
return and paid the income tax due (which may include payment through
an amended return or settlement of an audit). The contractor is liable
for any income tax due on any payment subject to withholding regardless
of whether the government entity actually withholds any amount from the
payment.
B. Application of the $10,000 Threshold to Corrections of Erroneous
Payments
The final regulations provide that the $10,000 payment threshold
applies to the actual payment made by the government entity, even if
the amount of the actual payment is incorrect. For example, if an
excessive payment is subject to section 3402(t) withholding, the
subsequent repayment of all or a portion of the initial payment does
not affect whether the $10,000 threshold was met with respect to the
initial payment. Any correction of income tax withholding applies only
to the withholding on the amount repaid and not to the remaining
portion of the original payment, even if that remaining portion is less
than $10,000. Similarly, if the payment was less than $10,000 due to an
insufficient payment to the payee, the $10,000 threshold applies
separately to the initial payment and the subsequent payment (to make
up for the insufficient payment) unless the anti-abuse rule applies
(that is, unless the payment was divided into two or more payments
primarily to avoid the $10,000 payment threshold).
IX. Extension of Applicability Date and Transition Relief for Existing
Contracts
Numerous commenters indicated that an extended period of time
following the issuance of final regulations would be necessary for
government entities to adopt the systems and processes necessary to
comply with the Sec. 3402(t) withholding and related reporting
requirements. Noting the necessity to formulate government acquisition
rules that are consistent with the final regulations, as well as the
infrastructure needed to apply those rules, some commenters stated that
government entities would need at least 18 months from the issuance of
final regulations under section 3402(t) to be able to comply.
In response to these practical considerations, the final
regulations provide that the withholding and reporting requirements
under these regulations apply to payments made after December 31, 2012,
subject to an existing contract exception. Thus, under the regulations,
payments made under written binding contracts in effect on December 31,
2012, are not subject to section 3402(t) withholding, while payments
made after December 31, 2012, under contracts entered into after
December 31, 2012, are subject to section 3402(t) withholding unless
otherwise excepted. In addition, if an existing contract is materially
modified after December 31, 2012, the contract ceases to be an existing
contract and payments under the contract become subject to section
3402(t) withholding. With respect to payments before January 1, 2013,
government entities are not required to apply section 3402(t)
withholding and the related reporting, and accordingly will not be
subject to any liability, penalties or interest for failure to do so.
Commenters requested that the material modification rule be removed
because of the difficulty in determining whether it applies. Commenters
anticipated disputes between parties about what constitutes a material
modification and questioned how such disputes would be resolved.
Certain commenters also requested that a mere contract renewal not be
considered a material modification. Some commenters suggested that, in
lieu of a material modification rule, withholding should apply to all
contracts after a certain effective date, including those that have not
been materially modified.
In response to these comments, at the same time that these final
regulations are being issued, the IRS and the Treasury Department are
proposing regulations to provide that the exception for payments made
under existing contracts will not apply to payments made on or after
January 1, 2014. See REG-151687-10. Thus, under these proposed
regulations, payments on or after January 1, 2014, under all contracts
(existing and new) would be subject to withholding under section
3402(t) unless an exception applies.
The final regulations retain the material modification rule but
provide that a mere contract renewal will generally not be considered a
material modification. For this purpose, a modification is not a
material modification unless it materially affects either the payment
terms of the contract or the services or property to be provided under
the contract. Thus, for example, a change order (meaning a change in
the specifications of a contract that the government entity is
authorized to make under the contract without the contractor's consent)
generally would not be a material
[[Page 26594]]
modification unless the change materially affected the price or other
payment terms, or the services or property to be provided. The final
regulations also provide that modifying a contract to conform to
changes in the applicable law is not a material modification.
Several commenters requested guidance on the application of section
3402(t) withholding to payments under Medicare provider agreements.
Under the final regulations, Medicare provider agreements in effect as
of December 31, 2012, are existing contracts for purposes of the
existing contract exception unless materially modified after December
31, 2012. Additionally, renewals of Medicare provider agreements will
not be treated as material modifications to the extent the agreement is
modified to conform to Federal law. As with other existing contracts,
the proposed regulations issued with these final regulations would
provide that payments made by government entities on or after January
1, 2014, under both existing and new Medicare provider agreements will
be subject to section 3402(t) withholding.
X. Transition Rule for Interest and Penalties on Underpayments
Consistent with the proposed regulations, the final regulations
provide a transition rule for payments for property and services made
before January 1, 2014. Under this rule, a government entity will not
be liable for interest and penalties for failure to withhold on
payments for property or services made before January 1, 2014, if the
entity made a good faith effort to comply with section 3402(t).
However, this rule does not relieve the entity from liability for the
amount of tax required to be withheld under section 3402(t).
Effective/Applicability Date
These regulations apply to payments made after December 31, 2012.
In addition, the regulations will not apply to payments under a
contract existing on December 31, 2012, unless the contract is
materially modified after December 31, 2012.
Special Analyses
It has been determined that this Treasury decision is not a
significant regulatory action as defined in Executive Order 12866.
Therefore, a regulatory assessment is not required. It also has been
determined that section 553(b) of the Administrative Procedure Act (5
U.S.C. chapter 5) does not apply to this regulation, and because the
regulation does not impose a collection of information on small
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not
apply. Pursuant to section 7805(f) of the Internal Revenue Code, the
notice of proposed rulemaking preceding this regulation was submitted
to the Chief Counsel for Advocacy of the Small Business Administration
for comment on its impact on small business.
Drafting Information
The principal author of these final regulations is A. G. Kelley,
Office of the Division Counsel/Associate Chief Counsel (Tax Exempt and
Government Entities). However, other personnel from the IRS and the
Treasury Department participated in their development.
List of Subjects in 26 CFR Part 31
Employment taxes, Fishing vessels, Gambling, Income taxes,
Penalties, Pensions, Railroad retirement, Reporting and recordkeeping
requirements, Social Security, Unemployment compensation.
Adoption of Amendments to the Regulations
Accordingly, 26 CFR part 31 is amended as follows:
PART 31--EMPLOYMENT TAXES AND COLLECTION OF INCOME TAX AT SOURCE
0
Paragraph 1. The authority citation for part 31 continues to read in
part as follows:
Authority: 26 U.S.C. 7805 * * *.
0
Par. 2. Sections 31.3402(t)-0, 31.3402(t)-1, 31.3402(t)-2, 31.3402(t)-
3, 31.3402(t)-4, 31.3402(t)-5, 31.3402(t)-6, and 31.3402(t)-7 are added
to read as follows:
Sec. 31.3402(t)-0 Outline of the Government withholding regulations.
This section lists paragraphs contained in Sec. Sec. 31.3402(t)-1
through 31.3402(t)-7.
31.3402(t)-1 Withholding requirement on certain payments made by
government entities.
(a) In general.
(b) Special rules.
(c) Deposit and reporting requirements.
(d) Effective/applicability date.
31.3402(t)-2 Government entities required to withhold under section
3402(t).
(a) In general.
(b) Government of the United States.
(c) State.
(d) Political Subdivision.
(e) [Reserved].
(f) Possessions of the United States.
(g) Passthrough entities.
(h) Small entity exception.
(i) Effective/applicability date.
31.3402(t)-3 Payments subject to withholding.
(a) In general.
(b) Payment threshold of $10,000.
(c) No withholding on successive payments.
(d) Payments made through a payment administrator or to a
contractor.
(e) [Reserved].
(f) Examples.
(g) Effective/applicability date.
31.3402(t)-4 Certain payments excepted from withholding.
(a) Payments subject to withholding under chapter 3 or chapter
24 (other than section 3406).
