35.3405-1T—Questions and answers relating to withholding on pensions, annuities, and certain other deferred income (temporary regulations).
The following questions and answers relate to withholding on pensions, annuities, and other deferred income under section 3405 of the Internal Revenue Code of 1954, as added by section 334 of the Tax Equity and Fiscal Responsibility Tax Act of 1982 (Pub. L. 97-248) (TEFRA):
a. In general.
b. Periodic payments.
c. Nonperiodic distributions.
d. Notice and election procedures.
e. Reporting and recordkeeping.
a-1. Q. How did TEFRA change the law on withholding requirements for pensions, annuities, and other deferred income?
A. TEFRA amended the Internal Revenue Code to impose withholding requirements on designated distributions paid after December 31, 1982. Further, although under prior law individuals could elect to have Federal income tax withheld from certain pension and annuity payments, TEFRA requires withholding on all designated distributions unless the payee elects not to have withholding apply.
a-2. Q. What type of payment is a designated distribution that is subject to the new withholding rules?
A. A designated distribution is any distribution or payment from or under an employer deferred compensation plan, an individual retirement plan (as defined in section 7701(a)(37) ), or a commercial annuity. However, a designated distribution does not include any portion of a distribution which it is reasonable to believe is not includible in the gross income of the payee. For rules concerning when it is reasonable to believe that all or part of a distribution is not includible in the gross income of the recipient, see questions a-24 through a-33. In addition, a payment or distribution that is treated as wages under section 3401(a) is not a designated distribution subject to the new withholding rules. For examples of these payments, see questions a-18 through a-23.
a-3 Q. What is an employer deferred compensation plan for purposes of the new withholding rules?
A. An employer deferred compensation plan is any pension, annuity, profit-sharing, stock bonus, or other plan that defers the receipt of compensation.
a-4. Q. What is a commercial annuity for purposes of the new withholding rules?
A. A commercial annuity is an annuity, endowment, or life insurance contract issued by an insurance company licensed to do business under the laws of any State. See, also, question f-21.
a-5. Q. When does the new law take effect?
A. In general, withholding is required on any designated distribution made after December 31, 1982. In the case of periodic payments beginning before January 1, 1983, the first payment after December 31, 1982 is treated as the first periodic payment for purposes of the withholding requirements. The Secretary has authority to delay (but not beyond June 30, 1983) the application of these withholding provisions to any payor if the payor can establish that it is impossible to comply with these provisions without undue hardship. Additionally, no penalty will be imposed for failure to withhold on periodic payments if the failure occurs before July 1, 1983, and if a good faith attempt is made to comply.
Procedures for requesting a delay in implementation of the withholding provisions are under consideration.
a-6. Q. What effect does the new law have on the old law provisions relating to withholding of tax from annuity payments by request?
A. If payment is part of a designated distribution, the rules of section 3402(o) (relating to voluntary withholding on certain payments) do not apply. Therefore, a payee receiving amounts that are subject to withholding under the new provisions described in this regulation may not choose to use the voluntary withholding system of section 3402(o) with respect to those amounts. Also, if a payee had a fixed amount withheld by request, a different amount will probably be withheld when the new provisions take effect unless the rule provided in question a-7 applies. However, section 3402(o) will continue to apply to annuity payments that are not designated distributions, to sick pay, and to supplemental unemployment benefits.
a-7. Q. If a recipient of a pension or annuity has previously elected voluntary withholding under section 3402(o), is the Form W-4P effective for withholding on payments after December 31, 1982?
A. Yes, if the plan administrator or payor wishes to honor it; the Form W-4P can be treated by the plan administrator or payor as an election to withhold the flat dollar amount specified on the form if the payee, is notified of his right to elect out of withholding and if he is notified that his previously filed W-4P will remain effective unless he elects out of withholding or files a new withholding certificate. If these requirements are met the plan administrator or payor may treat the Form W-4P as a voluntary withholding agreement under section 3402(p). See, also, section 3402(i). These amounts withheld should be reported in the same manner as amounts withheld under section 3405.
a-8. Q. What amount of Federal income tax will be withheld from designated distributions?
