[Federal Register Volume 73, Number 235 (Friday, December 5, 2008)]
[Proposed Rules]
[Pages 74082-74096]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E8-28789]


=======================================================================
-----------------------------------------------------------------------

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 31

[REG-158747-06]
RIN 1545-BG45


Withholding Under Internal Revenue Code Section 3402(t)

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

-----------------------------------------------------------------------

SUMMARY: This document contains proposed regulations relating to

[[Page 74083]]

withholding under section 3402(t) of the Internal Revenue Code (Code). 
The proposed 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 
proposed regulations provide guidance to assist the government entities 
in complying with section 3402(t). The regulations also provide certain 
guidance to persons receiving payments for property or services from 
government entities. This document also contains proposed amendments to 
regulations under sections 3406, 6011, 6051, 6071, and 6302 of the 
Code.

DATES: Written or electronic comments and requests for a public hearing 
must be received by March 5, 2009.

ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-158747-06), room 
5205, Internal Revenue Service, PO Box 7604, Ben Franklin Station, 
Washington, DC 20044. Submissions may be hand-delivered Monday through 
Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (REG-
158747-06), Courier's Desk, Internal Revenue Service, 1111 Constitution 
Avenue, NW., Washington, DC, or sent electronically via the Federal 
eRulemaking Portal at http://www.regulations.gov/ (IRS REG-158747-06).

FOR FURTHER INFORMATION CONTACT: Concerning these proposed regulations, 
Jean Casey, (202) 622-6040; concerning submissions of comments or to 
request a public hearing, Richard Hurst at 
[email protected] or (202) 622-7180 (not toll-free 
numbers).

SUPPLEMENTARY INFORMATION:

Background

    This document contains proposed amendments to 26 CFR part 31 under 
section 3402(t) of the Code. This document also contains proposed 
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. Under the statute, section 
3402(t) applies to payments made after December 31, 2010.
    Exceptions to section 3402(t) withholding are contained in section 
3402(t)(2). Section 3402(t)(2) provides that section 3402(t) 
withholding shall not apply to any payment--
    (A) Except as provided in section 3402(t)(2)(B), which is subject 
to withholding under any other provision of chapter 24 (Collection of 
Income Tax at Source on Wages, sections 3401 through 3406) or chapter 3 
(Withholding of Tax on Nonresident Aliens and Foreign Corporations, 
sections 1441 through 1464) of the Code;
    (B) Which is subject to withholding under section 3406 (backup 
withholding) and from which amounts are being withheld under such 
section;
    (C) Of interest;
    (D) For real property;
    (E) To any government entity subject to the requirements of section 
3402(t)(1), any tax-exempt entity, or any foreign government;
    (F) Made pursuant to a classified or confidential contract 
described in section 6050M(e)(3);
    (G) Made by a political subdivision of a State (or any 
instrumentality thereof) which makes less than $100,000,000 of such 
payments annually;
    (H) Which is in connection with a public assistance or public 
welfare program for which eligibility is determined by a needs or 
income test; and
    (I) To any government employee not otherwise excludable with 
respect to his or her services as an employee.
    Section 3402(t)(3) provides for the coordination of section 3402(t) 
with other Code sections. 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, payments to 
any person for property or services which are subject to withholding 
shall be treated as if such payments were wages paid by an employer to 
an employee.
    The legislative history in connection with section 3402(t) 
indicates that ``[t]he withholding requirement applies regardless of 
whether the government entity making such payment is the recipient of 
the property or services.'' H.R. Conf. Rep. No.109-455, 109th Cong., 2d 
Sess. at 300 (2006). Further, the conference report also provides, with 
respect to the exception provided by section 3402(t)(2)(H), that 
``payments under government programs to provide health care or other 
services that are not based on the needs or income of the recipients 
are subject to withholding, including programs where eligibility is 
based on the age of the beneficiary.'' H.R. Conf. Rep. No. 109-455 at 
page 301. In addition, with respect to section 3402(t)(2)(A), the 
conference report states that section 3402(t) withholding ``does not 
apply to payments of wages or to any other payment with respect to 
which mandatory (e.g., U.S.-source income of foreign taxpayers) or 
voluntary (e.g., unemployment benefits) withholding applies under 
present law.'' H.R. Conf. Rep. No. 109-455 at page 301. The origins of 
the provision indicate that it was conceived to address tax 
noncompliance. See also, ``Options to Improve Tax Compliance and Reform 
Tax Expenditures'' (JCS-2-05), Joint Committee on Taxation, Jan. 27, 
2005.
    Notice 2008-38, 2008-13 IRB 683, published by the IRS on March 31, 
2008, invited public comments regarding guidance under section 3402(t). 
In particular, Notice 2008-38 requested comments on the application of 
section 3402(t) to credit cards and payment cards, payments to payees 
not subject to United States taxation, passthrough entities in which a 
government entity is a partner or owner, government contractors and 
subcontractors, and de minimis payments. The Notice also requested 
comments on when and how amounts withheld under section 3402(t) should 
be transmitted to the IRS. See Sec.  601.601(d)(2)(ii)(b).
    Many comments were received in response to Notice 2008-38, and the 
comments were taken into consideration in developing the proposed 
regulations.

Explanation of Provisions

    The proposed regulations provide rules about which government 
entities are subject to the requirement of section 3402(t) withholding, 
which payments are subject to section 3402(t) withholding (and which 
are excepted from such withholding), when withholding is required on 
such payments, and how government entities pay and report the tax to 
the IRS. The proposed regulations also include transition rules 
providing relief from liability for the tax imposed by section 3402(t) 
with respect to payments under existing contracts. The proposed 
regulations also provide temporary relief from penalties and interest 
if a government entity makes a good faith effort but fails to withhold 
on payments as required under section 3402(t).
    The regulations provide guidance primarily on what government 
entities

[[Page 74084]]

need to do to comply so that they can make timely preparations. The 
Treasury Department and IRS anticipate issuing further guidance to 
address questions raised by taxpayers who expect to receive payments 
subject to section 3402(t) withholding from government entities 
including, but not limited to, how to claim credits and how to claim 
the benefit of statutory exemptions from withholding under section 
3402(t). Although some commenters requested that the Treasury 
Department and IRS issue guidance exempting payments from withholding 
where the 3-percent rate for withholding prescribed under section 
3402(t) is expected to exceed either the profit margin in the 
taxpayer's industry or the income tax the taxpayer will owe for reasons 
particular to the taxpayer's business, the Treasury Department and IRS 
have determined that exemptions of this type would be contrary to the 
requirements of the statute. Commenters also requested that they be 
permitted to credit amounts withheld under section 3402(t) against 
Federal taxes other than income taxes, such as employment taxes. 
Consistent with the statute's purpose of addressing income tax 
noncompliance, the Treasury Department and IRS propose to allow credits 
to be claimed only against income tax.