(b) Payments subject to withholding under section 3406 with
backup withholding deducted.
(c) [Reserved].
(d) Payments for real property.
(e) Payments to government entities, tax-exempt organizations,
and foreign governments.
(f) Payments made pursuant to a classified or confidential
contract.
(g) Exception for political subdivisions or instrumentalities
thereof making less than $100,000,000 of payments for property or
services annually.
(h) Payments made in connection with a public assistance or
public welfare program.
(i) Payments made to any government employee with respect to his
or her services.
(j) Payments received by nonresident alien individuals and
foreign corporations.
(k) Payments to Indian Tribal governments.
(l) Payments in emergency or disaster situations.
(m) Grants.
(n) Sales tax, excise tax, value-added tax, and other taxes.
(o) Loan guarantees.
(p) Debt.
(q) Investment securities.
(r) Partially exempt payments.
(s) Determination of eligibility for exemption.
(t) Withholding relief for 2012.
(u) Effective/applicability date.
31.3402(t)-5 Application to passthrough entities.
(a) In general.
(b) Definitions.
(c) Payments from a passthrough entity.
(d) Payments to a passthrough entity.
(e) Effective/applicability date.
31.3402(t)-6 Crediting of tax withheld under section 3402(t).
(a) Crediting against income tax liability only.
(b) Taxable year of credit.
(c) Estimated tax.
(d) Effective/applicability date.
31.3402(t)-7 Transition relief from interest and penalties.
(a) Good faith exception for interest and penalties on payments
before January 1, 2014.
(b) Effective/applicability date.
[[Page 26595]]
Sec. 31.3402(t)-1 Withholding requirement on certain payments made by
government entities.
(a) In general. Except as provided in Sec. Sec. 31.3402(t)-3(b)
and 31.3402(t)-4, 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 must deduct and withhold from
the payment a tax in an amount equal to 3 percent of such payment.
(b) Special rules. See Sec. 31.3402(t)-2 for government entities
required to withhold under this section, Sec. 31.3402(t)-3 for what
constitutes a payment to a person for property or services and when
such payment is deemed to occur for purposes of this section, and Sec.
31.3402(t)-4 for payments that are excepted from withholding under this
section.
(c) Deposit and reporting requirements. See Sec. 31.6302-4 for
deposit requirements with respect to withholding under section 3402(t).
See Sec. Sec. 31.6011(a)-4(b) and 31.6051-5 for the reporting
requirements with respect to withholding under section 3402(t).
(d) Effective/applicability date. (1) Except as provided in
paragraph (d)(2) of this section, this section applies to payments by
the Government of the United States, every State, every political
subdivision thereof, and every instrumentality of the foregoing
(including multi-State agencies) to any person providing property or
services made after December 31, 2012.
(2) Payments made under a written binding contract that was in
effect on December 31, 2012, are not subject to the withholding
requirements of this section. The preceding sentence does not apply to
payments made under any contract that is materially modified after
December 31, 2012. For this purpose, a material modification includes
only a modification that materially affects the property or services to
be provided under the contract, the terms of payment for the property
or services under the contract, or the amount payable for the property
or services under the contract. Notwithstanding the foregoing, a
material modification does not include a mere renewal of a contract
that does not otherwise materially affect the property or services to
be provided under the contract, the terms of payment for the property
or services under the contract, or the amount payable for the property
or services under the contract. A material modification also does not
include a modification to the contract to the extent required by
applicable Federal, State or local law.
Sec. 31.3402(t)-2 Government entities required to withhold under
section 3402(t).
(a) In general. The requirement to withhold under section 3402(t)
and Sec. 31.3402(t)-1(a) applies to the Government of the United
States (see paragraph (b) of this section) and every State (see
paragraph (c) of this section), as well as instrumentalities of the
foregoing. The requirement also applies to political subdivisions of
every State (see paragraph (d) of this section) and their
instrumentalities, unless the small entity exception of Sec.
31.3402(t)-4(g) applies.
(b) Government of the United States. The Government of the United
States includes the legislative branch, the judicial branch, and the
executive branch, and all components of the United States Government.
Thus, departments and agencies are included within the definition of
United States Government.
(c) State. The term State includes the District of Columbia.
However, an Indian Tribal government is not considered a State for
purposes of section 3402(t) and Sec. 31.3402(t)-1(a). See section
7871(a).
(d) Political subdivision. The term political subdivision for
purposes of section 3402(t) and Sec. 31.3402(t)-1(a) is defined as a
political subdivision within the meaning of Sec. 1.103-1(b) of this
chapter, except that a subdivision of an Indian Tribal government is
not considered a political subdivision. See section 7871(a) and (d).
(e) [Reserved].
(f) Possessions of the United States. For purposes of section
3402(t) and Sec. 31.3402(t)-1(a), the government of a possession or
territory of the United States is not treated as a government entity
subject to the withholding requirements of section 3402(t)(1).
(g) Passthrough entities. See Sec. 31.3402(t)-5(c) for the
treatment of payments from certain passthrough entities as subject to
the withholding requirements of Sec. 31.3402(t)-1.
(h) Small entity exception. See Sec. 31.3402(t)-4(g) for the
exception from the withholding requirements of Sec. 31.3402(t)-1 for
political subdivisions and instrumentalities thereof making less than
$100,000,000 of payments for property or services annually.
(i) Effective/applicability date. This section applies to amounts
paid on or after January 1, 2013.
Sec. 31.3402(t)-3 Payments subject to withholding.
(a) In general. A payment is subject to withholding for purposes of
Sec. Sec. 31.3402(t)-1 through 31.3402(t)-7 when paid by a government
entity to any person, as defined in Sec. 301.7701-6(a) of this
chapter, for property or services. If, however, the government entity
uses a payment administrator to pay a person for property or services,
payment occurs when the payment administrator pays such person. The
government entity subject to the withholding requirements of Sec.
31.3402(t)-1 is liable for the withholding required and responsible for
all related reporting regardless of whether the government entity or
its payment administrator makes the payment for property or services.
For this purpose, if a government entity makes an advance payment,
interim payment, financing payment, or similar payment, the amount is
treated as paid by the government entity at the time the funds are
disbursed, regardless of whether the government entity has received or
accepted the property or services at that time.
(b) Payment threshold of $10,000-- (1) In general. The term payment
threshold means an amount equal to $10,000. The withholding
requirements of Sec. 31.3402(t)-1 will not apply to any payment that
is less than the payment threshold. Whether a payment is equal to or in
excess of the payment threshold is determined when the payment is made.
Thus, the payment threshold applies to the actual payment even if the
amount of the actual payment is incorrect (except to the extent the
anti-abuse rule in paragraph (b)(3) of this section applies). A later
determination that the amount of the payment was in error does not
affect the application of the payment threshold (except to the extent
the anti-abuse rule in paragraph (b)(3) of this section applies), so
that the payment threshold applies to the erroneous payment when made,
and separately to any additional payment intended to correct an
erroneous underpayment.
(2) Payment threshold applied per payment. If a government entity
makes a single payment to a person for property or services combining
charges for more than one transaction with the person, the
determination of whether the payment threshold provided by paragraph
(b)(1) of this section is met is based on the amount of the single
payment, rather than the amount attributable to each separate
transaction. Thus, if a government entity makes a single payment of
$10,000 or more to a person, the government entity is required to
withhold on the payment, even if the payment is for more than one
property or service. The same rule applies if a government entity
enters
[[Page 26596]]
into multiple transactions with a single person, each of which would
result in a payment of less than $10,000 if paid separately, but elects
to make a single payment covering all the transactions such that the
aggregated payment is $10,000 or more. Under these circumstances, the
government entity is required to withhold on the aggregated payment.
