Proposed Internal Revenue Service regulations that would implement a 2005 law requiring all federal, state, and local governmental agencies to withhold a portion of payments to private vendors for tax purposes could result in more costs than benefits, Treasury Department officials are warning.
In addition, all federal agencies could face "hardship" if the proposed rules are adopted, Elaine Munroe, assistant director of internal control at the Treasury's office of the deputy chief financial officer, cautioned in a comment letter, dated March 5 but not publicly released until last week.
Although the letter was not addressed to anyone, the comments presumably were intended for the IRS, the branch of the Treasury that drafted the regulations. Monroe's office oversees the financial management of the department.
The cost of implementing systems to ensure proper withholding could outweigh the additional taxes recouped under the law, she wrote. Furthermore, she said, the rules will require agencies to assume the large workload of notifying vendors of the new withholding policy, and could cause those vendors financial harm by disrupting their cash flow.
In addition, the rules may diminish competition for contracts due to fewer vendors willing to do business with the government, and could result in vendors artificially inflating their prices to make up for the withholding losses.
The letter stopped short calling for a repeal of the withholding requirements. But another comment letter, submitted by a group of business associations called the Government Withholding Relief Coalition, demanded it, calling the law "counterproductive and oppressive."
The new stimulus law contains a provision delaying the enactment of the withholding requirement by one year until 2012, but the coalition - which includes the U.S. Chamber of Commerce - told the IRS that a full repeal is "the only real solution."
"Merely delaying the effective date is not a solution because there is still no equitable, practical, or cost-effective way to implement this new requirement" they stated in their March 10 letter. "Particularly during these extraordinary economic times, the significant additional financial burden on companies and governments is grossly misplaced," the coalition said.
The group also noted that even the IRS could expect increased financial burdens due to the provision.
Although the IRS cannot repeal a law passed by Congress, the group urged the agency to "utilize as much flexibility as possible" in interpreting the law, as well as remain open to modifying the rules to adjust for problems that arise when the law takes effect.
Several business and government groups, including the Government Finance Officers Association, have opposed the provision vehemently, saying it is a huge unfunded mandate, and state and local governments will be required to assume a larger workload to collect more federal tax dollars.
Although the proposed regulations contain some relief for government groups, such as clarifying that municipalities only have to withhold payments from contracts of $10,000 or more, GFOA and others have joined the coalition in calling for a full repeal of the law.
A public hearing to discuss the proposed regulations is slated for April 16, and the IRS is accepting applications to testify until March 25.
