[Federal Register Volume 85, Number 191 (Thursday, October 1, 2020)]
[Rules and Regulations]
[Pages 61813-61816]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-21777]


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

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 31 and 35

[TD 9920]
RIN 1545-BP69


Income Tax Withholding on Certain Periodic Retirement and Annuity 
Payments Under Section 3405(a)

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulation.

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

SUMMARY: This document sets forth a final regulation that provides 
rules for Federal income tax withholding on certain periodic retirement 
and annuity payments to implement an amendment made by the Tax Cuts and 
Jobs Act. This regulation affects payors of certain periodic payments, 
plan administrators that are required to withhold on such payments, and 
payees who receive such payments.

DATES: Effective date: This regulation is effective October 1, 2020.
    Applicability date: For the applicability date of this regulation, 
see Sec.  31.3405(a)-1(d).

FOR FURTHER INFORMATION CONTACT: Kara M. Soderstrom of the Office of 
Associate Chief Counsel (Employee Benefits, Exempt Organizations, and 
Employment Taxes) at (202) 317-5234 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

    This document sets forth an amendment to the Employment Tax 
Regulations (26 CFR parts 31 and 35) under section 3405 of the Internal 
Revenue Code (Code).

1. Periodic Payments

    Section 3405 provides Federal income tax withholding rules for 
payments of pensions, annuities, and certain other deferred income 
(retirement and annuity payments). Retirement and annuity payments that 
are subject to withholding under section 3405 include periodic 
payments, nonperiodic distributions, and eligible rollover 
distributions.
    A periodic payment is defined in section 3405(e)(2) as ``a 
designated distribution which is an annuity or similar periodic 
payment.'' Subject to certain exceptions,\1\ a designated distribution 
generally is defined in section 3405(e)(1)(A) as any distribution or 
payment from or under an employer deferred compensation plan, an 
individual retirement plan (as defined in section 7701(a)(37)), or a 
commercial annuity. For this purpose, an employer deferred compensation 
plan is defined in section 3405(e)(5) as any pension, annuity, profit-
sharing, or stock bonus plan or other plan deferring the receipt of 
compensation, and a commercial annuity is defined in section 3405(e)(6) 
as an annuity, endowment, or life insurance contract issued by an 
insurance company licensed to do business under the laws of any State. 
Section 35.3405-1T, Q&A a-9, provides that a periodic payment includes 
an annuity or similar periodic payment, whether paid by a licensed life 
insurance company, a financial institution, or a plan, and that an 
``annuity'' is a series of payments payable over a period greater than 
one year and taxable under section 72 as amounts received as an 
annuity, whether or not the payments are variable in amount.
---------------------------------------------------------------------------

    \1\ Under section 3405(e)(1)(B), a designated distribution does 
not include any amount that is wages without regard to section 3405; 
the portion of a distribution or payment (excluding any distribution 
or payment from or under an individual retirement plan, other than a 
Roth IRA) which it is reasonable to believe is not includible in 
gross income; any amount that is subject to withholding under 
subchapter A of chapter 3 (relating to withholding of tax on 
nonresident aliens and foreign corporations) by the person paying 
such amount or which would be so subject but for a tax treaty; or 
any distribution described in section 404(k)(2) (relating to 
distributions of ``applicable dividends'' by an employee stock 
ownership plan).
---------------------------------------------------------------------------

2. Withholding on Periodic Payments

    Section 3405(a) requires the payor of any periodic payment to 
withhold from

[[Page 61814]]

the payment as if the payment were wages paid by an employer to an 
employee, unless an individual has elected under section 3405(a)(2) not 
to have withholding apply, subject to the following exceptions. First, 
section 3405(c)(1)(A) provides that section 3405(a) does not apply in 
the case of any designated distribution that is an eligible rollover 
distribution (as defined in section 402(f)(2)(A)). Second, section 
3405(e)(12) provides that no election under section 3405(a)(2) will be 
treated as in effect (and the provisions of section 3405(a)(4) for 
determining the default rate of withholding will not apply) if a payee 
fails to furnish the payee's Taxpayer Identification Number (TIN) to 
the payor in the manner required by the Secretary or the Secretary 
notifies the payor before any payment or distribution that the TIN 
furnished by the payee is incorrect. Third, under section 3405(e)(13), 
no election under section 3405(a)(2) may be made with respect to 
certain periodic payments to be delivered outside of the United States 
and its possessions.