(3) Anti-abuse rule. If a government entity or payment
administrator divides a payment or payments to any person for property
or services into two or more payments (or permits a person providing
property or services to divide a request for payment into two or more
requests for payments) primarily to avoid the $10,000 payment threshold
provided in paragraph (b)(1) of this section on one or more of these
payments, the divided payments will be treated as a single payment made
on the date that the first of these payments is made. This rule will
not apply to a government entity or payment administrator that makes a
payment in accordance with the contractual terms, including any
requests for payments submitted by the person providing property or
services in compliance with the contractual terms, unless it knows, or
has reason to know, that the contractual terms regarding payments were
adopted, or the person providing property or services implemented such
contractual terms, with the primary purpose of avoiding the $10,000
payment threshold. In determining whether this paragraph (b)(3)
applies, a significant factor is whether the government entity or
payment administrator has exhibited a pattern or practice of dividing
payments to avoid the $10,000 payment threshold.
(4) Withholding on excepted payments. A government entity and a
person providing property or services to that government entity may
agree in writing that the government entity will or may apply section
3402(t) withholding to payments not subject to section 3402(t)
withholding, or an identified portion of payments not subject to
section 3402(t) withholding (for example, only such payments made from
a specified agency of the government entity), including payments below
the payment threshold provided in paragraph (b)(1) of this section.
This paragraph (b)(4) does not apply to government entity payments that
are subject to section 3402(t) withholding notwithstanding a
contractual provision between the parties.
(c) No withholding on successive payments. If a government entity
or its payment administrator makes a payment that is subject to the
withholding requirements of Sec. 31.3402(t)-1 to a person, no
subsequent transfer of cash or property from that payment by such
person to another person is treated as a payment subject to withholding
for purposes of Sec. Sec. 31.3402(t)-1 through 31.3402(t)-7.
(d) Payments made through a payment administrator or to a
contractor--(1) Definition. The following rules apply for purposes of
this section:
(i) A payment administrator is any person that acts with respect to
a payment solely as an agent for a government entity by making the
payment on behalf of the government entity to a person providing
property or services to, or on behalf of, the government entity.
(ii) A payment administrator is treated as a person providing
property or services for purposes of the withholding requirements of
section 3402(t) to the extent it receives a fee from the government
entity for its services as a payment administrator for the government
entity.
(2) Payments to a contractor. If a person provides property or
services to a government entity under a contract and is not a payment
administrator, the person, who is in privity with the government
entity, is treated as the person providing property or services subject
to withholding under section 3402(t) for all payments received from the
government entity, regardless of whether some payments the person
receives relate to invoices for property or services provided by
subcontractors.
(3) Application of payment threshold. Where a government entity
uses a payment administrator to make a payment, the determination of
whether the payment meets the payment threshold is made at the time the
payment administrator makes the payment to the person providing
property or services. If a government entity makes one transfer of
funds to a payment administrator that is composed of a fee to
compensate the payment administrator for its services and other funds
that are to be paid to persons providing property or services, the
determination of whether the payment threshold is met on the portion
that is the fee is made at the time of the transfer of the funds to the
payment administrator.
(e) [Reserved].
(f) Examples. This section is illustrated by the following
examples:
Example 1. (i) Prime contractor X has a contract with a
government entity to provide services and property to the government
entity. X contracts with numerous subcontractors to provide services
and property in connection with the contract. While the engagement
of any particular subcontractor is subject to approval by the
government entity, the subcontractors are not parties to the
contract between X and the government entity, and the government
entity is not a party to the contracts between X and subcontractors.
Under its contract with the government entity, X submits an invoice
for $48,000 for providing services and property to the government
entity, including charges for services and property provided by two
subcontractors, M and N. The invoice reflects charges of $16,000 for
M and $2,000 for N. The government entity pays X the entire amount
of the invoice in one payment of $48,000. X pays M for M's billed
portion of the invoice in a single payment of $16,000, and X pays N
for N's billed portion of the invoice in a single payment of $2,000.
(ii) Under the facts of this Example 1, X is the person
providing property or services to, or for the benefit of, the
government entity with respect to the entire amount of the $48,000
payment under the invoice, including the charges for services or
property provided by its subcontractors M and N. X is not a payment
administrator (as defined in paragraph (d)(1)(i) of this section)
because X is not making payments solely as an agent of the
government entity to persons providing property or services.
Instead, X makes payments to subcontractors M and N pursuant to X's
separate contracts with these subcontractors to which the government
entity is not a party. Therefore, under paragraphs (a) and (d)(2) of
this section, the entire amount of the $48,000 payment to X under
the invoice, including the charges for services and property
provided by its subcontractors M and N, is the payment subject to
withholding for purposes of section 3402(t).
(iii) Under paragraph (b)(1) of this section, the determination
whether the payment meets the payment threshold is based on the
entire amount of the payment from the government entity to X.
Withholding under section 3402(t) applies to the government entity's
$48,000 payment to X because the payment meets the payment threshold
and is not otherwise excepted from section 3402(t) withholding.
Thus, the payment is subject to withholding of 3 percent, or $1440.
(iv) Payments made by X to the subcontractors, M and N, are not
payments by the government entity or its payment administrator.
Thus, X's $16,000 payment to M and X's $2,000 payment to N for
services or property under the contract are not subject to
withholding under section 3402(t). See paragraphs (c) and (d)(2) of
this section.
(v) The government entity is liable for the $1440 withholding
required under section 3402(t) on its payment to X and is
responsible for the related reporting required under Sec. 31.6051-
5. See paragraph (a) of this section. X is the person receiving the
payment for purposes of reporting under Sec. 31.6051-5. Thus, the
government entity is responsible for furnishing X with a Form 1099-
MISC, ``Miscellaneous Income'' (or successor form), including the
entire amount of the payment ($48,000) and the entire amount of the
withholding ($1440) and filing a Form 1099-MISC with the Internal
Revenue Service.
[[Page 26597]]
Example 2. (i) Z has a contract with a government entity to make
payments as an agent of the government entity to persons providing
services or property to, or on behalf of, the government entity. The
only services Z provides under the contract are its services in
acting as an agent for the government entity in making payments to
persons providing property or services to, or on behalf of, the
government. The government entity transfers funds of $71,000 to Z,
which includes a fee of $1,000 to Z for its services as an agent
under the contract. Z then makes payments of the $70,000 remainder
of the funds to persons providing property or services to, or on
behalf of, the government entity, including a single payment of
$18,000 to P and a single payment of $7,000 to R.
(ii) Under the facts of this Example 2, Z is a payment
administrator (as defined in paragraph (d)(1)(i) of this section)
because Z makes payments solely as an agent for the government
entity to persons providing property or services to, or on behalf
of, the government entity. Under paragraphs (a) and (d) of this
section, Z is not treated as a person providing property or services
with respect to $70,000 of the transfer of funds (the amount of the
funds to be paid to persons providing property or services to, or on
behalf of, the government entity). Because Z is not treated as a
person providing property or services with respect to this $70,000
portion of the funds, this portion of the transfer of funds by the
government entity to Z is not subject to withholding under section
3402(t) when transferred to Z.
(iii) Under paragraph (d)(1)(ii) of this section, the payment
administrator is treated as a person providing property or services
with respect to the portion of the $71,000 fund transfer that is a
fee for its services as a payment administrator, or $1,000. Under
paragraph (d)(3) of this section, the determination of whether the
payment threshold is met with respect to the fee portion of the
payment from the government entity to Z at the time of the payment
from the government entity to Z is made. Because the $1,000 fee
portion of the payment falls beneath the $10,000 payment threshold,
withholding under section 3402(t) is not required with respect to
that portion of the payment.
