October 7, 2020
Final regulations allow IRS to determine withholding rate on periodic retirement and annuity payments
Under final regulations (TD 9920), the default withholding rate for certain periodic retirement and annuity payments made after December 31, 2020, will be determined in the manner described in the applicable forms, instructions, publications and other guidance prescribed by the IRS. For 2021, the default withholding rate on periodic payments will continue to be determined by treating the taxpayer as a married individual claiming three withholding allowances.
The final regulations implement a change from the previous rate made by the Tax Cuts and Jobs Act (TCJA).
The final regulations adopted the proposed regulations (REG-100320-20) with no changes.
Default withholding rate rules
IRC Section 3405 governs federal income tax withholding from retirement and annuity payments, including periodic payments, which are generally defined as any distribution or payment from or under an employer deferred compensation plan, individual retirement plan or commercial annuity. IRC Section 3405(a) generally requires the payor of periodic payments to withhold federal income tax in the same manner as an employer would withhold from wages paid to an employee.
Before the TCJA, if there was no withholding certificate (Form W-4P, Withholding Certificate for Pension or Annuity Payments) for a taxpayer's periodic payments, IRC Section 3405 imposed a default withholding rate determined by treating the taxpayer as a married individual claiming three withholding exemptions.
The TCJA amended IRC Section 3405(a)(4) to provide that the default withholding rate would be "determined under rules prescribed by the Secretary."
To implement the TCJA changes, the final regulations state that the default rate of withholding on periodic payments made after December 31, 2020, "is determined in the manner described in the applicable forms, instructions, publications, and other guidance prescribed by the Commissioner."
In the Preamble to the proposed regulations, the IRS said the proposed regulations provided "a flexible and administrable rule that leaves the communication and mechanical details of the default rate of withholding on periodic payments to be provided in applicable forms, instructions, publications, and other guidance prescribed by the Commissioner. This approach enables the Treasury Department and the IRS to make updates more quickly, including to address legislative changes, to provide payors and plan administrators processing payments adequate time to program their systems to withhold the proper amount of income tax."
The final regulations said the effective date and application of a new default withholding rate, if any, would be described in future guidance.
2021 form remains the same
In an accompanying news release, the IRS said the 2021 Form W-4P, Withholding Certificate for Pension or Annuity Payments, would be similar to the 2020 Form W-4P, and the default withholding rate on periodic payments would continue to be determined by treating the taxpayer as a married individual claiming three withholding allowances.
The IRS had released a draft 2021 Form W-4P with a new default rate applicable to periodic payments beginning in 2021 but postponed the issuance of the new form after receiving comments from taxpayers about the time needed to implement the new form and default rate.
It is welcome relief that payors will not be required to adopt a new default withholding rate when pension payment recipients have not provided them with a Form W-4P. Until future guidance is published (which may never happen), taxpayers can expect the same default withholding rate that has applied for many years to continue to apply in the future.