Government Entities Subject to Section 3402(t)

    Section 3402(t)(1) applies to ``the Government of the United 
States, every State, every political subdivision thereof, and every 
instrumentality of the foregoing.'' Section 3402(t) does not restrict 
the term the Government of the United States in any manner. Therefore, 
the entire Federal government, including the executive branch, the 
legislative branch, and the judicial branch, is subject to the 
requirements of section 3402(t). Thus, Congress, the Administrative 
Office of the United States Courts, the Executive Office of the 
President, Federal agencies, and all other components of the Federal 
government are included in the definition of Government of the United 
States and are required to withhold under section 3402(t).
    The term State includes the District of Columbia. See section 
7701(a)(10) of the Code. For purposes of section 3402(t), the term 
State does not include Indian tribal governments. Section 7871(a) 
prescribes when an Indian tribal government is to be treated as a State 
under the Code, and section 7871(a) does not provide that Indian tribal 
governments will be treated as States for purposes of section 3402(t). 
Consequently, the term political subdivision also does not include a 
subdivision of an Indian tribal government. See section 7871(a) and 
(d). Accordingly, because Indian tribal governments and their 
subdivisions are not among the listed government entities subject to 
section 3402(t), payments by Indian tribal governments and their 
subdivisions are not subject to the withholding requirements of section 
3402(t).
    The definition of political subdivision in the proposed regulations 
follows the definition in the section 103 regulations. Section 1.103-
1(b) of the Income Tax Regulations provides, in part, that the term 
political subdivision denotes any division of any State or local 
government unit that is a municipal corporation or that has been 
delegated the right to exercise part of the sovereign power of the 
unit.
    Although the Code makes references to government instrumentalities 
in multiple sections, the Code and regulations do not currently provide 
a definition of instrumentality. In Rev. Rul. 57-128, 1957-1 CB 311, 
the IRS adopted 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). The factors are: (1) 
Whether the organization is used for a government purpose and performs 
a government function; (2) whether performance of its function is on 
behalf of one or more States or political subdivisions; (3) whether 
there are any private interests involved, or whether the States or 
political subdivisions involved have the powers and interests of an 
owner; (4) whether control and supervision of the organization is 
vested in public authority or authorities; (5) if express or implied 
statutory or other authority is necessary for the creation and/or use 
of such an instrumentality, and whether such authority exists; and (6) 
the degree of financial autonomy and the source of its operating 
expenses. A number of revenue rulings published by the IRS illustrate 
the application of this test. See, for example, 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. See Sec.  601.601(d)(2)(ii)(b). The Treasury Department and IRS 
invite comments on use of the same or a similar test for purposes of 
section 3402(t).

Persons Subject to Withholding Under Section 3402(t)

    Section 3402(t) applies to government payments to ``persons'' 
providing any property or services. Section 7701(a)(1) of the Code 
provides that, when used in the Code, where not otherwise distinctly 
expressed or manifestly incompatible with the intent thereof, the term 
person shall be construed to mean and include an individual, a trust, 
estate, partnership, association, company, or corporation. Because no 
alternative definition of person is provided in section 3402(t), the 
definition in section 7701(a)(1) and the regulations under section 
7701(a)(1) applies. Therefore, section 3402(t) withholding can apply to 
payments for property or services to individuals, trusts, estates, 
partnerships, associations, companies, or corporations.

Payments Subject to Section 3402(t) Withholding

    The proposed 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. Under 
the proposed rules, the withholding requirements of section 3402(t) 
will not apply to any payment that is less than the payment threshold 
amount, which is $10,000. The Treasury Department and IRS are proposing 
this payment threshold of $10,000 because the burden of withholding on 
smaller transactions is likely to be substantial and outweigh the 
benefits of increased withholding. This threshold corresponds to a 
minimum withholding of $300.
    Under the proposed rules, multiple payments made by a government 
entity to any person generally would not be aggregated in determining 
whether the payment threshold amount has been met. However, the 
proposed regulations provide an anti-abuse rule to ensure that the 
payment threshold is not manipulated to avoid the required withholding. 
If a government entity divides a payment into two or more separate 
payments primarily to avoid the payment threshold for one or more 
payments, the separate payments would be treated as one payment made on 
the date that the first payment was made for purposes of this rule. For 
example, if a government entity is scheduled to make a contractual 
payment to a person for landscaping services of $15,000 on July 2, 
2011, but divides the payment into payments of $7,000 and $8,000 made 
on July 1, 2011, and July 2, 2011, respectively, the government entity 
would be treated as having made a single payment of $15,000 on July 1, 
2011. This anti-abuse rule would not apply if the primary reason for 
division into separate payments is unrelated to section 3402(t).
    If a government entity makes a single payment of $10,000 or more to 
any

[[Page 74085]]

person for more than one property or service provided by that person, 
the government entity would be required to withhold on the payment. For 
example, if a person bills a government entity $5,000 each day for 
seven days for services provided each day, but the government entity 
makes one payment of $35,000 in satisfaction of these bills, the 
payment threshold is applied to the $35,000 payment.
    Many commenters requested guidance on how the requirements of 
section 3402(t) apply to prime contractors and subcontractors. Under 
the proposed rules, if a government entity or its payment administrator 
makes a payment to a person that is subject to withholding under 
section 3402(t), no subsequent transfer of cash or property by that 
person to another person is treated as a payment for section 3402(t) 
purposes. Thus, if the government entity enters into a contract with a 
prime contractor for property and services, and that prime contractor 
separately contracts with subcontractors for delivery of certain 
property and services, then withholding under section 3402(t) 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.
    The proposed regulations apply to payments made by the government 
entity or its payment administrator. For purposes of the proposed 
regulations, 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. 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 withholding under section 3402(t). 
However, if the government entity pays the payment administrator a fee 
for its services, the government entity would treat the fee as a 
payment subject to withholding. The government entity 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 and regardless of when the payment for 
property or services is made under this section.

Credit Card Payments

    Many commenters questioned how the requirements of section 3402(t) 
apply to payments made by government credit card or payment card. Under 
the proposed regulations, when a government entity or its payment 
administrator uses a credit card or payment card to pay a person for 
providing property or services, payment occurs at the point of sale 
when the government credit card or payment card is tendered and not 
when the government entity pays the credit card company. The government 
entity is liable for the withholding and reporting associated with the 
payment, and this liability is not transferred to any other party 
involved in the credit card or payment card transaction, including, but 
not limited to, the acquiring bank, the issuing bank, or the credit 
card association. (The acquiring bank may be separately required to 
report amounts it pays under new section 6050W, which was enacted as 
part of the Housing Assistance Tax Act of 2008, Div. C of Pub. L. 110-
289.)

