[Federal Register Volume 89, Number 203 (Monday, October 21, 2024)]
[Rules and Regulations]
[Pages 84079-84083]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2024-24224]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 31
[TD 10008]
RIN 1545-BN52
Withholding on Certain Distributions Under Section 3405(a) and
(b)
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final regulation.
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SUMMARY: This document contains a final regulation regarding income tax
withholding on certain periodic payments and nonperiodic distributions
from employer deferred compensation plans, individual retirement plans,
and commercial annuities that are not eligible rollover distributions.
The regulation addresses a payor's obligation to withhold income taxes
in the circumstances in which those payments or distributions are made
to payees outside of the United States and affects payors and payees of
those periodic payments and nonperiodic distributions.
DATES:
Effective date. This regulation is effective October 21, 2024.
Applicability date. This regulation applies with respect to
payments and distributions made on or after January 1, 2026. However,
taxpayers may apply it to earlier payments and distributions.
FOR FURTHER INFORMATION CONTACT: Jeremy Lamb at (202) 317-4575 or Isaac
Stein at (202) 317-6320 (not toll-free numbers).
SUPPLEMENTARY INFORMATION:
Authority
Section 7805(a) authorizes the Secretary to prescribe all needful
rules and regulations for the enforcement of the Code.
Background
Section 3405(a)(1) of the Internal Revenue Code of 1986 (Code)
requires the payor of any periodic payment to withhold income tax from
the payment. Under section 3405(a)(2), an individual generally may
elect not to have section 3405(a)(1) apply with respect to periodic
payments made to the individual. Section 3405(b)(1) requires the payor
of any nonperiodic distribution to withhold income tax from the
distribution. Under section 3405(b)(2), an individual generally may
elect not to have section 3405(b)(1) apply with respect to any
nonperiodic distribution.
Section 3405(e)(2) defines a periodic payment as a designated
distribution that is an annuity or similar periodic payment. Section
3405(e)(3) defines a nonperiodic distribution as any designated
distribution that is not a periodic payment. A designated distribution
is defined in section 3405(e)(1) as generally any distribution or
payment from or under an employer deferred compensation plan, an
individual retirement plan (as defined in section 7701(a)(37) of the
Code), 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
[[Page 84080]]
issued by an insurance company licensed to do business under the laws
of any State.
Section 3405(e)(1)(B) identifies certain amounts or payments that
are not a ``designated distribution'' for purposes of section 3405
withholding. Under section 3405(e)(1)(B)(iii), any amount that is
subject to withholding under subchapter A of chapter 3 of the Code
(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 is not a designated distribution.
Section 3405(e)(13)(A) provides generally that, in the case of any
periodic payment or nonperiodic distribution that is ``to be delivered
outside of the United States and any possession of the United States,''
no election may be made under section 3405(a)(2) or (b)(2) with respect
to such payment, with the result that withholding may not be waived.
Section 3405(e)(13)(B) provides that section 3405(e)(13)(A) does not
apply if the recipient certifies to the payor, in such manner as the
Secretary of the Treasury may prescribe, that the recipient is not (i)
a United States citizen or a resident alien of the United States, or
(ii) an individual to whom section 877 of the Code applies. Section
877(h) provides that section 877 applies to certain nonresident alien
individuals whose expatriation date, as defined in section 877A(g)(3),
is before June 17, 2008.
Notice 87-7, 1987-1 CB 420, provides guidance under section
3405(e)(13)(A) to payors of designated distributions with respect to
their duty to withhold income tax from such distributions. The notice
applies to designated distributions for the following categories of
payees: (1) payees who have provided the payors with a residence
address outside of the United States; \1\ (2) payees who have provided
the payors with a residence address within the United States; and (3)
payees who have not provided the payors with a residence address.
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\1\ For purposes of this preamble, references to the ``United
States'' include any possession of the United States.
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Notice 87-7 specifies that, if a payee has provided the payor with
a residence address outside of the United States, the payor is required
to withhold income tax from designated distributions to the payee. If a
payee has provided the payor with a residence address within the United
States, the payor is required to withhold income tax from these
distributions to the payee unless the payee has elected no withholding
in accordance with the applicable provisions of section 3405. If a
payee has not provided the payor with a residence address, the payor is
required to withhold income tax from designated distributions; included
within this category is a payee who has provided the payor with an
address for the payee's nominee, trustee, or agent without also
providing the payee's residence address.
