The Treasury Department and the IRS issued Final Regulations under Internal Revenue Code (IRC) Section 3405(e), effective October 21, 2024, addressing 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. These regulations specifically focus on the payor’s obligation to withhold income taxes when these payments or distributions are made to payees outside of the United States.
The Regulations set forth the obligation to withhold income tax under IRC Section 3405(a) and (b), respectively, under four different circumstances provided below.
- Payments to payees with a military or diplomatic post office address, are treated as being located within the United States for tax withholding purposes. Because APO, FPO, and DPO addresses are generally related to U.S. military or diplomatic facilities, they are considered domestic and designated distributions to these addresses are not considered as delivered outside the U.S.
- Payments to payees with a residence address located within the United States, but also specifies that payments should be delivered outside of the United States are to be treated consistently with the text of Section 3405(e)(13)(A). Therefore, there is no election to waive withholdings.
- Payments to payees with a residence address located outside of the United States [unless IRC Section 3405(e)(13)(B) which provides an exception for certain nonresident aliens] or who have not provided a residence address are to be treated equally, requiring income tax withholdings on designated distributions regardless of delivery instructions or election attempts to avoid withholdings.
- Payments subject to withholding under Subchapter A of Chapter 3, indicating that distributions to nonresident aliens from U.S. source trusts are subject to IRC Section 1441 – Section 1446 withholding rules, rather than IRC Section 3405.
While the regulations apply to payments and distributions made on or after January 1, 2026, plans have the option to apply it to earlier payments and distributions.
Authors: Rich Ruvelson, Principal | [email protected] and Anna Farrand | [email protected]
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