Section 3402(t)(2)(A)--Payments Subject to Withholding Under Chapter 3 
or Chapter 24 and Section 3402(t)(2)(B)--Payments From Which Backup 
Withholding Is Withheld

    Section 3402(t)(2)(A) provides an exception from the requirement of 
section 3402(t) for amounts that are subject to withholding under some 
other provision of chapter 3 or chapter 24 (other than section 3406). 
Thus, payments that are subject to withholding under the wage 
withholding regime or the regime for withholding of tax on nonresident 
aliens and foreign corporations are exempt from withholding under 
section 3402(t). Furthermore, consistent with the legislative history, 
amounts for which the payee may elect withholding are exempt from 
withholding under section 3402(t), regardless of whether the payee in 
fact makes such an election. These payments include: (1) Unemployment 
compensation as defined in section 85(b) (section 3402(p)(2)); (2) 
social security benefits as defined in section 86(d) (section 
3402(p)(1)(C)(i)); (3) 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 (section 
3402(p)(1)(C)(ii)); (4) 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 (section 3402(p)(1)(C)(iii)); and (5) any payment of an annuity 
to an individual.
    A special rule applies for payments subject to backup withholding. 
Section 3402(t)(2)(B) provides that a payment that is subject to 28 
percent withholding under section 3406 (backup withholding) is not 
excepted from the requirement of 3 percent withholding under section 
3402(t) unless backup withholding is actually being deducted from the 
payment. Thus, if backup withholding is required with respect to a 
payment made by a government entity and the government entity performs 
backup withholding on the payment, section 3402(t) does not apply. If 
the government entity fails to backup withholding on such a payment, 
the government entity would remain liable for backup withholding 
regardless of whether it imposed withholding under section 3402(t) with 
respect to the payment. Proposed amendments to the regulations under 
section 3406 clarify that if backup withholding is required, 
withholding under section 3402(t) is not required.
    Under the proposed regulations, payments made to nonresident aliens 
or foreign individuals that are exempt from United States taxation 
pursuant to a treaty would be exempt from withholding under section 
3402(t) because such payments are subject to withholding absent 
application of the treaty. Specifically, absent a treaty, United States 
source fixed or determinable, annual or periodical (FDAP) income paid 
to a nonresident alien individual or foreign corporation is subject to 
withholding under chapter 3, except for income that is effectively 
connected with a U.S. trade or business (other than compensation for 
personal services) pursuant to sections 1441 and 1442. Relevant 
examples of FDAP include salaries, compensation and emoluments.
    Imposing a new withholding requirement on nonresident aliens and 
foreign corporations that owe no United States tax would serve no 
purpose. Foreign persons that are exempt from withholding under 
sections 1441 and 1442 by reason of an income tax treaty are not the 
source of the tax noncompliance problem that section 3402(t) was 
enacted to address. Further, our existing documentation procedures are 
intended to ensure that those claiming treaty benefits are in fact 
entitled to treaty benefits. See, for example, Form W-8BEN, 
``Certificate of Foreign Status of Beneficial Owner for United States 
Tax Withholding,'' and Form 8233, ``Exemption From Withholding on 
Compensation for Independent (and Certain Dependent) Personal Services 
of a Nonresident Alien Individual.'' Accordingly, the

[[Page 74086]]

proposed regulations under section 3402(t) provide that the ``subject 
to withholding under chapter 3'' exception in section 3402(t)(2)(A) 
applies to payments with respect to which a foreign person claims a 
zero rate of tax under an income tax treaty. Thus, if a foreign person 
furnishes documentation establishing entitlement to an exemption from 
withholding under chapter 3 by reason of an income tax treaty, 
government entities would not be required to withhold under section 
3402(t) from payments to such person.

Section 3402(t)(2)(C)--Interest

    Section 3402(t)(2)(C) provides that payments of interest are exempt 
from withholding. The proposed regulations do not provide a definition 
of interest. The Treasury Department and IRS request comments 
concerning whether a definition of interest is needed and if so, what 
that definition should be.

Section 3402(t)(2)(D)--Payments for Real Property

    Section 3402(t)(2)(D) provides that payments for real property are 
not subject to section 3402(t). Because the exception is not limited to 
payments for fee ownership, the proposed regulations provide that 
payments for real property include payments for leasing real property 
and leasehold improvements.
    Commenters asked whether real property included payments made under 
contracts for the construction of buildings or other public works. 
Neither the statute itself nor the legislative history defines ``real 
property'' for purposes of section 3402(t).
    The proposed regulations adopt the position that payments for the 
construction of buildings or public works are not payments for real 
property excepted by section 3402(t)(2)(D). Payments for the 
construction of a building are payments for services to build the 
building and personal property to be used in the construction of the 
building rather than payments for real property. This position is 
consistent with statutes governing construction contracts of the 
Federal government. See, for example, 40 U.S.C. 3131-3134 (the ``Miller 
Act'').

Section 3402(t)(2)(E)--Payments to Government Entities Subject to 
Section 3402(t), Tax-Exempt Organizations, and Foreign Governments

    Section 3402(t)(2)(E) provides exceptions from section 3402(t) 
withholding for payments to any government entity subject to the 
requirements of section 3402(t)(1), payments to any tax-exempt entity, 
and payments to any foreign government. The determination of whether an 
entity is a government entity such that payments it receives are exempt 
parallels the determination whether the entity is a government entity 
required to withhold on payments it makes. Thus, if a government entity 
is required to withhold under section 3402(t)(1), payments to that 
government entity are not subject to withholding under section 3402(t). 
The proposed regulations also clarify that, even if no withholding is 
required on payments from a government entity because the government 
entity qualifies for the exception of section 3402(t)(2)(G) for 
political subdivisions and instrumentalities making total payments of 
less than $100 million (discussed later in this preamble), payments to 
that government entity are not subject to withholding.
    The proposed regulations define the term tax-exempt entity for 
purposes of section 3402(t)(2)(E) as any organization exempt from 
federal income tax under section 501(a) as an organization described in 
section 501(c), 501(d), or section 401(a).

Section 3402(t)(2)(F)--Payments Made Pursuant to a Classified or 
Confidential Contract

    Section 3402(t)(2)(F) provides an exception from section 3402(t) 
withholding for payments made pursuant to a classified or confidential 
contract described in section 6050M(e)(3). Section 6050M(e)(3) 
describes a contract between a Federal executive agency and another 
person if--
    (A) The fact of the existence of such contract or the subject 
matter of such contract has been designated and clearly marked or 
clearly represented, pursuant to the provisions of Federal law or an 
Executive order, as requiring a specific degree of protection against 
unauthorized disclosure for reasons of national security, or
    (B) The head of such Federal executive agency (or his designee), 
pursuant to regulations issued by such agency, determines, in writing, 
that filing the required return under section 6050M (related to 
information returns required to be filed by any Federal executive 
agency with respect to persons receiving contracts) would interfere 
with the effective conduct of a confidential law enforcement or foreign 
counterintelligence activity.