A. The amount to be withheld by any payor (or, in certain cases, a plan administrator) depends upon whether the payment is a periodic payment, a nonperiodic distribution other than a qualified total distribution, or a qualified total distribution. However, the maximum amount to be withheld cannot exceed the sum of the amount of money and the fair market value of property (other than employer securities as defined in section 402(a)(3)) received in the distribution.
a-9. Q. What is a periodic payment?
A. A periodic payment is an annuity or similar periodic payment whether paid by a licensed life insurance company, a financial institution, or a plan. The term “annuity” means a series of payments payable over a period greater than one year and taxable under section 72 as amounts received as an annuity, whether or not the payments are variable in amount.
a-10. Q. How will federal income tax be withheld from a periodic payment?
A. In the case of a periodic payment, 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 filed a withholding certificate, the amount to be withheld is calculated by treating the payee as a married individual claiming three withholding allowances.
For additional questions and answers concerning periodic payments, see part b.
a-11. Q. How will Federal income tax be withheld from a “qualified total distribution?”
A. A “qualified total distribution” means any designated distribution which it is reasonable to believe is made within one taxable year of the payee, is made from or under a qualified plan described in section 401(a) or section 403(a), and consists of the balance to the credit of the employee under the plans. For additional questions and answers concerning qualified total distributions, see part c. The amount to be withheld on qualified total distributions will be determined under tables prescribed by the Secretary that approximate the tax that would be imposed under section 402(e) if the payee elected to treat the distribution as a lump sum distribution within the meaning of section 402(e)(4)(A). See, in this respect, question c-8.
a-12. Q. What amount of Federal income tax will be withheld from a designated distribution that is not a periodic payment or a qualified total distribution?
A. If a designated distribution is not a periodic payment or a qualified total distribution, the amount to be withheld is computed by multiplying the amount of the designated distribution by 10 percent.
a-13. Q. Who must withhold?
A. Generally, the payor of a designated distribution must withhold, and is liable for payment of, the tax required to be withheld. However, in the case of a distribution from a plan described in section 401(a) (relating to pension, profit-sharing, and stock bonus plans), section 403(a) (relating to certain annuity plans), or section 301(d) of the Tax Reduction Act of 1975 (relating to certain employee stock ownership plans, sometimes called “TRASOP's”), the plan administrator must withhold, and is liable for payment of, the withheld tax unless he directs the payor to withhold the tax and furnishes the payor with any information that may be required by the Secretary in forms or regulations. This provision applies to qualified plans as well as once qualified plans that are no longer qualified. For a description of the material that the plan administrator must furnish to the payor, see question e-3.
a-14. Q. Who is a plan administrator?
A. Under section 414(g), the plan administrator is the person specifically designated as the plan administrator by the terms of the plan or trust. If the plan or trust does not specifically designate the plan administrator (as provided in § 1.414(g)-1(a) of the Income Tax Regulations), then the plan administrator is generally determined as follows:
(2)
In the case of a plan maintained by two or more employers or jointly by one or more employers and one or more employee organizations, the association, committee, joint board of trustees, or other similar group of representatives who maintain the plan is the plan administrator.
(3)
In the case in which (1) or (2) does not apply, the person actually responsible for the control, disposition, or management of the assets is the plan administrator.
a-15. Q. If a bank trustee, regulated investment company, or insurance company makes a periodic payment to a payee solely at the direction of an employer sponsored individual retirement account (IRA), is the bank trustee, regulated investment company or insurance company a payor subject to the pension withholding provisions?
A. Yes. the term “payor” generally means the person actually paying the annuity or other payment (even if the person is acting as an agent). Because this is not a payment from a plan described in section 401(a) or 403(a), responsibility for withholding is on the bank trustee, regulated investment company, or insurance company and not on the employer who sponsors the account.
a-16. Q. If a bank trustee transfers plan funds to the employer who sponsors a plan described in section 401(a) and the employer makes the designated distributions, is the employer a payor?
