There are a variety of changes to federal tax laws as a result of recent legislation as well as triggers in long-existing legislation that impact employers, including repeal of withholding on payments to federal contractors, enhanced tax credits for hiring veterans, and increased federal unemployment tax rates resulting from states’ failure to repay federal loans.

Repeal of 3% Withholding on Payments to Government Contractors

On November 21, 2011, President Obama signed into law H.R. 674, the “3% Withholding Repeal and Job Creation Act,” which repeals the highly controversial 3% withholding on payments to contractors of federal, state and local governments under Internal Revenue Code section 3402(t). This provision, originally enacted in 2005, never actually went into effect because Congress kept delaying its implementation. Acknowledging the potentially devastating effect such withholding could have upon the cash flows and the operations of government contractors, Congress decided to remove the withholding requirement. This change is a significant benefit to government contractors and allows them to better plan their finances for coming years.

Enhanced Tax Credits for Hiring Veterans

H.R. 674 also created enhanced tax credits for employers that hire veterans under what is called the “The VOW To Hire Heroes Act.” The new law expands the current Work Opportunity Tax Credit (WOTC) and allows an employer to claim a tax credit of up to $2,400 if it hires veterans who have been unemployed for at least one month or $5,600 for hiring veterans who have been unemployed at least six months. In addition, an employer may obtain a tax credit of as much as $9,600 for hiring unemployed veterans who have service-related disabilities. There are also additional vocational training and rehabilitation services available to veterans.

According to the Bureau of Labor and Statistics (BLS), in 2010 there were 20.2 million male and 1.8 million female veterans in the civilian population, with approximately two-thirds of veterans being under 35 years old. BLS also reports that approximately 13 percent of all veterans have reported a service-connected disability. A significant number of veterans will be returning to the U.S. workforce over the next few years as well.

Federal Unemployment Tax Rates Set to Increase in Majority of States

During the Great Recession many states’ unemployment insurance funds (UI Funds) were hammered by increased claims and decreased tax revenues. As a result, a majority of state UI Funds became insolvent, and were forced to borrow money from the federal government in order to continue paying benefits.

As of July 1, 2011, employers pay FUTA tax at a rate of 6 percent on the first $7,000 in wages paid to an employee each calendar year. A 0.2 percent surcharge that had been in place for decades expired on June 30, 2011, without being reauthorized by Congress. Typically, an employer may take a credit against FUTA for state unemployment taxes paid on a timely basis into a state UI Fund of up to 5.4 percent. As a result, most employers pay a net FUTA tax of 0.6 percent after July 1, 2011, and 0.8 percent before that date.

However, when states borrow from the federal government to keep their UI Funds operational, they have two years to repay the loan balance, with a deadline of November 10. If the loan is not repaid on time, the amount of FUTA credit employers receive decreases by 0.3 percent in the first year and subsequent years. Such is the case for 20 states and the territories: Arkansas, California, Connecticut, Florida, Georgia, Illinois, Indiana, Kentucky, Michigan, Minnesota, Missouri, North Carolina, New Jersey, Nevada, New York, Ohio, Pennsylvania, Rhode Island, Virginia, Wisconsin and Virgin Islands.

Alabama and Idaho appear to have repaid their loans on the November 10 deadline, and therefore employers paying wages in those states should not suffer a loss of FUTA credit. South Carolina is in the process of repaying its loan and may obtain a one-year reprieve.

Employers in several states have already been suffering a reduced FUTA credit. For example, in Michigan employers have a 0.9 percent credit reduction because Michigan has had an outstanding loan for four years, while in Indiana the credit reduction is 0.6 percent because it has not repaid its loan for three consecutive years.

Photo credit: Bartek Szewczyk