Section 3402(t)(2)(G)--The Exception for Political Subdivisions and 
Instrumentalities Making Total Payments Under $100,000,000

    Section 3402(t)(2)(G) provides that payments made by certain 
smaller government entities are not subject to withholding under 
section 3402(t). Specifically, a political subdivision of a State (or 
any instrumentality thereof) 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 these proposed 
regulations) is not required to withhold under section 3402(t) on any 
of its payments. The proposed regulations provide a simple rule for 
determining before each year starts whether the exception provided by 
section 3402(t)(2)(G) applies to a given political subdivision or 
instrumentality. The determination would be based on the payments made 
during the accounting year of the political subdivision or 
instrumentality ending with or within the second preceding calendar 
year. For example, to determine whether the political subdivision or 
instrumentality is subject to withholding with respect to payments made 
in 2011, the proposed regulations would look to whether payments made 
by the political subdivision or instrumentality for its accounting year 
ending with or within the calendar year 2009 equaled or exceeded 
$100,000,000. For this purpose, the accounting year is considered to be 
the year used by the political subdivision or instrumentality to keep 
its accounting books and determine budgets. In most cases, political 
subdivisions and instrumentalities would be able to make a reasonably 
accurate estimate whether the exception applies before the end of the 
accounting year ending in 2009 based on budgetary projections. However, 
in cases where the payments are expected to be near the $100,000,000 
threshold, the time between the end of the accounting year in 2009, 
when a definitive determination could be made, and December 31, 2010, 
should give the political subdivision or instrumentality sufficient 
time to prepare for withholding under section 3402(t) for payments made 
in 2011.
    In determining whether the political subdivision or instrumentality 
has made $100,000,000 of total payments, the proposed regulations would 
require that all payments for property and services made during the 
accounting year be considered with the exception of those payments 
qualifying for any of the exceptions provided by Sec.  31.3402(t)-4(a) 
through (l) of the proposed regulations.

[[Page 74087]]

For this purpose, payments that are less than the $10,000 payment 
threshold count toward the $100,000,000 test.
    This exception provided by section 3402(t)(2)(G) does not apply to 
the United States Government, States, or instrumentalities of the 
United States Government or States.
    The Treasury Department and IRS request comments on the application 
of section 3402(t)(2)(G), particularly with regard to whether the rules 
for determining whether the exception applies would provide adequate 
time to modify systems for compliance with section 3402(t), whether a 
special rule should be considered allowing the averaging of multiple 
accounting years for political subdivisions and instrumentalities that 
have unusually high expenditures in a given accounting year, and 
whether the determination of total payments under the proposed 
regulations is practicable.

Section 3402(t)(2)(H)--Payments in Connection with a Public Welfare or 
Public Assistance Plan

    Section 3402(t)(2)(H) provides an exception from section 3402(t) 
withholding for any payment in connection with a public assistance or 
public welfare program for which eligibility is determined by a needs 
or income test. The proposed 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. The proposed regulations also 
are consistent with the legislative history in providing that 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). The proposed regulations provide that, 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.

Section 3402(t)(2)(I)--Payments to a Government Employee With Respect 
to Services as an Employee

    Section 3402(t)(2)(I) provides an exception from section 3402(t) 
withholding for payments to any government employee not otherwise 
excludable with respect to the employee's services as an employee. The 
proposed regulations broadly interpret this exception to exclude from 
section 3402(t) withholding any form of compensation that is paid to 
the employee or on the employee's behalf. For example, the proposed 
regulations exclude employer contributions to employee benefit and 
deferred compensation plans as well as employee contributions to such 
plans. This exception applies to any payments by an employer for fringe 
benefits or deferred compensation to, or for the benefit of, an 
employee.
    The proposed regulations provide that the section 3402(t)(2)(I) 
exclusion from section 3402(t) withholding also applies to: (a) Travel 
reimbursements paid by a government entity to a government employee 
under accountable plans within the meaning of section 62(c) for the 
individual employee's travel, lodging, and meal expenses; and (b) the 
government employee's payments to third parties that provide travel, 
lodging, and meals that are reimbursable under such travel 
reimbursement plans. Most payments for individual travel, lodging, and 
meal expenses would fall beneath the $10,000 payment threshold. 
Nevertheless, this exception may be significant in determining whether 
the government entity making the payments qualifies for the exception 
under section 3402(t)(2)(G) for political subdivisions of a State (or 
their instrumentalities) making payments under $100,000,000, as 
payments under section 3402(t)(2)(I) are excluded when calculating the 
total amount of payments.
    Section 31.3401(a)-4(a) of the Employment Tax Regulations provides 
that if a reimbursement or other expense allowance arrangement meets 
the requirements of section 62(c) and Sec.  1.62-2 and the expenses are 
substantiated within a reasonable period of time, payments made under 
the arrangement that do not exceed the substantiated expenses are 
treated as paid under an accountable plan and are not wages. Thus, 
these payments would qualify for the exception under section 
3402(t)(2)(I).
    By comparison, if the travel reimbursement or payment by the 
employer is not paid under an accountable plan, the reimbursement would 
be treated as paid under a nonaccountable plan. Payments to the 
employee under a nonaccountable plan are includible in gross income and 
wages and subject to income tax withholding under section 3402(a). 
Thus, such payments would be excepted from withholding under section 
3402(t) by section 3402(t)(2)(A).

Exception for Certain Payments Received by Nonresident Alien 
Individuals and Foreign Corporations

    In general, in the case of a nonresident alien individual or a 
foreign corporation (foreign person), sections 872(a) and 882(b) 
provide that gross income for United States income tax purposes 
consists of (1) gross income derived from sources within the United 
States; and (2) gross income derived from sources outside the United 
States (foreign source income), but only if it is effectively connected 
with a trade or business within the United States. The source of income 
is determined under sections 861 through 865. The source of income 
derived from the performance of services is the place where the 
services are performed as provided in sections 861(a)(3) and 862(a)(3), 
whereas the source of income from the purchase and sale of inventory 
property (other than unprocessed timber) is the location where the sale 
takes place as described in Sec.  1.861-7(c) of the Income Tax 
Regulations (see also sections 861(a)(6) and 862(a)(6)). Therefore, if 
a foreign person provides services or sells inventory property in a 
foreign country, it will have no United States income tax liability 
with respect to the income earned from providing the services or 
selling the property--even to a United States government entity--
provided that the income is not effectively connected with the conduct 
of a trade or business within the United States.
    Accordingly, the proposed regulations exclude such payments made to 
foreign persons from 3-percent withholding under section 3402(t). For 
administrative reasons, subjecting these foreign source payments to 
withholding under 3402(t) would be unduly burdensome to the foreign 
persons receiving such payments and the IRS. The foreign persons, most 
of whom are not presently United States income tax filers, would have 
to get taxpayer identification numbers (TINs) and file refund claims. 
Likewise, the IRS would have to issue TINs, process the claims, and 
refund all of the funds collected. Withholding on foreign source 
payments to foreign persons has no potential to reduce tax 
noncompliance because the potential income resulting from the payments 
is not subject to United States income taxation. Procedures to be 
followed by government entities and foreign persons for purposes of 
claiming this exception from section 3402(t) withholding will be issued 
at a later date.

