The Internal Revenue Service is requesting comments on proposed guidance that would require state and local governments to withhold, for tax purposes, a portion of the payments they make for property or services.

State and local groups are expected to comment on the proposed guidance, which they have criticized as an enormous unfunded mandate on governments that will be burdensome and costly. The IRS has set an April 28 deadline for receiving the comments.

The notice on the proposed guidance details how the tax law provisions that contain the requirements - Section 511 of the Tax Increase Prevention and Reconciliation Act of 2005 - will be implemented by the agency. Section 511 stipulates that state and local governments must withhold 3% of any payments made for property or services, to ensure that the appropriate tax amounts are collected. The law was passed in an effort to close the tax gap between the taxes that should have been paid and those that were actually paid - a gap that totaled $345 billion in 2001, as estimated by the Senate Finance Committee.

The withholding requirement does not take effect until 2011, and only applies to governments that make more than $100 million in such payments. The law also requires the reporting of all such payments.

The notice stipulates that programs that provide assistance to low-income or needy individuals will be exempt from the withholding requirements. "Payments made through a federal, state, or local government public assistance or public welfare program for which eligibility is determined by a needs or income test" is not subject to the required withholding, the notice stated.

Groups including the Government Finance Officers Association, the National Association of State Budget Officers, and the National League of Cities, claimed in letters sent two years ago to House Ways and Means Committee chairman Charles Rangel, D-N.Y., and other lawmakers that the bill would force governments to overhaul their accounts payable system to implement the new withholding.

In addition, bills that would repeal the Section 511 requirements are pending in both the Senate and House. The bill pending in the Senate that was sponsored by Sen. Larry Craig, R-Idaho - S. 777, the Withholding Tax Relief Act - has been referred to the Senate Finance Committee. A companion bill in the House, sponsored by Reps. Wally Herger, R-Calif., and Kendrick Meek, D-Fla, has over 240 cosponsors and is pending before the Ways and Means Committee.

The GFOA has said it will probably comment on the notice, and expects many of the same groups that addressed the 2005 legislation will do the same, but it is unknown at this time what those comments will be.

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