A. Yes. The employer is a payor because it acts as an agent for the bank trustee. Even though the plan administrator has transferred liability to the bank trustee under section 3405(c)(2), the transfer of funds to the employer does not relieve the bank trustee of its liability for withholding because the rule on transfer of liability only applies to plan administrators. Therefore, if the employer fails to withhold on designated distributions, either the employer or the bank trustee may be liable for failure to withhold. Note, however, that the plan administrator could transfer liability for withholding to the employer as payor under section 3405(c)(2). See, in this respect, questions e-2 and e-3.
a-17. Q. Do the withholding provisions apply to annuities paid from an employer deferred compensation plan, an individual retirement plan, or a commercial annuity to the surviving spouse or other beneficiary of a deceased payee?
A. Yes.
a-18. Q. Do these withholding provisions apply to designated distributions under all nonqualified employer deferred compensation plans?
A. No. The withholding provisions relating to pensions and annuities do not apply to any amounts that are wages without regard to these provisions. Wages to which the general wage withholding rules apply mean any remuneration paid by an employer for services performed by an employee unless the amount paid falls within one of the exceptions of section 3401(a). For example, wages do not include remuneration paid to, or on behalf of, an employee or beneficiary from or to a trust qualified under section 401(a) and tax-exempt under section 501(a). There is no exception for contributions to, or benefits paid from, some nonqualified plans. In general, any contributions to, or benefits from, a nonqualified plan that are taxable under section 83 are subject to wage withholding at the time that they are includible in the recipient's gross income.
a-19. Q. Do these withholding provisions apply to designated distributions from a bond purchase plan described in section 405(a)?
A. Yes. Although a bond purchase plan is not a qualified plan, section 3402(a) does not apply to contributions to, or distributions from, such a plan. Therefore, designated distributions from a bond purchase plan are subject to the new withholding rules of section 3405. Similarly, the new withholding rules apply to designated distributions of an individual retirement bond described in section 409 or from an annuity plan described in section 403(a). For purposes of the withholding provisions of section 3405, a designated distribution from a bond purchase plan described in section 405(a) or an individual retirement bond described in section 409 occurs when an individual redeems a bond.
a-20. Q. Do these withholding provisions apply to designated distributions from a tax-sheltered annuity described in section 403(b)?
A. Yes. Section 31.3401(a)-1(b)(1)(i) of the Employment Tax Regulations provides that there is no withholding required under the wage withholding provisions to the extent that any amounts are taxable under the rules of section 72 or 403. Because designated distributions are not subject to the general wage withholding provisions, the new provisions of section 3405 apply to these designated distributions.
a-21. Q. An employer maintains a nonqualified deferred compensation plan such as a supplemental executive retirement (“top hat”) plan. Payments under the plan are made in the form of a single sum payment at retirement. Amounts paid at retirement are includible in income as compensation in the year received. Must the payor withhold on these amounts according to the rules in section 3405?
A. No. Section 3405(d)(1)(B)(i) provides that a designated distribution on which withholding is required does not include amounts that are wages without regard to the rules of section 3405. Therefore, withholding on payments that are includible in income as compensation are based on the rules for withholding on wages contained in section 3402.
a-22. Q. Do the withholding provisions of section 3405 apply to a retirement plan maintained by a State or local government on behalf of its employees?
A. Yes. A retirement plan maintained by a State or local government on behalf of its employees is a plan that defers the receipt of compensation. The fact that a plan deferring the receipt of compensation is maintained by a governmental unit does not make the withholding provisions inapplicable. Thus, annuity payments and other distributions under the Federal Civil Service Retirement System or under the plan of any State or municipality are subject to withholding.
a-23. Q. Are payments from a state or local plan of deferred compensation described in section 457 subject to the withholding requirements of section 3405?
A. No. Amounts paid from a plan described in section 457 are paid from a plan that defers the receipt of compensation. However, amounts paid from a deferred compensation plan described in section 457 are wages under section 3401(a). Therefore, the general wage withholding rules, not the special rules of section 3405, apply to these payments.
a-24. Q. An individual retires and begins receiving periodic payments under a commercial annuity contract that was distributed to him from a contributory qualified plan. The insurance company is the payor and is liable for withholding because the plan administrator has transferred liability under the rules of section 3405(c)(2). Must the payor determine whether the employee's investment in the contract is recoverable within three years?