Exception for Payments to Indian Tribal Governments

    Indian tribal governments are not subject to United States income 
tax. Subjecting payments made by government entities to Indian tribal 
governments to withholding under section 3402(t) would be unduly 
burdensome for the same reasons

[[Page 74088]]

discussed above with respect to certain payments made to foreign 
persons. Therefore, the proposed regulations except these payments from 
3-percent withholding under section 3402(t).

Deposits and Reporting of Amounts Withheld Under Section 3402(t)

    In determining rules for reporting amounts withheld under section 
3402(t), the Treasury Department and IRS have considered the 
administrative burden on government entities imposed by reporting, the 
need for payees to receive timely and accurate information about the 
amounts withheld, and the need for IRS systems to process the 
information reported. Many comments reflected a preference for using an 
existing system and adapting current forms and procedures to 
accommodate section 3402(t) withholding, rather than creating a new 
system and forms for such withholding. The commenters indicated that 
using an existing system would ease compliance by government entities 
and would ease the processing of the payment and reporting of such tax.
    The Treasury Department and IRS believe the existing procedure for 
reporting nonwage withholding on Form 945, ``Annual Return of Withheld 
Federal Income Tax,'' and reporting payments subject to withholding on 
Form 1099-MISC, ``Miscellaneous Income,'' with slight modifications to 
existing forms, would provide the most satisfactory method of payment 
and reporting. Because most government entities have a system for 
issuing Form 1099-MISC, using this system with modifications for 
reporting section 3402(t) withholding should ease compliance. 
Additionally, using Form 1099-MISC would give payees the information 
they need to timely file their income tax returns claiming credit for 
the withholding. Because this system would be similar to the system 
used currently for reporting and paying nonwage income tax withholding, 
the IRS would be able to process the withholding timely and on a cost-
effective basis.
    Accordingly, the proposed amendments to the regulations under 
section 6011 provide that payors required to withhold amounts under 
section 3402(t) must file Form 945 reporting the amounts withheld. 
Proposed amendments to the regulations under section 6302 further 
provide that the amounts withheld under section 3402(t) must be 
deposited and reported in the same manner as other nonwage withheld 
amounts, such as withholding on gambling winnings and pensions. 
Pursuant to existing regulations, such 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, 
as provided in Sec.  31.6302-4.
    Additionally, proposed amendments to 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 reporting such payments and tax withheld. Because this 
reporting would be done pursuant to regulations under section 6051, the 
exceptions provided in the regulations under section 6041 relating to 
Form 1099 would not apply (for example, the exception for payments to 
corporations).

Payments for Jury Duty, Utilities, and Fuel Surcharges

    Commenters asked whether jury duty pay is subject to withholding 
under section 3402(t). Jury duty pay generally will not meet the 
$10,000 payment threshold provided in the proposed regulations. No 
special rule for jury duty pay is provided.
    Commenters also requested guidance about utility payments. Rates 
for utility services are generally prescribed through a State 
regulatory process. Commenters expressed concern about the consequences 
of paying something less than the regulatorily prescribed rate to the 
utility. In fact, utility companies--like all persons receiving 
payments subject to withholding under section 3402(t)--would be 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. Therefore, unless 
otherwise excepted, utility payments are subject to withholding under 
section 3402(t) on the same basis as payments for other property and 
services.
    Commenters also requested that fuel surcharges be exempted from 
withholding, arguing that a fuel surcharge provided under a contract is 
merely a cost recovery mechanism used to garner the lowest possible 
rates for the government by controlling volatile cost components in bid 
calculations. Although the use of separately stated charges for certain 
costs may well serve this purpose in contracting, section 3402(t) 
provides no exception for fuel surcharges or any other separately 
stated cost item. Section 3402(t) requires withholding on payments made 
regardless of how the payee may apply them against costs. Therefore, 
the proposed regulations do not provide an exception for payments 
allocated to fuel surcharges or any other separately stated costs.

Application of Section 3402(t) to Passthrough Entities

    Commenters requested guidance with respect to the application of 
section 3402(t) where either the payor or the payee is a partnership or 
S corporation (``passthrough entities''). With respect to payments from 
a passthrough entity, the proposed regulations provide that such 
payments are not generally subject to withholding under section 3402(t) 
unless 80 percent or more of the passthrough entity is owned by 
government entities that are required to withhold under section 
3402(t)(1). With respect to payments to a passthrough entity, the 
proposed regulations provide that such payments are generally subject 
to withholding under section 3402(t) unless 80 percent or more of the 
passthrough entity is owned 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). An 80-
percent threshold is consistent with similar thresholds in various 
areas of the tax law. See, for example, section 775(b)(3) and 
Sec. Sec.  1.414(c)-2(b)(2) and 301.7701(i)-1(d)(3)(i)(A). The proposed 
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 entity's taxable year. The Treasury Department and IRS believe that 
this general rule simplifies compliance and administration by requiring 
one annual determination of whether a passthrough entity's payments are 
subject to withholding under section 3402(t). However, the proposed 
regulations provide that any manipulation of the ownership percentage 
with an intent to avoid application of section 3402(t) would be 
recharacterized as appropriate to reflect the actual ownership 
percentage.

Effective Date and Transition Relief for Existing Contracts

    The proposed regulations provide that the regulations will 
generally be effective for payments made after the later of December 
31, 2010, or the date that is 6 months after the publication of final 
regulations. Commenters questioned whether section 3402(t) would apply 
to payments made under contracts in existence prior to the effective 
date of section 3402(t). They noted that many government entities are 
party to multi-year contracts. These contracts did not contemplate the 
withholding of income tax from payments under the contracts. Future

[[Page 74089]]

contracts can address the withholding requirement and its effect on the 
contractor's cash flow. Accordingly, the proposed regulations provide 
that payments made under written binding contracts in effect on the 
later of December 31, 2010, or the date that is 6 months after the 
publication of final regulations are not subject to withholding under 
section 3402(t), unless such contract is materially modified. Payments 
pursuant to contracts entered into after the later of December 31, 
2010, or the date that is 6 months after the publication of final 
regulations will be subject to section 3402(t).
    Under the proposed regulations, if there is a material modification 
to an existing contract after the later of the effective date of the 
legislation or six months after the issuance of final regulations under 
section 3402(t), the contract would cease to be an existing contract 
for purposes of this transition relief and payments under the contract 
would become subject to the withholding requirements of section 
3402(t). The Treasury Department and IRS are considering whether 
contracts that contain the option of renewal should be considered new 
contracts as of the date of renewal. The final regulations may provide 
that a contract that is renewable as of a certain date is treated as a 
new contract on the first date the contract is renewed. The Treasury 
Department and IRS request comments on how option terms in contracts, 
including, but not limited to, options to renew, should affect the 
transition relief for payments under written binding contracts.

