Prior to the Tax Cuts and Jobs Act, those receiving periodic payments from pensions, annuities and certain other deferred income had withholding computed by default at the rate imposed on a married wage earner claiming 3 exemptions. As the Tax Cuts and Jobs Act revisions eliminated the prior method of wage withholding, IRC §3405(a) was modified to change this default withholding, providing for methods to be determined by the IRS.

The IRS has now issued final regulations[1] to provide for withholding on such retirement distributions. The regulations apply to payments made after December 31, 2020. For 2020 payments, the IRS had issued guidance found in Notice 2020-03, issued in December 2019.

The IRS adds new Reg. §31.3405-1, Questions and answers relating to Federal income tax withholding on periodic retirement and annuity payments, to outline the new withholding provisions on such payments. The regulation is written in question and answer format, with two provisions with detailed rules and a final question to outline the effective date.

How Income Will Be Withheld from a Periodic Payment

The first question discusses how Federal income tax will be withheld from periodic retirement and annuity payments:

(b)(1) Q-1: How will Federal income tax be withheld from a periodic payment?

(2) A-1: In the case of a periodic payment that is subject to withholding under section 3405(a), amounts are withheld as if the payment were a payment of wages by an employer to the employee for the appropriate payroll period. If the payee has not furnished a withholding certificate, the amount to be withheld is determined in the manner described in the applicable forms, instructions, publications, and other guidance prescribed by the Commissioner. The rules for withholding when the payee has not furnished a withholding certificate apply regardless of whether the payor is aware of the payee’s actual marital status or actual Federal income tax filing status.

Note that the IRS has moved the default withholding amounts out of the regulations, and rather allows the rate to be set in forms, instructions, publications and other guidance prescribed by the agency.

Similar Rules to Those for Wage Withholding

The second question provides that rules similar to those for withholding certificates for wages will apply to these payments:

(c)(1) Q-2: Do rules similar to those for wage withholding apply to the furnishing of a withholding certificate for periodic payments?

(2) A-2: Yes. Unless the rules of section 3405 specifically conflict with the rules of section 3402, the rules for withholding on periodic payments that are not eligible rollover distributions will parallel the rules for wage withholding. Thus, if a withholding certificate is furnished by a payee, it will generally take effect in accordance with section 3402(f)(3) and as provided in applicable forms, instructions, publications, and other guidance prescribed by the Commissioner. If no withholding certificate is furnished, the amount withheld must be determined in the manner described in the applicable forms, instructions, publications, and other guidance prescribed by the Commissioner for withholding on periodic payments when no withholding certificate is furnished.

[1] TD 9920, September 28, 2020, https://www.irs.gov/pub/irs-drop/td-9920.pdf (retrieved September 28, 2020)