IRS Proposed Regs Address Tax Withholding on Certain Periodic Retirement and Annuity Payments

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Highlights

  • The Internal Revenue Service (IRS) issued a proposed 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 (TCJA).
  • The proposed regulation is intended to provide a flexible and administrable rule that leaves the communication of the default rate of withholding on periodic payments to be determined by the IRS in applicable forms, instructions, publications and other guidance.
  • The proposed rule would apply to periodic payments made after Dec. 31, 2020. Public comments may be submitted to the IRS electronically by July 27, 2020.

The Internal Revenue Service (IRS) released proposed regulations amending Employment Tax Regulations (26 CFR Parts 31 and 35) under section 3405 of the Internal Revenue Code (IRC). The regulations propose new rules for federal income tax withholding on periodic retirement and annuity payments to implement an amendment made by section 11041(c)(2)(G) of the Tax Cuts and Jobs Act (TCJA).

Section 3405 of the IRC addresses federal income tax withholding on payments of pensions, annuities and certain other deferred income including retirement and annuity payments made as periodic payments, nonperiodic distributions and eligible rollover distributions. A periodic payment is generally defined as any distribution or payment from or under an employer-deferred compensation plan (which includes qualified pension and profit-sharing plans), an individual retirement plan or a commercial annuity.

Section 3405(a) requires the payor of any periodic payment to withhold from the payment as if the payment were wages paid by an employer to an employee, unless an individual has elected not to have withholding apply, subject to certain exceptions. Prior to amendment by the TCJA, section 3405(a)(4) of the IRC provided that, if a withholding certificate is not in effect, the amount withheld from the periodic payment is determined by treating the payee as married and claiming three withholding allowances. Under the TCJA changes, the amount withheld from the periodic payment when there is no withholding limit in effect will be "determined under rules prescribed by the Secretary."

The IRS previously issued guidance in Notice 2018-14 (Section V) and Notice 2020-1 (Section IV) identifying the applicable default rate for withholding when no withholding certificate has been provided. Under the applicable provisions of each of the notices, the default rule for withholding from periodic payments when no withholding certificate was provided was to treat the payee as married claiming three withholding allowances, mirroring the pre-TCJA regulations. The rules for withholding on periodic payments that are not eligible rollover distributions continue to follow the rules applicable to wage withholding when a withholding certificate has not been provided.

The proposed regulations are intended to provide a flexible and administrable rule that leaves the communication of the default rate of withholding on periodic payments to be determined by the IRS in applicable forms, instructions, publications and other guidance. The proposed rule would apply to periodic payments made after Dec. 31, 2020, but taxpayers may rely on these rules until the date of publication of a Treasury Decision adopting this proposed rule as a final regulation. Public comments may be submitted to the IRS electronically by July 27, 2020.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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