3. Default Rate of Withholding on Periodic Payments and TCJA Amendment

    Before amendment by the Tax Cuts and Jobs Act, Public Law 115-97, 
131 Stat. 2054 (2017) (TCJA), section 3405(a)(4) provided that, in the 
case of any periodic payment with respect to which a withholding 
certificate is not in effect, the amount withheld from the periodic 
payment is ``determined by treating the payee as a married individual 
claiming 3 withholding exemptions.'' TCJA amended section 3405(a)(4) to 
eliminate the requirement that the payee be treated as a married 
individual claiming three withholding exemptions and to provide instead 
that, in the case of any periodic payment with respect to which a 
withholding certificate is not in effect, the amount withheld from the 
periodic payment will be ``determined under rules prescribed by the 
Secretary.'' However, certain provisions of Sec.  35.3405-1T continued 
to reflect the rule under section 3405(a)(4) prior to amendment by 
TCJA.
    Following enactment of TCJA, the Department of the Treasury 
(Treasury Department) and the IRS issued three notices addressing this 
change to section 3405(a)(4). These notices provide that, for calendar 
years 2018, 2019, and 2020, the default rate of withholding on periodic 
payments under section 3405(a) is based on treating the payee as a 
married individual claiming three withholding allowances. See Notice 
2020-3, 2020-3 I.R.B. 330 (for 2020); \2\ Notice 2018-92, 2018-51 
I.R.B. 1038 (for 2019); and Notice 2018-14, 2018-7 I.R.B. 353 (for 
2018).
---------------------------------------------------------------------------

    \2\ Notice 2020-3 also provides that the Treasury Department and 
the IRS are considering whether the default rate of withholding on 
periodic payments that is in effect for 2020 will continue to be 
appropriate for calendar years after 2020 and requests comments on 
whether the adoption of a new default rate of withholding on 
periodic payments that applies prospectively would present any 
administrative challenges. One comment was received on this issue 
(available at: https://www.regulations.gov/document?D=IRS-2019-0051-0004). The commenter provides suggestions regarding the effective 
date and prospective application of any change to the default rate 
of withholding on periodic payments and suggestions regarding the 
applicable withholding tables for periodic payments for calendar 
years after 2020.
---------------------------------------------------------------------------

4. Notice of Proposed Rulemaking

    On May 27, 2020, the Treasury Department and the IRS published a 
notice of proposed rulemaking (proposed regulation) (REG-100320-20) in 
the Federal Register (85 FR 31714) that proposed to update certain 
provisions of Sec.  35.3405-1T to conform to the TCJA change to section 
3405(a)(4). Specifically, the notice of proposed rulemaking proposed to 
remove from Sec.  35.3405-1T Q&As a-10, b-3, and b-4, which each 
provided that the default rate of withholding on periodic payments is 
determined by treating the payee as married and claiming three 
withholding allowances, and to update and replace the provisions of 
each of these three Q&As with new Sec.  31.3405(a)-1. These changes are 
explained in detail in the preamble to the proposed regulation.
    The IRS did not receive any requests for a public hearing on the 
proposed regulation, and therefore no public hearing was held. All 
written comments responding to the proposed regulation are available 
for public inspection and copying at http://www.regulations.gov or upon 
request. After consideration of the comments received on the proposed 
regulation, this Treasury decision adopts the proposed regulation as 
final with no modifications, as explained in the Summary of Comments 
and Explanation of Provisions.

Summary of Comments and Explanation of Provisions

    The Treasury Department and the IRS received two written comments 
that responded to the proposed regulation. As explained in this Summary 
of Comments and Explanation of Provisions, these comments make 
recommendations regarding the default rate of withholding on periodic 
payments that would not require a change to the proposed regulation. 
Accordingly, the proposed regulation is adopted as final without 
modification. However, the comments remain under consideration for 
future revisions to forms, instructions, publications, and other 
guidance relating to withholding on periodic payments, including 
revisions to the Form W-4P, ``Withholding Certificate for Pension or 
Annuity Payments.''

1. Default Rate of Withholding on Periodic Payments

    The proposed regulation proposed to remove Q&As a-10, b-3, and b-4 
from Sec.  35.3405-1T because they prescribed the substantive default 
rate of withholding rule under section 3405(a)(4) prior to amendment by 
TCJA. Specifically, the proposed regulation proposed to update and 
replace the provisions of each of these three Q&As with new Sec.  
31.3405(a)-1, which provides that the default rate of withholding on 
periodic payments made after December 31, 2020, is determined in the 
manner described in the applicable forms, instructions, publications, 
and other guidance prescribed by the Commissioner.
    Both responsive comments recommend that the default rate of 
withholding on periodic payments be a flat 10 percent rate, rather than 
a rate based on Federal income tax withholding on wages, to simplify 
the default rate of withholding on periodic payments and provide 
transparency, flexibility, efficiency, and accuracy.
    The proposed regulation did not set forth a specific default rate 
of withholding on periodic payments, instead providing a flexible and 
admininstrable rule that leaves the communication and mechanical 
details of the default rate of withholding on periodic payments to be 
provided in applicable forms, instructions, publications, and other 
guidance prescribed by the Commissioner. This approach enables the 
Treasury Department and the IRS to make updates more quickly, including 
to address legislative changes, to provide payors and plan 
administrators processing payments adequate time to program their 
systems to withhold the proper amount of income tax. Accordingly, this 
final regulation adopts the proposed regulation without modification.