On May 31, 2019, the Department of the Treasury (Treasury
Department) and the IRS published a notice of proposed rulemaking
regarding withholding on certain periodic payments and nonperiodic
distributions under section 3405 (other than eligible rollover
distributions) in the Federal Register (84 FR 25209). No comments
responsive to the notice of proposed rulemaking were received, and no
public hearing was requested or held. Thus, this final regulation
adopts the provisions of the proposed regulation with no modifications
except for the change in the applicability date to January 1, 2026, and
other minor changes in wording that are nonsubstantive.
Explanation of Provisions
This document contains a final regulation under section 3405(e)
that provides withholding guidance for payors of periodic payments and
nonperiodic distributions under section 3405(a) and (b), respectively.
The regulation generally addresses a payor's obligation to withhold
under section 3405(a) and (b) in the following situations: (1) payments
to payees with a military or diplomatic Post Office address; (2)
payments to payees with a residence address located within the United
States; (3) payments to payees with a residence address located outside
of the United States or who have not provided a residence address; and
(4) payments subject to withholding under subchapter A of chapter 3
(sections 1441 through 1446 of the Code).
1. Payees With a Military or Diplomatic Post Office Address
For purposes of section 3405(e)(13)(A), the regulation treats an
Army Post Office (APO), a Fleet Post Office (FPO), or a Diplomatic Post
Office (DPO) \2\ address as an address located within the United
States. In 1986, when this provision was added to the Code by the Tax
Reform Act of 1986, Public Law 99-514 (TRA '86), it was one of several
provisions intended to increase compliance with the internal revenue
laws by United States persons resident abroad and green card holders.
The Senate Finance Committee Report for TRA '86 indicates a concern,
based on data gathered by the General Accounting Office (GAO),\3\ that
the percentage of taxpayers who fail to file returns is substantially
higher among Americans living abroad than it is among those resident in
the United States, and that it is often difficult for the IRS to
enforce compliance by these taxpayers. S. Rep. No. 99-313, at 390
(1986).
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\2\ APO is associated with Army or Air Force installations. FPO
is associated with Navy installations and ships. APO/FPO addresses
are utilized by Department of Defense personnel, their family
members, and other authorized users. DPO provides global mail
service to authorized personnel assigned to designated posts abroad.
\3\ Effective July 7, 2004, the GAO's legal name was changed
from the General Accounting Office to the Government Accountability
Office.
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The GAO data referred to in the legislative history does not
include United States military personnel and their families as
taxpayers who are living abroad. Johnny C. Finch, United States
Citizens Living in Foreign Countries and Not Filing Federal Income Tax
Returns, United States General Accounting Office, May 8, 1985. In
addition, enforcement of compliance by individuals receiving mail at an
APO, an FPO, or a DPO address generally does not involve the same
challenges as enforcing compliance by other taxpayers living abroad.
Because APO, FPO, and DPO delivery destinations are generally United
States military or diplomatic facilities, taxpayers with an APO, an
FPO, or a DPO address commonly maintain a current or former employment
or contractor relationship with the United States government. Moreover,
these addresses generally are treated as ``domestic'' by the United
States Postal Service. United States Domestic Mail Manual, 608.2.2.
For these reasons, the Treasury Department and the IRS have
determined that treating a United States military or diplomatic post
office address as located within the United States for purposes of
section 3405(e)(13)(A) is consistent with the tax avoidance concerns
underlying the enactment of that provision. Accordingly, the regulation
provides that designated distributions to United States military and
diplomatic personnel or their families are not treated as delivered
outside of the United States solely because those payments or
distributions are to be delivered to an APO, an FPO, or a DPO address.