(iv) P and R are persons providing services or property to, or
on behalf of, the government entity with respect to the payments
they receive from Z.
(v) Withholding is required under section 3402(t) on the payment
by Z, a payment administrator, to a person providing property or
services to, or on behalf of, a government entity provided the
payment meets the payment threshold and is not otherwise excepted.
Under paragraph (d)(3) of this section, the determination of whether
the payment threshold is met on the payment Z makes to a person
providing property or services is made at the time Z pays the person
providing property or services. Under the facts of this Example 2,
Z's payment to P of $18,000 meets the payment threshold, and
therefore withholding of $540 under section 3402(t) applies. Z's
payment to R of $7,000 does not meet the payment threshold, and
therefore, no withholding under section 3402(t) is required.
(vi) The government entity, not Z, is liable for any withholding
required under section 3402(t) on the payments from Z to persons
providing property or services. Also, the government entity, not Z,
is responsible for any reporting required under Sec. 31.6051-5 on
the payment from Z to persons providing property or services. See
paragraph (a) of this section. Each person providing property or
services for which withholding is required, not Z, is the person
receiving the payment for purposes of the reporting required under
Sec. 31.6051-5 if withholding under section 3402(t) applies. Thus,
the government entity is responsible for furnishing P Form 1099-MISC
reflecting the amount of the payment from Z to P of $18,000 and the
amount of withholding of $540 and filing a Form 1099-MISC with the
Internal Revenue Service.
Example 3. (i) On March 1, 2013, a government entity makes a
payment of $12,000 to Y for providing property or services. The
payment for property or services is not excepted from withholding
under Sec. 31.3402(t)-4. On March 20, 2013, it is determined that
the payment should have been $9,000, and therefore, Y owes the
government entity $3,000 to repay the excess payment.
(ii) The facts are the same as in paragraph (i) of this Example
3, except that, in addition, on April 30, 2013, the government
entity makes a net payment of $6,000 to Y for providing property or
services, which is based on the payment of a bill for property or
services equal to $11,000, which is offset by the repayment of the
$3,000 debt that Y owes with respect to the erroneous March 1, 2013,
payment, and the repayment of a $2,000 unrelated debt to the Federal
Government. No exception from withholding under Sec. 31.3402(t)-4
applies to the $11,000 amount.
(iii) The facts are the same as in paragraph (ii) of this
Example 3, except that, in addition, on May 31, 2013, the government
entity makes a single payment of $14,000 to Y that consists of a
$9,000 portion that is subject to section 3402(t) withholding
(without regard to the payment threshold) and a $5,000 portion that
is excepted from section 3402(t) withholding under Sec. 31.3402(t)-
4.
(iv) Under the facts of paragraph (i) of this Example 3, the
payment on March 1, 2013, is subject to withholding under section
3402(t) because it meets the payment threshold under paragraph (d)
of this section. The government entity is liable for withholding
section 3402(t) tax on the payment equal to 3% of $12,000, or $360.
The subsequent determination on March 20, 2013, that an incorrect
amount was paid to Y does not affect the application of the $10,000
payment threshold to the payment on March 1, 2013. If there were no
additional payments or repayments between the government entity and
Y during 2013, and if the government entity correctly withheld $360
under section 3402(t), the government entity would issue Y a 2013
Form 1099-MISC (or successor form) reporting $12,000 of payments
subject to section 3402(t) withholding and $360 of withholding.
(v) Under the facts of paragraph (ii) of this Example 3, the
payment on April 30, 2013, is also subject to withholding under
section 3402(t). As an initial matter, the government entity
calculates its liability for withholding section 3402(t) on the
payment equal to 3% of $11,000, or $330, because the amount of the
payment for purposes of section 3402(t) and the payment threshold is
not reduced by the amount of offsets for debts owed the government.
Thus, the payment exceeds the payment threshold under paragraph (d)
of this section. However, the repayment within the same calendar
year of the $3,000 excess amount which was paid on March 1, 2013,
means that the government is entitled to correct its income tax
withholding liability with respect to Y by the amount of section
3402(t) withholding paid with respect to the $3,000, or $90. Thus
the net withholding amount deducted from the $6,000 net payment is
$240. The offset of $2,000 for other unrelated debt owed the Federal
Government has no effect on section 3402(t) liability. Neither the
offset for the $3,000 repayment nor the offset for the $2,000 other
debt affects the application of the payment threshold to the March
1, 2013, payment or the April 30, 2013, payment. If there were no
additional payments or repayments between the government entity and
Y during 2013, and if the government entity withheld properly, the
government entity would be required to furnish Y a Form 1099-MISC
(or successor form) reporting $20,000 of payments subject to section
3402(t) withholding ($12,000 plus $11,000 less $3,000 repayment) and
$600 withholding ($360 plus $330 less $90) and to file a Form 1099-
MISC with the Internal Revenue Service.
(vi) Under the facts of this paragraph (iii) of this Example 3,
the government entity is not required to withhold on the payment
because only $9,000 of the payment is potentially subject to section
3402(t) withholding and this amount does not meet the payment
threshold. However, under the optional rule of Sec. 31.3402(t)-
4(r), because only a portion of the payment is exempt from section
3402(t) withholding, the government entity may treat the entire
amount of the payment as subject to section 3402(t) withholding
provided the payee has agreed to this withholding. If the government
entity applies the optional rule of Sec. 31.3402(t)-4(r), the
payment threshold would be met and the government entity would
withhold under section 3402(t) the amount of $420, or 3% of the
$14,000 payment. If the government entity treats the entire amount
of the payment as subject to section 3402(t) withholding and
withholds, the entire amount of the payment ($14,000) plus the $420
withholding would be reported on Form 1099-MISC (or successor form).
(g) Effective/applicability date. This section applies to payments
by the Government of the United States, every State, every political
subdivision thereof, and every instrumentality of the foregoing
(including multi-State agencies) to any person providing property or
services made after December 31, 2012.
[[Page 26598]]
Sec. 31.3402(t)-4 Certain payments excepted from withholding.
(a) Payments subject to withholding under chapter 3 or chapter 24
(other than section 3406)--(1) In general. Payments are excepted from
withholding under section Sec. 31.3402(t)-1(a) if they are subject to
withholding under chapter 3 of the Internal Revenue Code (Code) or
under sections 3401 through 3405 (other than section 3402(t)).
(2) Payments subject to withholding under chapter 3. Payments
subject to withholding under chapter 3 of the Code include those
payments that are subject to, but exempt from, withholding under
chapter 3 of the Code on the ground that the payments are exempt from
United States income tax pursuant to an income tax convention to which
the United States is a party.
(3) Payments subject to withholding at election of payee. For
purposes of this exception from section 3402(t), payments for which the
payee may elect withholding are exempt from withholding under Sec.
31.3402(t)-1(a) regardless of whether the payee in fact makes such an
election. These payments include--
(i) Unemployment compensation as defined in section 85(b) (see
section 3402(p)(2));
(ii) Social security benefits as defined in section 86(d) (see
section 3402(p)(1)(C)(i));
(iii) Any payment referred to in the second sentence of section
451(d) that is treated as insurance proceeds, relating to certain
disaster payments received under the Agricultural Act of 1949, as
amended, or Title II of the Disaster Assistance Act of 1988 (see
section 3402(p)(1)(C)(ii));
(iv) Any amount that is includible in gross income under section
77(a), relating to amounts received as loans from the Commodity Credit
Corporation that the taxpayer has elected to treat as income (see
section 3402(p)(1)(C)(iii)); and
(v) Any payment of an annuity to an individual.