[[Page 61815]]

2. Implementation of a New Default Rate of Withholding on Periodic 
Payments

    As an alternative to a flat 10 percent rate for the default rate of 
withholding on periodic payments, both comments recommend that a new 
default rate of withholding on periodic payments apply prospectively 
only and have a January 1 (rather than a mid-year) effective date. The 
comments additionally recommend a January 1 effective date that is at 
least two full years after the end of the 2020 calendar year (or at 
least two full years after the end of the calendar year for which Form 
W-4P is redesigned to mirror Form W-4, ``Employee's Withholding 
Certificate,'' if later), in order to provide payors time to update 
their systems, forms, and procedures. (The comments also recommend 
avoiding a mid-year implementation deadline for any revised version of 
Form W-4P that reflects changes made to Form W-4 in light of TCJA.)
    The proposed regulation did not specify an effective date for a new 
default rate of withholding on periodic payments or how a new default 
rate of withholding should be applied. Although the proposed regulation 
was proposed to apply to periodic payments made after December 31, 
2020, this applicability date describes the periodic payments for which 
the default rate of withholding is determined in the manner described 
in the applicable forms, instructions, publications and other guidance 
prescribed by the Commissioner. The effective date and application of a 
new default rate of withholding on periodic payments, like the default 
rate of withholding on periodic payments itself, would be described in 
that guidance. The proposed approach provides a flexible and 
admininstrable rule that leaves the communication and mechanical 
details of the default rate of withholding on periodic payments to be 
provided in applicable forms, instructions, publications, and other 
guidance prescribed by the Commissioner that may be updated more 
quickly, including to address legislative changes. Accordingly, this 
final regulation adopts the proposed regulation without modification.

Effective and Applicability Dates

    This regulation is effective October 1, 2020. This regulation 
applies to periodic payments made after December 31, 2020.

Special Analyses

1. Regulatory Planning and Review

    This final regulation is not subject to review under section 6(b) 
of Executive Order 12866 pursuant to the Memorandum of Agreement (April 
11, 2018) between the Treasury Department and the Office of Management 
and Budget regarding review of tax regulations.

2. Paperwork Reduction Act

    Any collection of information associated with this final regulation 
has been submitted to the Office of Management and Budget (OMB) for 
review under OMB control number 1545-0074 in accordance with the 
Paperwork Reduction Act of 1995 (44 U.S.C. 3507(d)). In general, the 
collection of information is required under section 3405 of the Code. 
The Treasury Department and the IRS request comments on all aspects of 
information collection burdens related to this final regulation, 
including estimates for how much time it would take to comply with the 
paperwork burdens described in OMB control number 1545-0074 and ways 
for the IRS to minimize the paperwork burden. An agency may not conduct 
or sponsor and a person is not required to respond to a collection of 
information unless it displays a valid OMB control number.

3. Regulatory Flexibility Act

    Under the Regulatory Flexibility Act (RFA) (5 U.S.C. chapter 6), it 
is hereby certified that this final regulation will not have a 
significant economic impact on a substantial number of small entities 
that are directly affected by the final regulation. This final 
regulation will apply to all payors of periodic payments, including 
small entities, and is likely to affect a substantial number of small 
entities. The economic impact, however, will not be significant. The 
primary change is to effect a TCJA legislative amendment to remove the 
reference in section 3405(a)(4) to a married individual claiming three 
exemptions as the default withholding rate and to provide, in its 
place, that the amount to be withheld is determined pursuant to the 
applicable forms, instructions, publications, and other guidance 
prescribed by the Commissioner. Accordingly, this rule would conform 
the current regulation to the statute and will not have a significant 
economic impact on a substantial number of small entities.
    Pursuant to section 7805(f), the notice of proposed rulemaking 
preceding this regulation was submitted to the Chief Counsel for 
Advocacy of the Small Business Administration for comment on its impact 
on small business, and no comments were received.

Statement of Availability of IRS Documents

    IRS Notices cited in this preamble are published in the Internal 
Revenue Bulletin and are available from the Superintendent of 
Documents, U.S. Government Publishing Office, Washington, DC 20402, or 
by visiting the IRS website at http:/www.irs.gov.