A. Yes. Under section 72(d), if the annuity payments during the first three years equal or exceed the amount contributed by the employee to the plan, no amounts are includible in income until the employee's contributions are recovered. Because the application of section 72(d) may affect the extent to which it is reasonable to believe that amounts are not includible in income and, therefore, not subject to withholding, the payor must determine whether section 72(d) applies to the annuity payments. As a general rule, the information necessary to determine the employee's investment in the contract must be provided to the payor by the plan administrator. See, however, questions a-27 and a-33.
a-25. Q. If the payor in question a-24 determines that the employee's investment in the contract is not recoverable within 3 years, must the payor compute the exclusion ratio under section 72(b) to calculate the amount of each payment that is not includible in gross income?
A. Yes. The operation of section 72(b) affects the extent to which it is reasonable to believe that amounts are not includible in gross income. Therefore, the payor must compute the exclusion ratio to determine what portion of each payment is subject to withholding under section 3405. As a general rule, the information necessary to determine the employee's exclusion ratio must be provided to the payor by the plan administrator. See, however, questions a-27 and a-33.
a-26. Q. In questions a-24 and a-25, may the payor (i.e., the insurance company) rely on the information furnished by the plan administrator to determine the amounts that are includible in gross income?
A. In the absence of information to the contrary supplied by the payee, the payor may rely on the information furnished by the plan administrator. See, with respect to the plan administrator's duty to report to the payor, questions e-2 and e-3.
a-27. Q. What is the result in questions a-24 and a-25 if the plan administrator fails to provide the payor with any information concerning the amount of employee contributions?
A. Until the earlier of December 31, 1983, or the date on which the plan administrator provides the payor with information concerning the amount of employee contributions, it is reasonable for the payor to assume that the employee's investment in the annuity contract is zero unless the payor has independent specific knowledge of the amount of employee contributions. Additionally, if the payee notifies the payor of the amount of employee contributions, the payor must compute the taxable portion of the payment based on the information supplied by the payee. If the plan administrator fails to provide the payor with this information on or before December 31, 1983, the plan administrator will be liable for failure to withhold and pay the tax due. See questions e-2 through e-5 for rules on the plan administrator's ability to transfer liability for withholding to the payor. See also question a-33 with respect to the plan administrator's failure to provide the necessary information prior to December 31, 1983.
a-28. Q. If a beneficiary receives the balance to the credit of an employee from an annuity described in section 403(b) on account of the employee's death, is it reasonable to believe that the $5,000 death benefit exclusion of section 101(b) is not includible in gross income?
A. Yes. Although the amount of the death benefit exclusion allowable may be limited by section 101(b)(2)(B)(iii), the payor, for withholding purposes, may use the maximum death benefit exclusion ($5,000) in computing the amount of the distribution that is subject to withholding. See also, in this respect, question c-3.
a-29. Q. What is the appropriate treatment of a distribution (whether periodic or nonperiodic) that includes employer securities?
A. Employer securities are significant in the calculation of amounts subject to withholding in two respects. First, the maximum amount to be withheld cannot exceed the sum of the amount of money plus the fair market value of property received, except employer securities. In other words, a payor will not be forced to dispose of employer securities in order to meet withholding tax liability. Thus, for example, if an individual receives a distribution from a stock bonus plan that includes $1,000 worth of employer stock and $5 in cash for payment of fractional shares of stock, all of the cash, but none of the stock, may be retained by the payor to satisfy the withholding obligation. Second, under certain circumstances, the net unrealized appreciation in employer securities is not includible in gross income. See, in this respect, the rules of sections 402(a)(1) and 402(e)(4)(J).
a-30. Q. Is it reasonable to believe that all net unrealized appreciation from employer securities is not includible in gross income in the case of a qualified total distribution?
A. Yes. Although a qualified total distribution may include a distribution that is not a lump sum distribution, it is reasonable to believe that all net unrealized appreciation from employer securities is not includible in gross income.
a-31. Q. Is it reasonable to believe that a distribution is not includible in gross income if the distribution consists of employee contributions from a plan described in section 401(a) and the amount distributed is not specifically designated as accumulated deductible employee contributions?