(b) Payments subject to withholding under section 3406 with backup
withholding deducted. A payment is not subject to withholding under
section 3402(t) if the payment is subject to withholding under section
3406, relating to backup withholding, and if backup withholding is
actually being withheld from such payment.
(c) [Reserved].
(d) Payments for real property. Payments for real property are not
subject to the withholding requirements of Sec. 31.3402(t)-1. For
purposes of this exception, the term payments for real property
includes the purchase and the leasing of real property (including
payments made by a lessee to a lessor related to the use or occupancy
of the leased property and made in accordance with the terms of the
applicable lease, but not including either a payment for construction,
or payment to a person other than the lessor, even if related to the
use or occupancy of the leased property and required by the terms of
the lease). However, payments for the construction of buildings or
other public works projects, such as bridges or roads, are not payments
for real property.
(e) Payments to government entities, tax-exempt organizations, and
foreign governments--(1) Government entities. Payments are not subject
to withholding under section 3402(t) if the payments are made to
government entities that are subject to the withholding requirements of
section 3402(t)(1) pursuant to Sec. 31.3402(t)-2. For purposes of this
exception, payments to government entities that qualify for the
exception for political subdivisions and instrumentalities making less
than $100,000,000 of payments for property and services annually, as
provided by section 3402(t)(2)(G) and paragraph (g) of this section,
are treated as payments to government entities that are subject to the
withholding requirements of section 3402(t)(1).
(2) Tax-exempt organizations. Payments to an organization that is
exempt from taxation under section 501(a) as an organization described
in section 501(c), 501(d), or 401(a) are not subject to withholding
under section 3402(t).
(3) Foreign governments. Payments to foreign governments are not
subject to withholding under section 3402(t). For purposes of this
paragraph (e), a government of a possession or territory of the United
States is treated as a foreign government.
(f) Payments made pursuant to a classified or confidential
contract. Payments made pursuant to a classified or confidential
contract described in section 6050M(e)(3) are not subject to
withholding under section 3402(t).
(g) Exception for political subdivisions or instrumentalities
thereof making less than $100,000,000 of payments for property or
services annually--(1) In general. Section 3402(t) withholding is not
required on payments made by a political subdivision of a State (or any
instrumentality of a political subdivision of a State) that makes less
than $100,000,000 of payments for property or services annually.
(2) Determination of whether an entity is a political subdivision
of a State. Whether an entity is a political subdivision of a State for
purposes of paragraph (g)(1) of this section is determined under Sec.
31.3402(t)-2(d).
(3) Determination of whether a political subdivision or
instrumentality makes less than $100,000,000 of payments for property
or services annually--(i) General determination rule. In general,
whether a political subdivision or instrumentality makes less than
$100,000,000 of payments for property or services annually for purposes
of paragraph (g)(1) of this section is determined for each calendar
year based on the total payments made by the entity for property or
services in the entity's accounting year ending with or within the
second preceding calendar year. For this purpose, payments that qualify
for the exceptions from withholding under Sec. 31.3402(t)-4(a) through
(q) (or would have qualified had these regulations been in effect) are
not included in determining total payments made. However, payments that
are not subject to withholding because the payments are less than the
$10,000 payment threshold described in Sec. 31.3402(t)-3(b), or based
on the applicability date rules or transition rules contained in Sec.
31.3402(t)-1(d), Sec. 31.3402(t)-2(i), Sec. 31.3402(t)-3(g), Sec.
31.3402(t)-4(u), or Sec. 31.3402(t)-5(e), or based on the withholding
relief for 2012 provided in Sec. 31.3402(t)-4(t), but are not
otherwise excepted, are included in determining total payments. For
this purpose, the accounting year refers to the fiscal year (consisting
of 12 months) or calendar year used by the government entity in setting
its budgets and keeping its accounting books. If a political
subdivision or instrumentality was not in existence in the second
preceding calendar year or if no 12-month accounting year exists ending
in the second preceding calendar year, eligibility for this exception
is determined based on the total projected payments for the accounting
year consisting of 12 months ending in that calendar year.
(ii) Optional determination rule. A political subdivision of a
state or an instrumentality of that political subdivision may treat
itself as eligible for the exception provided in paragraph (g)(1) of
this section for a calendar year if the average of the total payments
calculated under the rules of paragraph (g)(3)(i) of this section for
four of the five successive accounting years, the fifth year of which
is the entity's determination year, is less than $100,000,000. For this
purpose, for a calendar year the political subdivision's
[[Page 26599]]
or instrumentality's determination year is the accounting year ending
with or within the second preceding calendar year. If a political
subdivision or instrumentality withholds and pays (or deposits) tax
under section 3402(t) for a calendar year and files a return reporting
the withheld tax under section 3402(t) for that calendar year based on
the general determination rule of paragraph (g)(3)(i) of this section,
it is deemed to have waived any right to use the optional determination
rule of this paragraph (g)(3)(ii) of this section for that calendar
year.
(4) Examples. The following examples illustrate the provisions of
paragraph (g) of this section:
Example 1. (i) Government entity X, which qualifies as a
political subdivision or instrumentality of a political subdivision
for calendar years 2013 and 2014, uses a fiscal year ending June 30
to determine its budgets and to keep its accounting books. During
its fiscal year ending June 30, 2011, X made payments to persons for
property and services of $200,000,000, including $102,000,000 of
payments that would have been excepted under Sec. 31.3402(t)-4(a)
through (q) if section 3402(t) had been in effect.
(ii) During its fiscal year ending June 30, 2012, X made
payments for property and services of $210,000,000, including
$106,000,000 that would have been excepted under Sec. 31.3402(t)-
4(a) through (q) if section 3402(t) had been in effect. The payments
X made for property or services during the fiscal year ending June
30, 2012, included $15,000,000 of payments below the $10,000 payment
threshold described in Sec. 31.3402(t)-3(b).
(iii) For the calendar year 2013, the general determination rule
of paragraph (g)(3)(i) of this section applies to determine whether
X is eligible for the exception provided in paragraph (g)(1) of this
section based on the total payments X made for its accounting year
ending June 30, 2011. Because total payments for this purpose
exclude payments that would be excepted under Sec. 31.3402(t)-4(a)
through (q), total payments were $200,000,000 less $102,000,000, or
$98,000,000. Therefore, for calendar year 2013, X would be eligible
for the exception provided in paragraph (g)(1) of this section, and
would not be required to withhold under section 3402(t).
(iv) For the calendar year 2014, the general determination rule
of paragraph (g)(3)(i) of this section applies to determine whether
X is eligible for the exception provided in paragraph (g)(1) of this
section based on the total payments it made for its accounting year
ending June 30, 2012. Because total payments for this purpose
exclude payments that would have been excepted under Sec.
31.3402(t)-4(a) through (q), but include payments below the $10,000
payment threshold described in Sec. 31.3402(t)-3(b), total payments
were $210,000,000 less $106,000,000, or $104,000,000. Therefore, for
calendar year 2014, X would not qualify for the exception provided
in paragraph (g)(1) of this section and would be required to
withhold under section 3402(t), provided it is not eligible for or
does not use the exception under the optional determination rule
provided in paragraph (g)(3)(ii) of this section.
Example 2. (i) Government entity Y, which qualifies as a
political subdivision or instrumentality of a political subdivision
for calendar years 2013 and 2014, uses a fiscal year ending June 30
to determine its budgets and to keep its accounting books. During
its fiscal year ending June 30, 2007, Y made payments to persons for
property and services of $195,000,000, including $110,000,000 of
payments that would have been excepted under Sec. 31.3402(t)-4(a)
through (q) if section 3402(t) had been in effect.