Credit Against Income Tax

    The Treasury Department and IRS received numerous comments from 
taxpayers expecting to receive payments subject to section 3402(t) 
withholding. Most of these comments asked how taxpayers would take the 
credit for the section 3402(t) withholding. Section 31 provides the 
general crediting rule for withholding of income tax. Specifically, 
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) and allows a credit 
against income tax only.
    Section 31(a)(2) provides the general rule on the timing of the 
allowance of the credit: ``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, the rule of 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 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. Congress did not provide a similar exception for the timing 
of the credit for section 3402(t) withholding. Section 31(c) is limited 
by its terms to section 3406 withholding only. Thus, the general rule 
of section 31(a)(2) applies to section 3402(t) withholding rather than 
the special rule of section 31(c).
    The effect of section 31(a)(2) is that fiscal year taxpayers may be 
entitled to take credit for withholding under section 3402(t) only in a 
taxable year subsequent to the taxable year in which the amount was 
withheld. For example, if amounts were withheld under section 3402(t) 
from a June 30 fiscal year taxpayer during the period from January 1, 
2011, to June 30, 2011, the taxpayer will be entitled to take credit 
for the withheld tax on its income tax return for the fiscal year 
ending June 30, 2012, rather than its income tax return for the fiscal 
year ending June 30, 2011.
    The Treasury Department and IRS recognize that, in the case of 
fiscal year taxpayers, the application of the rule in section 31(a)(2) 
requiring that the credit be taken in the second of two possible 
taxable years may be burdensome for taxpayers. The Treasury Department 
and IRS request comments on what impact the timing rule in section 
31(a)(2) described above for income tax credits will have on taxpayers 
that have tax withheld under section 3402(t).

Crediting Against Estimated Income Tax Liability

    Taxpayers may take into account the income tax withheld under 
section 3402(t) and allowed as a credit under section 31 in determining 
estimated tax liability pursuant to sections 6654 and 6655. With 
respect to individual taxpayers, section 6654(g)(1) provides that, for 
purposes of determining the application of the penalty for an 
individual's failure to pay estimated tax, the amount of the credit 
allowed under section 31 for the taxable year shall be deemed a payment 
of estimated tax. As with other income tax withheld, an individual 
recipient may account for income tax withheld in computing estimated 
income tax liability on Form 1040-ES, ``Estimated Tax for 
Individuals.'' Because most individuals are calendar year taxpayers, 
the section 3402(t) withholding would generally be treated as a payment 
of estimated tax for the same calendar year, and the individual's 
liability for other payments of estimated tax for that year would be 
reduced. However, if the individual is a fiscal year taxpayer, the 
individual may not take into account the withholding for estimated tax 
purposes until the fiscal year that begins in the calendar year in 
which the tax is withheld.
    Similar rules apply to corporate taxpayers. In determining the 
amount of estimated tax required to be paid to avoid the section 6655 
penalty applicable to corporations for failure to pay estimated tax, 
section 6655(g)(1)(B) provides in effect that credits against tax under 
section 31 are taken into account. Thus, corporate taxpayers can also 
take into account the amount of credit allowed under section 31(a) in 
determining income tax liability and in computing estimated income tax 
liability. As with individual taxpayers, corporate taxpayers on a 
fiscal year could have the problem of delay in taking account of the 
credit if withholding occurs in the part of the calendar year before 
the beginning of the fiscal year that begins in that calendar year.

Credit Against Employment Taxes or Other Taxes

    Many commenters requested that taxpayers be allowed to take credit 
for section 3402(t) withholding with respect to employment taxes or 
other taxes. The statute directs that crediting follow the rules under 
section 31(a), which provide for crediting against income tax. Where 
the 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 3507(d) (providing for the 
treatment of advance payments of the earned income credit as payments 
of the income tax withholding and FICA liability of the employer); 
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 tax contribution and benefit base). The

[[Page 74090]]

Code does not provide for withholding under section 3402(t) to be 
treated as payments of the taxpayer's employment tax liability.

Rate of Income Tax Withholding

    Some taxpayers requested that the Treasury Department and IRS 
provide for lower withholding rates for taxpayers with lower profit 
margins or lower marginal income tax rates. The statute provides for a 
uniform 3-percent rate of withholding. Thus, the proposed regulations 
apply withholding at the 3-percent rate to all payments for services 
and property from which withholding under section 3402(t) is required 
to be made.

Liability for Section 3402(t) Withholding in the Event of Failure To 
Withhold

    If a government entity fails to withhold the tax imposed by section 
3402(t), section 3403 applies. Under section 3402(t)(3) and section 
3403, the government entity is generally liable for the payment of the 
tax to the IRS unless it can prove that the payee has paid its income 
tax liability.
    Section 3403 provides that the employer shall be liable for the 
payment of tax required to be deducted and withheld under chapter 24, 
and shall not be liable to any person for the amount of any such 
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 the wages of an employee is liable for the payment of such 
tax whether or not it is collected from the employee by the employer. 
If, for example, the employer deducts less than the correct amount of 
tax, or if the employer fails to deduct any part of the tax, the 
employer is nevertheless liable for the correct amount of the tax. 
Section 3402(t)(3) provides that for purposes of section 3403, payments 
to any person for property or services that are subject to withholding 
under section 3402(t) are treated as if such payments were wages paid 
by an employer to an employee.
    Thus, sections 3402(t)(3) and 3403 establish the liability of the 
government entity for the amount of the tax imposed by section 3402(t) 
if it fails to withhold.
    However, section 3402(d) provides an exception to the entity's 
liability for income tax withholding in certain cases. Under this 
exception, if the entity required to withhold fails to do so, and 
thereafter the tax is paid, the tax will not be collected from the 
entity that failed to withhold. Thus, for purposes of section 3402(t), 
the government entity generally will be liable if it fails to withhold 
unless it is able to demonstrate, consistent with IRS procedures, that 
the taxpayer reported the amounts that were subject to withholding on 
its income tax return and paid the income tax due.

Transition Rule for Penalties and Interest on Underpayments

    The proposed regulations provide a special transition rule for a 
government entity's liability for interest and penalties with respect 
to the failure to pay the tax on payments for property and services 
made before January 1, 2012. Under the transition rule, a government 
entity would not be liable for penalties and interest with respect to 
liability for withholding imposed by section 3402(t), on payments for 
property or services made before January 1, 2012, if the entity made a 
good faith effort to comply with the requirements of section 3402(t). 
However, this transition rule would not provide relief from liability 
for the amount of tax required to be withheld under section 3402(t).

Proposed Effective Date

    These regulations are proposed to apply to payments made after the 
later of December 31, 2010, or six months after the date of publication 
of final regulations. In addition, the regulations will not apply to 
payments under contracts existing on the later of December 31, 2010, or 
six months after the date of publication of final regulations.

Special Analyses

    It has been determined that this notice of proposed rulemaking 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, this 
regulation has been submitted to the Chief Counsel for Advocacy of the 
Small Business Administration for comment on its impact on small 
business.

