By Barry Salkin
The Internal Revenue Service (“IRS”) and the Treasury Department on October 21, 2024, issued final regulations under Sections 3405(a) and 3405(b) of the Internal Revenue Code of 1986, as amended (“Code”). (The IRS had issued previous guidance with respect thereto in Notice 87-7 and the IRS and Treasury had proposed regulations in May 2019.). Code Sections 3405(a) and 3405(b) generally require the payor of any distribution from an employer deferred compensation plan, both tax-qualified and non-qualified, an individual retirement plan (“IRA”) or a commercial annuity to withhold income taxes from the distribution unless the payee elects not to have taxes withheld.
Code Section 3405 provides a number of exceptions to that general rule in the international context. First, the tax withholding rules under Code Section 3405 do not apply to any payment or distribution that relates to the taxation of nonresident aliens under the rules of Code Sections 1441 through 1445 (or that would be subject to federal income taxation under those Code Sections, but for a tax treaty). For example, federal income tax withholding under Code Section 3405 would not apply to a U.S.-sourced distribution. In such a case, the withholding rules of Code Section 1441 that apply to nonresident aliens would apply to the distribution.
Under a second exception to the general rule, in the case of any periodic or nonperiodic distribution that is “to be delivered outside of the United States and any possession of the United States,” a payee may not elect that no withholding be made from the distribution . This second exception does not apply if the payee certifies to the payor that he or she is a nonresident alien.
The final regulations provide that:
- An Army Post Office, a Fleet Post Office and a Diplomatic Post Office are treated as addresses within the United States.
- Even if the payee’s residence address is located in the United States, an election of no withholding in connection with a distribution subject to income tax withholding under Code Section 3405 is invalid if the payee provides any of the following instructions:
- Send the distribution to a financial institution or other person located outside the United States.
- 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 the funds to be forwarded to a financial institution or other person located outside the United States.
- Send the distribution to a financial institution or other person pursuant to payment instructions (including addenda information) that referto an International Automated Clearing House Transaction, International Bank Account Number, Society for Worldwide Interbank Financial Telecommunication (SWIFT), Business Identifier Code or similar identifier linked to a financial institution or other person located outside the United States.
- Except for distributions to certain nonresident aliens, if a payee’s residence address is located outside the United States, the payor of the distribution is required to withhold without regard to any delivery instructions or elections not to withhold.
- If the payee of a distribution has not provided the payor with the payee’s residence address, the payor must withhold from the distribution. For purposes of this Code requirement, 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, is treated as not having provided a residence address to the payor.
The final regulations apply with respect to distributions and payments made on or after January 1, 2026. However, taxpayers may apply the guidance under the final regulations to earlier distributions and payments.
If you have any questions on the Code’s tax withholding requirements for distributions from employer deferred compensation plans or IRAs, please contact us.