(ii) During its fiscal year ending June 30, 2008, Y made
payments to persons for property and services of $204,000,000,
including $115,000,000 of payments that would have been excepted
under Sec. 31.3402(t)-4(a) through (q) if section 3402(t) had been
in effect.
(iii) During its fiscal year ending June 30, 2009, Y made
payments to persons for property and services of $215,000,000,
including $124,000,000 of payments that would have been excepted
under Sec. 31.3402(t)-4(a) through (q) if section 3402(t) had been
in effect.
(iv) During its fiscal year ending June 30, 2010, Y made
payments to persons for property and services of $225,000,000,
including $130,000,000 of payments that would have been excepted
under Sec. 31.3402(t)-4(a) through (q) if section 3402(t) had been
in effect.
(v) During its fiscal year ending June 30, 2011, Y made payments
to persons for property and services of $275,000,000, including
$135,000,000 of payments that would have been excepted under Sec.
31.3402(t)-4(a) through (q) if section 3402(t) had been in effect.
(vi) During its fiscal year ending June 30, 2012, Y made
payments for property and services of $235,000,000, including
$140,000,000 that would have been excepted under Sec. 31.3402(t)-
4(a) through (q) if section 3402(t) had been in effect.
(vii) For the calendar year 2013, the general determination rule
of paragraph (g)(3)(i) of this section applies to determine whether
Y is eligible for the exception provided in paragraph (g)(1) of this
section based on the total payments Y made for its accounting year
ending June 30, 2011. Because total payments for this purpose
exclude payments that would be excepted under Sec. 31.3402(t)-4(a)
through (q), total payments were $275,000,000 less $135,000,000, or
$140,000,000. Therefore, for calendar year 2013, Y would not qualify
for the exception provided in paragraph (g)(1) of this section and
would be required to withhold under section 3402(t), unless it was
eligible for, and used, the optional determination rule provided in
paragraph (g)(3)(ii) of this section.
(viii) For the calendar year 2013, under the optional
determination rule of paragraph (g)(3)(ii) of this section, Y would
have total payments for this purpose in the accounting year ending
June 30, 2007, of $85,000,000; in the accounting year ending June
30, 2008, of $89,000,000; in the accounting year ending June 30,
2009, of $91,000,000; in the accounting year ending June 30, 2010,
of $95,000,000; and in the accounting year ending June 30, 2011, of
$140,000,000. The average of four of those years (excluding the
highest year of $140,000,000) would be $90,000,000 (85,000,000 plus
89,000,000 plus 91,000,000 plus 95,000,000 equals 360,000,000;
360,000,000 divided by 4 equals 90,000,000). Thus, for the calendar
year 2013, under the optional determination rule of paragraph
(g)(3)(ii) of this section, Y is eligible for the exception provided
in paragraph (g)(1) of this section and is not required to withhold
under section 3402(t). Alternatively, Y could apply the general
determination rule, ignore the optional determination rule, and
withhold under section 3402(t).
(ix) For the calendar year 2014, under the general determination
rule of paragraph (g)(3)(i) of this section, Y has total payments of
$95,000,000. Thus, Y is eligible for the exception provided in
paragraph (g)(1) of this section and is not required to withhold
under section 3402(t).
(h) Payments made in connection with a public assistance or public
welfare program--(1) In general. Section 3402(t) withholding does not
apply to payments made in connection with a public assistance or public
welfare program for which eligibility is determined by a needs or
income test.
(2) Needs or income test. Eligibility for a public assistance or
public welfare program is not considered to be determined by a needs or
income test if eligibility for the program is based solely on the age
of the beneficiary. A public assistance program providing disaster
relief to victims of a natural or other disaster is considered to be a
program for which eligibility is determined under a needs test.
Payments under government programs to provide health care or other
services that are not based on the needs or income of the recipient are
subject to section 3402(t) withholding, including programs where
eligibility is based on the age of the beneficiary.
(3) Payments to third parties. The exception provided by this
paragraph (h) also applies to payments made to third parties to provide
benefits to beneficiaries under a public assistance or public welfare
program for which eligibility is determined by a needs or income test.
(4) Allocation of payments. If only a portion of a payment is made
in connection with a public assistance or public welfare program for
which eligibility is determined by a needs or income test, the portion
that is made in connection with the program and therefore is not
subject to section 3402(t)
[[Page 26600]]
withholding may be determined using any reasonable allocation method.
If the government entity makes a reasonable, good faith determination
that either the excludable or the nonexcludable portion is
insignificant in comparison to the entire payment, the insignificant
portion may be disregarded for purposes of this paragraph (h) (so that
the entire payment is either eligible or ineligible for the exception
provided by this paragraph (h)).
(i) Payments made to any government employee with respect to his or
her services. Section 3402(t) withholding does not apply to payments
made to any government employee with respect to his or her services as
an employee of the government. This exception applies to contributions
to deferred compensation plans on behalf of an employee, contributions
to employee benefit plans on behalf of an employee, fringe benefits
provided to employees, and payments to employees under accountable
plans for expenses incurred by the employee for the employee's travel
while on government business. This exception also applies to payments
made by the government employee under accountable plans (as defined in
Sec. 1.62-2(c)(2) of this chapter) to providers of the employee`s
travel, meals, and lodging when the government employee is traveling on
government business.
(j) Payments received by nonresident alien individuals and foreign
corporations. Section 3402(t) withholding does not apply to any payment
received by a nonresident alien individual or foreign corporation for
providing services or property if the payment is derived from sources
outside the United States, as determined under sections 861, 862, 863,
and 865, and is not effectively connected with the conduct of a trade
or business within the United States by the nonresident alien
individual or foreign corporation.
(k) Payments to Indian Tribal governments. Section 3402(t)
withholding does not apply to any payment made to an Indian Tribal
government or its political subdivisions.
(l) Payments in emergency, disaster, or hardship situations. The
Internal Revenue Service may provide by publication in the Internal
Revenue Bulletin (see Sec. 601.601(d)(2)(ii)(b) of this chapter) for
additional exceptions from section 3402(t) withholding for certain
payments made in an emergency, disaster, or hardship situation if the
Internal Revenue Service determines that withholding from the payments
would impede a government entity's efforts to respond to the emergency,
disaster, or hardship.
(m) Grants--(1) In general. Section 3402(t) withholding does not
apply to any grant as defined in paragraph (m)(2) of this section. This
exclusion does not apply to the use by a government entity of the
proceeds of a grant received by that government entity (unless the
government entity uses the proceeds to make a grant).
(2) Definition of grant. For purposes of this paragraph (m), a
grant is a transfer of funds by a government entity to a recipient
(which may be a state government, local government, or other recipient)
pursuant to an agreement reflecting a relationship between the
government entity and the recipient when the principal purpose of the
relationship is to transfer a thing of value to the recipient to carry
out a public purpose of support or stimulation authorized by law
instead of acquiring (by purchase, lease, or barter) property or
services for the direct benefit or use of the government entity, and
substantial involvement is not expected between the government entity
and the recipient when carrying out the activity contemplated in the
agreement.
(n) Sales tax, excise tax, value-added tax, and other taxes. For
purposes of this section, section 3402(t) withholding applies to any
payment of sales tax, excise tax, value-added tax, or other tax made as
part of a payment to any person providing property or services.
Notwithstanding the foregoing, the payment of sales tax, excise tax,
value-added tax, or other tax may be excluded from section 3402(t)
withholding, provided this exclusion is applied consistently to all
payments to a given payee during the calendar year.
(o) Loan guarantees. Section 3402(t) withholding does not apply to
a loan guarantee or the payment of principal and interest on a loan
pursuant to a loan guarantee. However, if a government entity (through
a right of subrogation or similar right) assumes the operation of a
project or activity funded by the loan, section 3402(t) withholding
applies to payments by the government entity for property or services
relating to the project or activity unless otherwise excepted under
this section.