Comments and Requests for Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any written (a signed original and eight 
(8) copies) or electronic comments that are timely submitted to the 
IRS. All comments will be available for public inspection and copying. 
A public hearing will be scheduled if requested in writing by any 
person that timely submits written or electronic comments. If a public 
hearing is scheduled, notice of the date, time, and place for the 
hearing will be published in the Federal Register.

Drafting Information

    The principal author of these proposed 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, Income taxes, Penalties, Pensions, Railroad 
retirement, Reporting and recordkeeping requirements, Social Security, 
Unemployment compensation.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR part 31 is proposed to be amended as follows:

PART 31--EMPLOYMENT TAXES AND COLLECTION OF INCOME TAX AT SOURCE

    Paragraph 1. The authority citation for part 31 continues to read 
in part as follows:

    Authority: 26 U.S.C. 7805 * * *

    Par. 2. The following Sec. Sec.  31.3402(t)-0, 31.3402(t)-1, 
31.3402(t)-2, 31.3402(t)-3, 31.3402(t)-4, and 31.3402(t)-5 are added, 
Sec.  31.3402(t)-6 is added and reserved, and Sec.  31.3402(t)-7 is 
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)-5, and Sec.  31.3402(t)-7.


Sec.  31.3402(t)-1  Withholding requirements on certain payments made 
by government entities.

    (a) In general.
    (b) Special rules.
    (c) Deposit and reporting requirements.
    (d) Effective/applicability date.


Sec.  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.

[[Page 74091]]

    (g) Passthrough entities.
    (h) Small entity exception.
    (i) Effective/applicability date.


Sec.  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) Payments by credit card or payment card.
    (f) Examples.
    (g) Effective/applicability date.


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).
    (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) Effective/applicability date.


Sec.  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.


Sec.  31.3402(t)-6  Crediting of tax withheld under section 3402(t) 
[Reserved].


Sec.  31.3402(t)-7  Effective date and transition rules.

    (a) General rule.
    (b) Exception for payments made under existing written binding 
contracts.
    (c) Good faith exception for interest and penalties on payments 
before January 1, 2012.

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 shall deduct and withhold 
from such 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 is effective for 
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 the later of December 31, 2010, or the 
date that is 6 months after the date of publication in the Federal 
Register of final regulations under section 3402(t).
    (2) Payments made under a written binding contract that was in 
effect on the later of December 31, 2010, or the date that is 6 months 
after the publication in the Federal Register of final regulations 
under section 3402(t), 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 the later of 
December 31, 2010, or the date that is 6 months after the date of 
publication in the Federal Register of final regulations under section 
3402(t).


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 is effective the 
later of January 1, 2011, or the date that is 6 months after the date 
of publication in the Federal Register of final regulations under 
section 3402(t).


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-

[[Page 74092]]

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.
    (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.
    (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 applies will be 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 will be 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 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 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.
    (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--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 funds to the 
payment administrator.
    (e) Payments by credit card or payment card. For purposes of 
section 3402(t), a payment made by a government entity by credit card 
or payment card to a person for property or services occurs when the 
credit card or payment card is tendered at the point of sale. The 
government entity is liable for withholding under section 3402(t) and 
reporting associated with such withholding. See section 6050W of the 
Internal Revenue Code for separate reporting obligations imposed on the 
acquiring bank of the person receiving payment by credit card or 
payment card.
    (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 $1,440.
    (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 $1,440 withholding 
required under section 3402(t) on its payment to X and is

[[Page 74093]]

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 providing X with a Form 1099 
including the entire amount of the payment ($48,000) and the entire 
amount of the withholding ($1,440).
    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 is made at the time of the 
payment from the government entity to Z. 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 with respect to 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 issuing P a 
Form 1099 reflecting the amount of the payment from Z to P of 
$18,000 and the amount of withholding of $540.
    (g) Effective/applicability date. This section is effective for 
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 the later of December 31, 2010, or the 
date that is 6 months after the date of publication in the Federal 
Register of final regulations under section 3402(t).


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 of the Code (other than section 
3402(t)).
    (2) Payments subject to withholding under chapter 3. Payments 
subject to withholding under chapter 3 include those payments that are 
subject to, but exempt from, withholding under chapter 3 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. 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

[[Page 74094]]

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. The determination of whether an entity is a political 
subdivision of a State is made 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. The determination of whether the exception 
provided by paragraph (g)(1) of this section applies is made for each 
calendar year. For purposes of any calendar year, the determination of 
whether a political subdivision or instrumentality makes less than 
$100,000,000 of payments for property or services annually is 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 purposes of this paragraph (g), payments that would 
have qualified for the exceptions from withholding under Sec.  
31.3402(t)-4(a) through (l) had these regulations been in effect shall 
not be included in calculating the total payments made. However, 
payments that would have been excepted from withholding only because 
such payments were less than the $10,000 payment threshold contained in 
Sec.  31.3402(t)-3(b) are included in calculating the total payments 
for purposes of this paragraph (g). Also, payments that were not 
subject to withholding under section 3402(t) solely based on the 
effective 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(m), Sec.  31.3402(t)-5(e), or Sec.  31.3402(t)-7 are included in 
calculating total payments for purposes of this paragraph (g). For 
purposes of this determination, 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, 
the determination of whether this exception applies for a calendar year 
shall be based on the total payments as projected for the accounting 
year consisting of 12 months ending in that calendar year.

    (4) Example. (i) Government entity X, which qualifies as a 
political subdivision or instrumentality thereof for the calendar 
years 2011 and 2012, uses a fiscal year ending June 30 to determine 
its budgets and to keep its accounting books. During its fiscal year 
ending June 30, 2009, 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 (l) if 
section 3402(t) had been in effect.
    (ii) During its fiscal year ending June 30, 2010, 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 (l) if section 3402(t) had been in effect. In addition, 
during the fiscal year ending June 30, 2010, X made $15,000,000 of 
payments that were below the payment threshold of $10,000 in Sec.  
31.3402(t)-3(b) if section 3402(t) had been in effect.
    (iii) For the calendar year 2011, X determines whether it is 
eligible for the exception provided by this paragraph (g) based on 
the total payments X made for its accounting year ending June 30, 
2009. Because total payments for this purpose exclude payments that 
would be excepted under Sec.  31.3402(t)-4(a) through (l), total 
payments were $200,000,000 less $102,000,000, or $98,000,000. 
Therefore, for calendar year 2011, X would qualify for the exception 
provided by this paragraph (g), and would not be required to 
withhold under section 3402(t).
    (iv) For the calendar year 2012, X determines whether it is 
eligible for the exception provided by this paragraph (g) based on 
the total payments it made for its accounting year ending June 30, 
2010. Because total payments for this purpose exclude payments that 
would have been excepted under Sec.  31.3402(t)-4(a) through (l), 
but include payments below the payment threshold of $10,000 provided 
under Sec.  31.3402(t)-3(b), total payments were $210,000,000 less 
$106,000,000, or $104,000,000. Therefore, for calendar year 2012, X 
would not qualify for the exception provided by this paragraph (g) 
and would be 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 shall 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.
    (i) Payments made to any government employee with respect to his or 
her services. Section 3402(t) withholding shall 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 the individual travel expenses of the employee. This 
exception also applies to payments made by the government employee 
under accountable plans 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 shall not apply to any 
payment received by a nonresident alien individual or foreign 
corporation (foreign person) 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 foreign person.