[[Page 84081]]
2. Payees With a Residence Address Located Within the United States
The regulation imposes withholding requirements on payors regarding
certain payees who have provided the payor with a residence address
located within the United States. Under Notice 87-7, payors are not
required to withhold if a payee provides a residence address located
within the United States and the payee elects no withholding. Notice
87-7 does not specifically address whether payors are required to
withhold when a payee provides a residence address located within the
United States, but also provides payment instructions indicating that
the funds are to be delivered outside of the United States. As
explained in the Background section of this preamble, the mandatory
withholding for amounts to be delivered outside of the United States
was enacted because Congress was concerned about noncompliance. Section
3405(e)(13)(A) refers to ``any periodic payment or nonperiodic
distribution which is to be delivered outside of the United States.''
Consistent with the text of section 3405(e)(13)(A) and its purpose, the
regulation requires payors to withhold in certain circumstances when a
payee provides a residence address located within the United States but
also provides payment instructions indicating that the funds are to be
delivered outside of the United States.
3. Payees With a Residence Address Located Outside of the United States
or Who Have Not Provided a Residence Address
Unless section 3405(e)(13)(B) (which provides an exception for
certain nonresident aliens) applies, if the payee's residence address
that is provided to the payor is located outside of the United States,
the payor is required to withhold income tax under section 3405 from
any designated distribution, without regard to the delivery
instructions and without regard to any attempt to elect no withholding.
Thus, for example, withholding under section 3405 would be required
even if a payee with a foreign residence address has requested that the
distribution be deposited with a financial institution located within
the United States. Given the ease with which the funds deposited with a
financial institution in the United States can be withdrawn by a person
located outside the United States, the Treasury Department and the IRS
have concluded that the payee's residence address is more likely to be
indicative of the place the distribution is ultimately to be delivered
than the location of the financial institution. The same requirement to
withhold income tax under section 3405 applies if a payee has not
provided a residence address to the payor. Furthermore, a payee who has
provided the payor with an address for the payee's nominee, trustee, or
agent without also providing the payee's residence address has not
provided a residence address for purposes of this regulation.
These rules are consistent with the approach in Notice 87-7, which
uses the residence address of the payee in order to determine whether a
taxpayer is permitted to make an election not to have withholding apply
under section 3405(a)(2) or (b)(2). The Treasury Department and the IRS
have determined that this interpretation articulated in Notice 87-7
provides an administrable standard that has been relied upon for many
years, is consistent with the TRA '86 legislative history, and
appropriately addresses tax avoidance concerns underlying section
3405(e)(13)(A).\4\
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\4\ The Senate Finance Committee Report states that ``it will be
appropriate to require withholding with respect to pension payments
to persons with foreign addresses absent a showing that withholding
is not required.'' S. Rep. No. 99-313, at 391 (1986).
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4. Payments Subject to Withholding Under Subchapter A of Chapter 3
In accordance with section 3405(e)(1)(B)(iii), the regulation
clarifies that a designated distribution does not include a
distribution that is subject to withholding under subchapter A of
chapter 3 (or that would be subject but for a tax treaty). Therefore,
the withholding rules under section 3405(a) and (b) do not apply to
such a distribution. For example, section 3405(a) or (b) withholding
would not apply to a United States-source distribution to a nonresident
alien individual from a trust described in section 401(a) of the Code.
In such a case, the withholding rules of section 1441 (within
subchapter A of chapter 3) that apply to nonresident aliens would apply
to such a distribution. See Sec. 1.1441-1(b)(1).
Applicability Date
This regulation applies with respect to payments and distributions
made on or after January 1, 2026. However, taxpayers may apply the
regulation to earlier payments and distributions. Notice 87-7 is
obsoleted with respect to payments and distributions made after
December 31, 2025.
Statement of Availability of IRS Documents
The IRS notice cited in this preamble is published in the
Cumulative Bulletin and is available from the Superintendent of
Documents, U.S. Government Publishing Office, Washington, DC 20402.
Special Analyses
I. Regulatory Planning and Review
Pursuant to the Memorandum of Agreement, Review of Treasury
Regulations under Executive Order 12866 (June 9, 2023), tax regulatory
actions issued by the IRS are not subject to the requirements of
section 6 of Executive Order 12866, as amended. Therefore, a regulatory
impact assessment is not required.