(p) Debt. Section 3402(t) withholding does not apply to payment of
principal on a loan. However, if a government entity issues a debt
obligation to a person providing services as all or part of the
purchase price, the debt obligation's fair market value is subject to
section 3402(t) withholding, unless an exception applies. If a
government entity issues a debt obligation to a person providing
property as all or part of the purchase price, the debt obligation's
issue price as determined under section 1273 or section 1274, whichever
is applicable to the debt obligation, is subject to section 3402(t)
withholding, unless an exception applies. In lieu of the issue price,
the government entity and the person providing property may agree to
treat the stated principal amount of the debt obligation as the payment
amount attributable to the debt obligation that is subject to section
3402(t) withholding. If a government entity uses a third party debt
obligation (a debt obligation issued by any entity other than that
government entity) to pay for property or services, the fair market
value of the debt obligation is subject to section 3402(t) withholding,
unless an exception applies.
(q) Investment securities. Section 3402(t) withholding does not
apply to any payments to purchase stock, bonds, or other securities
primarily for investment purposes.
(r) Partially exempt payments. If a payment includes both an amount
subject to section 3402(t) withholding and an amount that is not
subject to section 3402(t) withholding, section 3402(t) withholding
applies only to the relevant portion of the payment. Notwithstanding
the foregoing, a government entity may apply section 3402(t)
withholding to the entire payment provided the payee has agreed to this
withholding.
(s) Authorization for additional rules and procedures on payees and
payments exempt from section 3402(t) withholding. The Commissioner is
authorized to provide rules and procedures concerning payments that are
exempt from withholding, including the classification of additional
types of payees or payments as exempt from section 3402(t) withholding,
and procedures under which a government entity may determine the
eligibility of a payee for an exemption from section 3402(t)
withholding (and may rely on this determination notwithstanding the
payee's eligibility for this exemption), in revenue procedures,
notices, or other guidance published in the Internal Revenue Bulletin
(see Sec. 601.601(2) of this chapter).
(t) Withholding relief for 2012. Withholding under section 3402(t)
is not required with respect to payments made before January 1, 2013.
Any person that deducts and withholds tax under section 3402(t) from
payments made in 2012 shall deposit and report such tax withheld
pursuant to Sec. 31.6302-4 and Sec. 31.6011(a)-4(b), and include the
payment and the amount withheld on Form 1099-MISC, ``Miscellaneous
Income,'' or successor form, unless the amount of tax withheld
[[Page 26601]]
under section 3402(t) is repaid to the payee before January 1, 2013.
(u) Effective/applicability date. This section applies to payments
by the Government of the United States, every State, every political
subdivision thereof, and every instrumentality of the foregoing
(including multi-State agencies) to any person providing property or
services made after December 31, 2012, except that paragraph (t) of
this section applies to payments made after December 31, 2011, and
before January 1, 2013.
Sec. 31.3402(t)-5 Application to passthrough entities.
(a) In general. Section 3402(t)(1) does not apply to payments made
by passthrough entities except as described in paragraph (c) of this
section. In addition, section 3402(t)(1) applies to payments made to
passthrough entities except as described in paragraph (d) of this
section.
(b) Definitions. The following definitions apply for purposes of
this section:
(1) Passthrough entity. The term passthrough entity means a
partnership (for Federal income tax purposes) or an S corporation.
(2) Owner. The term owner means a partner (for Federal income tax
purposes) or an S corporation shareholder.
(3) Ownership percentage. The term ownership percentage means an
owner's interest, as a percentage, in partnership profits or capital
(whichever is greater) in the case of a partnership, or an owner's
interest, as a percentage, in S corporation stock in the case of an S
corporation.
(4) Testing day. The term testing day refers to the first day of a
passthrough entity's taxable year.
(c) Payments from a passthrough entity--(1) General rule. Section
3402(t)(1) does not apply to payments made by passthrough entities
during the taxable year, except as provided in paragraph (c)(2) of this
section.
(2) Exception. Section 3402(t)(1) applies to any payment during the
taxable year from a passthrough entity if the aggregate ownership
percentage held, directly or indirectly, in the entity on the testing
day by one or more of the government entities described in section
3402(t)(1) is at least 80 percent. For purposes of this paragraph
(c)(2), any manipulation of the ownership percentage with an intent to
avoid application of section 3402(t) will be recharacterized as
appropriate to reflect the actual ownership percentage.
(d) Payments to a passthrough entity--(1) General rule. Section
3402(t)(1) applies to payments made to passthrough entities during the
taxable year, except as provided in paragraph (d)(2) of this section.
(2) Exception--(i) In general. Section 3402(t)(1) does not apply to
any payment during the taxable year to a passthrough entity if the
aggregate ownership percentage held, directly or indirectly, in the
entity on the testing day by one or more persons each of which is
described in section 3402(t)(2)(E) or is an Indian Tribal government is
at least 80 percent. For purposes of this paragraph (d)(2)(i), any
manipulation of the ownership percentage with an intent to avoid
application of section 3402(t) will be recharacterized as appropriate
to reflect the actual ownership percentage, if the government entity
making the payment knew or should have known that the payee's ownership
percentage had been manipulated with intent to avoid application of
section 3402(t).
(ii) Payments derived from sources outside the United States.
Section 3402(t)(1) does not apply to any payment during the taxable
year to a partnership if the aggregate ownership percentage held,
directly or indirectly, in the partnership on the testing day by one or
more persons each of which is a nonresident alien individual or foreign
corporation is at least 80 percent, and the payment to the partnership
is not effectively connected with the conduct of a trade or business
within the United States by the partnership, and is derived from
sources outside the United States, as determined under sections 861,
862, 863, and 865. For purposes of this paragraph (d)(2)(ii), any
manipulation of the ownership percentage with an intent to avoid
application of section 3402(t) will be recharacterized as appropriate
to reflect the actual ownership percentage, if the government entity
making the payment knew or should have known that the payee's ownership
percentage had been manipulated with intent to avoid application of
section 3402(t).
(e) Effective/applicability date. This section applies to payments
by the Government of the United States, every State, every political
subdivision thereof, and every instrumentality of the foregoing
(including multi-State agencies) to any person providing property or
services made after December 31, 2012.
Sec. 31.3402(t)-6 Crediting of tax withheld under section 3402(t).
(a) Credit against income tax liability only. Tax withheld under
section 3402(t) is allowable as a credit against the tax imposed by
Subtitle A of the Internal Revenue Code (Code) upon the recipient of
the income in accordance with the rules set forth in section 31(a) and
Sec. 1.31-1 of this chapter. Tax withheld under section 3402(t) is not
allowable as a credit against taxes imposed on wages or compensation of
employees under Chapters 21, 22, 23, or 24 of the Code.
(b) Taxable year of credit. Tax withheld under section 3402(t)
during any calendar year is allowed as a credit against the tax imposed
by Subtitle A in accordance with section 31(a)(2) of the Code and Sec.
1.31-1(b) of this chapter.
(c) Estimated tax. The tax withheld under section 3402(t) and
allowable as a credit under section 31(a) may be taken into account in
determining estimated tax liability under sections 6654 and 6655 for
the taxable year against which the taxes may be credited under
paragraph (b) of this section.
(d) Effective/applicability date. This section applies with respect
to amounts withheld under section 3402(t) after December 31, 2012.
Sec. 31.3402(t)-7 Transition relief from interest and penalties.