[[Page 74095]]

    (k) Payments to Indian tribal governments. Section 3402(t) 
withholding shall not apply to any payment made to an Indian tribal 
government or its political subdivisions.
    (l) Payments in emergency or disaster situations. The Secretary 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 
or disaster situation if the Secretary determines that withholding from 
the payments would impede a government entity's efforts to respond to 
the emergency or disaster.
    (m) Effective/applicability date. This section is effective for 
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 the later of December 31, 2010, or the 
date that is 6 months after the date of publication in the Federal 
Register of final regulations under section 3402(t).


Sec.  31.3402(t)-5  Application to passthrough entities.

    (a) In general. This section sets forth rules that provide that 
section 3402(t)(1) does not apply to payments made by passthrough 
entities except as described in paragraph (c) of this section. In 
addition, the rules provide that 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 set forth the meaning of 
certain terms 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) shall 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) shall apply 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 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) shall apply to payments made to passthrough entities during 
the taxable year, except as provided in paragraph (d)(2) of this 
section.
    (2) Exception. Section 3402(t)(1) shall not apply to any payment 
during a taxable year to a passthrough entity if the aggregate 
ownership percentage held, directly or indirectly, in the entity on the 
testing day by persons described in section 3402(t)(2)(E) is at least 
80 percent. For purposes of this paragraph (d)(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.
    (e) Effective/applicability date. This section is effective for 
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 the later of December 31, 2010, or the 
date that is 6 months after the date of publication in the Federal 
Register of final regulations under section 3402(t).


Sec.  31.3402(t)-6  Crediting of tax withheld under section 3402(t).

    [Reserved].


Sec.  31.3402(t)-7  Effective date and transition rules.

    (a) General Rule. Except as provided in paragraph (b) of this 
section, the requirement to withhold under Sec.  31.3402(t)-1(a) 
applies to payments made after the later of December 31, 2010, or the 
date that is 6 months after the date of publication in the Federal 
Register of final regulations under section 3402(t).
    (b) Exception for payments made under existing written binding 
contracts. Payments made under a written binding contract that was in 
effect on the later of December 31, 2010, or the date that is 6 months 
after the date of publication in the Federal Register of final 
regulations under section 3402(t), are not subject to the withholding 
requirements in Sec.  31.3402(t)-1. The preceding sentence does not 
apply to payments made under any contract that is materially modified 
after the later of December 31, 2010, or the date that is 6 months 
after the date of publication in the Federal Register of final 
regulations under section 3402(t).
    (c) Good faith exception for interest and penalties on payments 
made before January 1, 2012. Government entities that make a good faith 
effort to comply with the provisions of these regulations will not be 
liable for penalties and interest with respect to income tax 
withholding under section 3402(t) that the government entity failed to 
withhold from payments made before January 1, 2012. However, this 
provision shall not relieve the government entity of liability for 
income tax that it failed to withhold. See, however, Sec.  31.3402(d)-
1.
    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), with respect to a payment to which both types 
of withholding would apply. Pursuant to section 3402(t)(2)(B), 
withholding under section 3402(t) shall not apply if amounts are being 
withheld under section 3406 with respect to a 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 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) relating to certain 
payments made by government entities applies to payments made by 
government entities under section 3402(t) made after the later of 
December 31, 2010, or the date that is 6 months after the date of 
publication in the Federal Register of final regulations under section 
3402(t).

[[Page 74096]]

    Par. 4. Section 31.6011(a)-4 is amended by adding paragraphs (b)(6) 
and (d) to read as follows:


Sec.  31.6011(a)-4  Returns of income tax withheld.

* * * * *
    (b) * * *
    (6) Certain payments made by government entities subject to 
withholding under section 3402(t).
* * * * *
    (d) Effective/applicability date. Paragraph (b)(6) 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 the later of December 31, 2010, or the 
date that is 6 months after the date of publication in the Federal 
Register of final regulations under section 3402(t).
    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 
Secretary. Such duplicate shall constitute an information return.
    (c) Prescribed form. The prescribed form for the statement required 
by this section is Form 1099-MISC, ``Miscellaneous Income.''
    (d) Information required. Each statement on Form 1099-MISC 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.
    (e) Time for furnishing statements. The statement 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.
    (f) Cross references. For provisions relating to the time for 
filing the information returns required by this section and to 
extensions of the time for filing, see Sec. Sec.  31.6071(a)-1(a)(3) 
and 1.6081-1(b)(3), respectively. For penalties applicable to failure 
to file information returns and furnish payee statements, see sections 
6721 through 6724.
    (g) Effective/applicability date. This section is effective on the 
later of January 1, 2011, or the date that is 6 months after the date 
of publication in the Federal Register of final regulations under 
section 3402(t).
    Par. 6. Section 31.6071(a)-1 is amended by revising paragraph 
(a)(3)(i) to read as follows:


Sec.  31.6071(a)-1  Time for filing returns and other documents.

* * * * *
    (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 which is required to be made 
under Sec.  31.6051-2 or of income tax withheld from payments by 
government entities as required under Sec.  31.6051-5 shall 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 
statement shall be filed on or before the last day of the second 
calendar month following the period for which the tax return is filed.
* * * * *
    Par. 7. Section 31.6302-1 is amended by adding paragraph 
(e)(1)(iii)(E) and revising paragraph (n) to read as follows:


Sec.  31.6302-1  Federal tax deposit rules for withheld income taxes 
and taxes under the Federal Insurance Contributions Act (FICA) 
attributable to payments made after December 31, 1992.

* * * * *
    (e) * * * (1) * * *
    (iii) * * *
    (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. Section 31.6302-1(e)(1)(iii)(E) 
applies with respect to the deposit of employment taxes attributable to 
payments made by government entities under section 3402(t) made after 
the later of December 31, 2010, or the date that is 6 months after the 
date of publication in the Federal Register of final regulations under 
section 3402(t).
    Par. 8. Section 31.6302-4 is amended by revising paragraph (b)(5) 
and adding paragraphs (b)(6) and (e) to read as follows:


Sec.  31.6302-4  Federal tax deposit rules for withheld income taxes 
attributable to nonpayroll payments made after December 31, 1993.

* * * * *
    (b) * * *
    (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. Paragraph (b)(6) relating to 
certain payments made by government entities applies to payments made 
by government entities under section 3402(t) made after the later of 
December 31, 2010, or the date that is 6 months after the date of 
publication in the Federal Register of final regulations under section 
3402(t).

Linda E. Stiff,
Deputy Commissioner for Services and Enforcement.
 [FR Doc. E8-28789 Filed 12-4-08; 8:45 am]
BILLING CODE 4830-01-P