Internal Revenue Code section 3402(t) requires that after December 31, 2010, all payments by governmental entities for property or services are subject to 3% income tax withholding, with some exceptions. Notice 2008-38 provides more information on these requirements.
Payments made to other governmental or tax-exempt entities, income assistance payments, and payments subject to other forms of withholding are not subject to the provisions. Payments for interest and real property are also exempt.
The withheld amounts are a credit against the tax liability of the recipient, and will be shown on an information return after the end of the tax year, similar to backup withholding or withholding on wages.
All Federal agencies and state governments are subject to the provisions. However, subdivisions or instrumentalities of state government are not subject to the requirements if the total annual payments are less than $100,000,000.
The IRS is asking for public comment on the implementation of this law. Click here to read the Notice and the procedures for submitting comments.
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