(a) Good faith exception for interest and penalties on payments
made before January 1, 2014. Government entities that make a good faith
effort to comply with the withholding requirements in Sec. 31.3402(t)-
1 will not be liable for interest and penalties with respect to income
tax withholding under section 3402(t) that the government entity failed
to withhold from payments made before January 1, 2014. However, this
provision does not relieve the government entity of liability for
income tax that it failed to withhold. See, however, Sec. 31.3402(d)-
1.
(b) Effective/Applicability Date. This section applies with respect
to payments made after December 31, 2012.
0
Par. 3. Section 31.3406(g)-2 is amended by adding paragraphs (h) and
(i) to read as follows:
Sec. 31.3406(g)-2 Exception for reportable payment for which
withholding is otherwise required.
* * * * *
(h) Certain payments made by government entities. A government
entity that is required to withhold both on reportable payments
pursuant to section 3406(a) and on certain payments pursuant to section
3402(t) must comply with the withholding requirements of section 3406,
and not section 3402(t), for each payment to which both types of
withholding would apply. Pursuant to section 3402(t)(2)(B), withholding
under section 3402(t) does not apply to a given payment if amounts are
being withheld
[[Page 26602]]
under section 3406 for that payment. If a government entity fails to
withhold as required under section 3406, the payment will not be deemed
to be subject to withholding under another provision of the Internal
Revenue Code for purposes of this paragraph (h). Thus, even if the
government entity withholds on such payment pursuant to section
3402(t), it will remain liable for the amount required to be withheld
under section 3406.
(i) Effective/applicability date. Paragraph (h) of this section
relating to certain payments made by government entities applies to
payments made by government entities under section 3402(t) made after
December 31, 2012.
0
Par. 4. Section 31.6011(a)-4 is amended by revising paragraphs (b)(4)
and (5) and adding paragraph (b)(6) and revising paragraph (d) to read
as follows:
Sec. 31.6011(a)-4 Returns of income tax withheld.
* * * * *
(b) * * *
(4) Pensions, annuities, IRAs, and certain other deferred income
subject to withholding under section 3405;
(5) Reportable payments subject to backup withholding under section
3406; and
(6) Certain payments made by government entities subject to
withholding under section 3402(t).
* * * * *
(d) Effective/applicability date. Paragraph (b)(6) of this section
(relating to certain payments made by government entities subject to
withholding under section 3402(t)) applies to payments made by
government entities under section 3402(t) made after December 31, 2012.
0
Par. 5. Section 31.6051-5 is added to read as follows:
Sec. 31.6051-5 Statement and information return required in case of
withholding by government entities.
(a) Statements required from government entities. Every government
entity required to deduct and withhold tax under section 3402(t) must
furnish to the payee a written statement containing the information
required by paragraph (d) of this section.
(b) Information returns required from government entities. Every
government entity required to furnish a payee statement under paragraph
(a) of this section must file a duplicate of such statement with the
Internal Revenue Service. Such duplicate constitutes an information
return.
(c) Prescribed form. The prescribed form for the statement required
by this section is Form 1099-MISC, ``Miscellaneous Income,'' or any
successor form.
(d) Information required. Each statement on Form 1099-MISC (or any
successor form) must show the following--
(1) The name, address, and taxpayer identification number of the
person receiving the payment subject to withholding under section
3402(t);
(2) The amount of the payment withheld upon;
(3) The amount of tax deducted and withheld under section 3402(t);
(4) The name, address, and taxpayer identification number of the
government entity filing the form;
(5) A legend stating that such amount is being reported to the
Internal Revenue Service; and
(6) Such other information as is required by the form and the
instructions.
(e) Time for furnishing statements. The statement required by
paragraph (a) of this section must be furnished to the payee no later
than January 31 of the year following the calendar year in which the
payment subject to withholding was made. However, the February 15 due
date under section 6045 applies to the statement if the statement is
furnished in a consolidated reporting statement under section 6045. See
Sec. Sec. 1.6045-1(k(3), 1.6045-2(d)(2), 1.6045-3(e)(2), 1.6045-
4(m)(3), and 1.6045-5(a)(3)(ii) of this chapter.
(f) Cross references. For provisions relating to the time for
filing the information returns required by this section with the
Internal Revenue Service and to extensions of the time for filing the
returns, see Sec. Sec. 31.6071(a)-1(a)(3), 1.6081-1 of this chapter,
and 1.6081-8 of this chapter. For penalties applicable to failure to
file information returns and furnish payee statements, see sections
6721 through 6724.
(g) Effective/applicability date. This section applies for calendar
years beginning on or after January 1, 2013.
0
Par. 6. Section 31.6071(a)-1 is amended by revising paragraphs
(a)(3)(i) and (g) to read as follows:
Sec. 31.6071(a)-1 Time for filing returns and other documents.
(a) * * *
(3) Information returns--(i) General rule. Each information return
in respect of wages as defined in the Federal Insurance Contributions
Act or of income tax withheld from wages as required under Sec.
31.6051-2 or of income tax withheld from payments by government
entities as required under Sec. 31.6051-5 must be filed on or before
the last day of February (March 31 if filed electronically) of the year
following the calendar year for which it is made, except that, if a tax
return under Sec. 31.6011(a)-5(a) is filed as a final return for a
period ending prior to December 31, the information return must be
filed on or before the last day of the second calendar month following
the period for which the tax return is filed.
* * * * *
(g) The requirement under paragraph (a)(3)(i) of this section
pertaining to the information return in respect of income tax withheld
by government entities as required by Sec. 31.6051-5 of this part
applies for calendar years beginning on or after January 1, 2013.
0
Par. 7. Section 31.6302-1 is amended by:
1. Revising paragraph (e)(1)(iii)(C).
2. Adding paragraph (e)(1)(iii)(E).
3. Revising paragraph (n).
The revisions and additions read as follows:
Sec. 31.6302-1 Deposit rules for taxes under the Federal Insurance
Contributions Act (FICA) and withheld income taxes.
* * * * *
(e) * * *
(1) * * *
(iii) * * *
(C) Certain annuities described in section 3402(o)(1)(B);
* * * * *
(E) Certain payments made by government entities under section
3402(t); and
* * * * *
(n) Effective/applicability date. Except for the deposit of
employment taxes attributable to payments made by government entities
under section 3402(t), Sec. Sec. 31.6302-1 through 31.6302-3 apply
with respect to the deposit of employment taxes attributable to
payments made after December 31, 1992. Paragraph (e)(1)(iii)(E) of this
section applies with respect to the deposit of employment taxes
attributable to payments made by government entities under section
3402(t) made after December 31, 2012.
* * * * *
0
Par. 8. Section 31.6302-4 is amended by:
0
1. Revising paragraph (b)(4).
0
2. Revising paragraph (b)(5).
0
3. Adding paragraph (b)(6).
0
4. Revising paragraph (e).
The revisions and additions read as follows:
Sec. 31.6302-4 Deposit rules for withheld income taxes attributable
to nonpayroll payments.
* * * * *
[[Page 26603]]
(b) * * *
(4) Amounts withheld under section 3405, relating to withholding on
pensions, annuities, IRAs, and certain other deferred income;
(5) Amounts withheld under section 3406, relating to backup
withholding with respect to reportable payments; and
(6) Amounts withheld under section 3402(t), relating to certain
payments made by government entities.
* * * * *
(e) Effective/applicability date. Section 31.6302-4(d) applies to
deposits and payments made after December 31, 2010. Paragraph (b)(6) of
this section relating to certain payments made by government entities
applies to payments made by government entities under section 3402(t)
made after December 31, 2012.
Steven T. Miller,
Deputy Commissioner for Services and Enforcement.
Approved: April 26, 2011.
Michael Mundaca,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 2011-10760 Filed 5-6-11; 8:45 am]
BILLING CODE 4830-01-P