II. Paperwork Reduction Act
The collection of information related to the withholding
requirements is captured within the forms and instructions for Forms W-
4P and W-4R. Both of these forms are approved under OMB Number 1545-
0074. This regulation does not alter any previously approved
information collection requirements contained within the forms and
instructions for Forms W-4P and W-4R, and this regulation does not
create new collection requirements not already approved by the Office
of Management and Budget.
III. Regulatory Flexibility Act
Pursuant to the Regulatory Flexibility Act (5 U.S.C. chapter 6) it
is hereby certified that the collection of information in this
regulation will not have a significant economic impact on a substantial
number of small entities. The number of small entities potentially
affected by this regulation is unknown but could be substantial because
based on data and information available to the Treasury Department and
the IRS, most defined benefit and defined contribution retirement plans
are sponsored by small employers (defined as employers with fewer than
100 employees), while annuities and IRAs are typically set up by large
financial institutions. Although a substantial number of small entities
is potentially affected by this regulation, the Treasury Department and
the IRS have concluded that this regulation will not have a significant
economic impact on a substantial number of small entities. This is
because the main purpose and effect of this regulation is to treat
military and diplomatic post office addresses the same as residence
addresses located within the United States for purposes of income tax
[[Page 84082]]
withholding, and payors of distributions from retirement plans and
annuities are already processing distributions to payees with residence
addresses located within the United States. Accordingly, this
regulation will not have a significant economic impact on a substantial
number of small entities. Therefore, a regulatory flexibility analysis
under the Regulatory Flexibility Act is not required.
Pursuant to section 7805(f) of the Code, 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.
IV. Unfunded Mandates Reform Act
Section 202 of the Unfunded Mandates Reform Act of 1995 requires
that agencies assess anticipated costs and benefits and take certain
other actions before issuing a final rule that includes any Federal
mandate that may result in expenditures in any one year by a state,
local, or tribal government, in the aggregate, or by the private
sector, of $100 million in 1995 dollars, updated annually for
inflation. This regulation does not include any Federal mandate that
may result in expenditures by state, local, or tribal governments, or
by the private sector in excess of that threshold.
V. Executive Order 13132: Federalism
Executive Order 13132 (Federalism) prohibits an agency from
publishing any rule that has federalism implications if the rule either
imposes substantial, direct compliance costs on state and local
governments, and is not required by statute, or preempts state law,
unless the agency meets the consultation and funding requirements of
section 6 of the Executive Order. This rule does not have federalism
implications and does not impose substantial direct compliance costs on
state and local governments or preempt state law within the meaning of
the Executive Order.
VI. Congressional Review Act
Pursuant to the Congressional Review Act (5 U.S.C. 801 et seq.),
the Office of Information and Regulatory Affairs designated this rule
as not a major rule, as defined by 5 U.S.C. 804(2).
Drafting Information
The principal author of this regulation is Jeremy Lamb, of the IRS
Office of Associate Chief Counsel (Employee Benefits, Exempt
Organizations, and Employment Taxes (EEE)). However, other personnel
from the Treasury Department and the IRS participated in the
development of the regulation.
List of Subjects in 26 CFR Part 31
Employment taxes, Income taxes, Penalties, Pensions, Railroad
retirement, Reporting and recordkeeping requirements, Social security,
Unemployment compensation.
Adoption of Amendments to the Regulations
Accordingly, 26 CFR part 31 is amended as follows:
PART 31--EMPLOYMENT TAXES AND COLLECTION OF INCOME AT THE SOURCE
0
Paragraph 1. The authority citation for part 31 continues to read in
part as follows:
Authority: 26 U.S.C. 7805.
* * * * *
0
Par. 2. Section 31.3405(e)-1 is added to read as follows:
Sec. 31.3405(e)-1 Questions and answers relating to withholding on
pensions, annuities, and certain other deferred income.
(a) The following questions and answers apply for purposes of
determining whether a payor of periodic payments or nonperiodic
distributions from pensions, annuities, and certain other deferred
income (other than eligible rollover distributions) must withhold
federal income tax under section 3405(a) or (b) of the Code. For
purposes of this section, references to the United States include
possessions of the United States.
(b)(1) Q-1. Is an Army Post Office (APO), a Fleet Post Office
(FPO), or a Diplomatic Post Office (DPO) address an address located
within the United States for purposes of section 3405(e)(13)(A)?
