Starting January 1, 2013, you may be subject to a 3% withholding tax on your payment. This was part of the Tax Increase Prevention and Reconciliation Act of 2005; its implementation has been delayed several times.
Payments from federal, state and local governments are covered by this act. The 3% withholding applies to any one payment in excess of $10,000 to a corporation, S corporation, partnership or individual. If you have a government contract and your invoices never exceed $10,000, you might say “I will never have the 3% deducted from my payments.” That might not be the case; the government could aggregate several invoices when a payment is made. These could result a total in excess of $10,000 and you would be subject to the 3% tax withholding.
The following are exempt from the 3% tax withholding:
- Tax Exempt Organizations
- Grants
- Sale of real estate to the government
- Sub contractors of the primary contractor to the government (the 3% is withheld from payments made to the primary)
Examples of businesses that might be subject to the 3% tax withholding;
- Doctors or Doctor groups for payments from Medicare or Medicaid
- Computer related businesses
- Construction companies
- Defense contractors
- Auto dealers or companies
- Food services
What happens to the tax that is withheld from my payment? On an annual basis the 3% withholding is taken as credit on the income tax return of the business or individual similar to withholding on a W-2. It can be used to reduce the required quarterly estimated tax payments.
If you are subject to the 3% withholding, it could have an impact on your cash flow–you had planned to utilize the payments from this contract to pay for your inventory purchases or operation expenses, but now you will have less cash available to make those payments timely.
Contact us [1] and we will be able to assist you with the cash flow analysis and income tax planning related to this new tax regulation.