Drafting Information

    The principal author of this final regulation is Kara M. 
Soderstrom, Office of Associate Chief Counsel (Employee Benefits, 
Exempt Organizations, and Employment Taxes). However, other personnel 
from the Treasury Department and the IRS participated in its 
development.

List of Subjects

26 CFR Part 31

    Employment taxes, Fishing vessels, Gambling, Income taxes, 
Penalties, Pensions, Railroad retirement, Reporting and recordkeeping 
requirements, Social security, Unemployment compensation.

26 CFR Part 35

    Employment taxes, Income taxes, Pensions, Reporting and 
recordkeeping requirements.

Adoption of Amendments to the Regulations

    Accordingly, 26 CFR parts 31 and 35 are amended as follows:

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

0
Paragraph 1. The authority citation for part 31 is amended by adding an 
entry for Sec.  31.3405(a)-1 in numerical order to read in part as 
follows:

    Authority: 26 U.S.C. 7805.
* * * * *
    Section 31.3405(a)-1 also issued under 26 U.S.C. 3405(a)(4).
* * * * *

0
Par. 2. Section 31.3405(a)-1 is added to read as follows:


Sec.  31.3405(a)-1  Questions and answers relating to Federal income 
tax withholding on periodic retirement and annuity payments.

    (a) The questions and answers in this section relate to Federal 
income tax withholding on periodic payments under section 3405(a), as 
amended by section 11041(c)(2)(G) of the Tax Cuts and Jobs Act (Pub. L. 
115-97, 131 Stat. 2054 (2017)). The withholding rules of

[[Page 61816]]

section 3405(a) do not apply to periodic payments that are eligible 
rollover distributions (as defined in section 402(f)(2)(A)). See 
generally section 3405(c) and Sec.  31.3405(c)-1 for Federal income tax 
withholding rules applicable to eligible rollover distributions. See 
section 3405(e)(13) for additional rules applicable to certain periodic 
payments under section 3405(a) and nonperiodic distributions under 
section 3405(b) that are to be delivered outside the United States and 
its possessions. For additional guidance regarding periodic payments, 
see Sec. Sec.  35.3405-1 and 35.3405-1T of this chapter.
    (b)(1) Q-1: How will Federal income tax be withheld from a periodic 
payment?
    (2) A-1: In the case of a periodic payment that is subject to 
withholding under section 3405(a), amounts are withheld as if the 
payment were a payment of wages by an employer to the employee for the 
appropriate payroll period. If the payee has not furnished a 
withholding certificate, the amount to be withheld is determined in the 
manner described in the applicable forms, instructions, publications, 
and other guidance prescribed by the Commissioner. The rules for 
withholding when the payee has not furnished a withholding certificate 
apply regardless of whether the payor is aware of the payee's actual 
marital status or actual Federal income tax filing status.
    (c)(1) Q-2: Do rules similar to those for wage withholding apply to 
the furnishing of a withholding certificate for periodic payments?
    (2) A-2: Yes. Unless the rules of section 3405 specifically 
conflict with the rules of section 3402, the rules for withholding on 
periodic payments that are not eligible rollover distributions will 
parallel the rules for wage withholding. Thus, if a withholding 
certificate is furnished by a payee, it will generally take effect in 
accordance with section 3402(f)(3) and as provided in applicable forms, 
instructions, publications, and other guidance prescribed by the 
Commissioner. If no withholding certificate is furnished, the amount 
withheld must be determined in the manner described in the applicable 
forms, instructions, publications, and other guidance prescribed by the 
Commissioner for withholding on periodic payments when no withholding 
certificate is furnished.
    (d)(1) Q-3: What is the applicability date of this section?
    (2) A-3: This section applies with respect to periodic payments 
made after December 31, 2020.

PART 35--EMPLOYMENT TAX AND COLLECTION OF INCOME TAX AT SOURCE 
REGULATIONS UNDER THE TAX EQUITY AND FISCAL RESPONSIBILITY ACT OF 
1982

0
Par. 3. The authority citation for part 35 continues to read in part as 
follows:

    Authority:  26 U.S.C. 6047(e), 7805; 68A Stat. 917; 96 Stat. 
625; Public Law 97-248 (96 Stat. 623) * * *


Sec.  35.3405-1T  [Amended]

0
Par. 4. Section 35.3405-1T is amended by removing and reserving entry 
a-10 in section A and entries b-3 and b-4 in section B.

Sunita Lough,
Deputy Commissioner for Services and Enforcement.

    Approved: September 25, 2020.
David J. Kautter,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 2020-21777 Filed 9-30-20; 8:45 am]
BILLING CODE 4830-01-P