(2) A-1. For purposes of section 3405(e)(13)(A), an APO, an FPO, or
a DPO address is an address located within the United States.
(c)(1) Q-2. Is the payor of a designated distribution described in
section 3405(a) or (b) required to withhold income tax from the
distribution if the payee's residence address that is provided to the
payor is located within the United States?
(2) A-2. If the payee's residence address that is provided to the
payor of a designated distribution described in section 3405(a) or (b)
is located within the United States, then the payor is required to
withhold income tax from the distribution unless the payee has made a
valid election of no withholding in accordance with section 3405(a)(2)
or (b)(2). Any election of no withholding with respect to such a
distribution under section 3405(a)(2) or (b)(2) is not valid if the
payee instructs the payor to do one or more of the following in
connection with the distribution:
(i) Send the distribution to a financial institution or other
person located outside of the United States;
(ii) Send the distribution to a financial institution or other
person located within the United States with further instructions (such
as for further credit to instructions) directing that the funds be
forwarded to a financial institution or other person located outside of
the United States; or
(iii) Send the distribution to a financial institution or other
person pursuant to payment instructions (including addenda information)
that reference an International Automated Clearing House Transaction
(IAT), International Bank Account Number (IBAN), Society for Worldwide
Interbank Financial Telecommunication (SWIFT) Business Identifier Code
(BIC), or similar identifier linked to a financial institution or other
person located outside of the United States.
(d)(1) Q-3. Is the payor of a designated distribution described in
section 3405(a) or (b) required to withhold income tax from the
distribution if the payee's residence address that is provided to the
payor is located outside of the United States?
(2) A-3. Unless section 3405(e)(13)(B) (which provides an exception
for certain nonresident aliens) applies, if the payee's residence
address that is provided to the payor is located outside of the United
States, the payor of a designated distribution described in section
3405(a) or (b) is required to withhold income tax from the distribution
without regard to the delivery instructions and without regard to any
request by the payee to elect no withholding. Withholding would be
required, in this case, even if the payee has requested that the
distribution be delivered to a financial institution or other person
located within the United States.
(e)(1) Q-4. Is the payor of a designated distribution described in
section 3405(a) or (b) required to withhold income tax from the
distribution if the payee has not provided the payor with the payee's
residence address?
(2) A-4. If a payee has not provided the payor of a designated
distribution described in section 3405(a) or (b) with the payee's
residence address, the payor is required to withhold income tax from
the distribution. Such a payee may not elect no withholding under
section 3405(a)(2) or (b)(2), and any purported election of no
withholding by such a
[[Page 84083]]
payee is not valid. For purposes of this section, a payee who has
provided the payor with an address for the payee's nominee, trustee, or
agent without also providing the payee's residence address has not
provided a residence address.
(f)(1) Q-5. Do the withholding rules under section 3405(a) and (b)
apply to a payee who is to receive a payment or distribution that is
subject to the withholding rules that apply to nonresident aliens (or
that would be so subject but for a tax treaty)?
(2) A-5. In accordance with section 3405(e)(1)(B)(iii), a
designated distribution does not include a distribution of a United
States-source payment that is subject to withholding under the rules of
sections 1441 through 1446 of the Code (or that would be so subject but
for a tax treaty). Therefore, the withholding rules under section
3405(a) and (b) do not apply to such a distribution. For example,
section 3405(a) or (b) withholding would not apply to a pension or
other deferred compensation plan distribution to be made to a payee who
is a nonresident alien (or other individual payee who is presumed to be
a foreign person under the presumption rules of Sec. 1.1441-1(b)(3)).
In such a case, withholding under the rules of section 1441, rather
than under the rules of section 3405(a) or (b), would apply to such a
distribution.
(g)(1) Q-6. What is the applicability date of this section?
(2) A-6. This section applies with respect to payments and
distributions made on or after January 1, 2026. However, taxpayers may
apply it to earlier payments and distributions.
Douglas W. O'Donnell,
Deputy Commissioner.
Approved: September 21, 2024.
Aviva R. Aron-Dine,
Deputy Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 2024-24224 Filed 10-18-24; 8:45 am]
BILLING CODE 4830-01-P