Withholding on Certain Distributions Under Section 3405(a) and (b), 84079-84083 [2024-24224]

Agencies

• Internal Revenue Service
• DEPARTMENT OF THE TREASURY

[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