A. Yes. Employee contributions to a plan described in section 401(a) are not deductible from gross income when contributed unless they are deductible employee contributions under section 72(o)(5). Unless the payor has specific knowledge that employee contributions distributed from a plan described in section 401(a) are accumulated deductible employee contributions, it is reasonable to assume that the amounts are excludible from gross income in the year when received.
a-32. Q. In the case of disability payments paid under a noncontributory plan to a disability retiree who has not attained age 65, is it reasonable to believe that all amounts paid to the payee are includible in gross income?
A. Yes. Whether or not all or part of the disability payments paid under a noncontributory plan to a permanently disabled retiree who has not attained age 65 are includible in gross income depends on the adjusted gross income of the taxpayer and on whether the taxpayer is permanently and totally disabled. In this situation, it is reasonable for the payor to assume that all amounts paid to the payee are includible in gross income unless the payor has specific independent knowledge that all or part of the periodic payments are not includible in gross income. Additionally, if the payee notifies the payor of the amount excludible from gross income, the payor must compute the taxable portion of the payment based on information provided by the payee.
a-33. Q. In the case of a periodic payment, is it reasonable to believe that all amounts paid to the payee are includible in gross income?
A. Yes. As an alternative to the general rule that a designated distribution does not include amounts which it is reasonable to believe are not includible in gross income, the payor of any periodic payment may assume that the entire amount of the payment is includible in gross income. The wage withholding tables must be used without adjustment for the fact that Federal income tax is being withheld on the gross amount. If the payor uses this alternative method of calculating the amount of the designated distribution, he must include with the notice of the election not to have withholding apply the following additional statements:
(1)
Tax will be withheld on the gross amount of the payment even though the payee may be receiving amounts that are not subject to withholding because they are excludible from gross income;
(3)
The payee may adjust the allowances claimed on the withholding certificate if he wants a lesser amount withheld from each payment or he may provide the payor with the information necessary to calculate the taxable portion of each payment.
This alternative will not apply to periodic payments made after the earlier of December 31, 1983, or the date on which the plan administrator supplies the payor with the information necessary to calculate the taxable portion of the distribution.
See, also, questions e-3, e-4, and e-5.
a-34. Q. May the payor rely on a plan administrator's computation of the amount to be withheld?
A. Yes. Although the plan administrator is not required to compute the amount to be withheld in order to transfer liability for withholding to the payor, the plan administrator may provide such information to the payor, and the payor may rely on such computations unless the payor knows or has reason to know that the computations are incorrect.
a-35. Q. Under the plans of certain States, individuals may receive payments from more than one retirement system, such as payments from the state's teacher's retirement plan and from the state's regular retirement plan. Must these payments be aggregated for purposes of providing a single notice and election to a payee or for purposes of determining whether the floor on withholding tax (i.e., $5,400 for a married individual claiming three allowances) has been reached?
A. No. However, if it is feasible to aggregate payments under more than one retirement system, the payor is permitted to do so for these purposes.
a-36. Q. If a payment is made by one check to more than one beneficiary, such as a surviving spouse and a minor child, how is the amount to be withheld computed?
A. The payor may compute the withholding on a payment made by one check to more than one beneficiary as if the payment were made to only one beneficiary. In this case, the payor must base withholding for the total amount of the designated distribution on the withholding certificate of the payee to whom the election was sent.
Alternatively, if each payee files a withholding certificate and the payor knows the amount of the payment of which each payee is entitled, the payor may determine the amount to be withheld with respect to each payee. If the payor does not know the amount of the payment to which each payee is entitled, he may treat the payment as being made pro-rata to each payee. If only one withholding certificate is received, the payor must base withholding for the total amount of the designated distribution on the withholding certificate of one of the payees, such as the surviving spouse's certificate. Thus, if notice of the election not to have withholding apply is supplied to each payee at the times required in section 3405(c) (10) and only one payee makes the election or files a certificate, the payor must assume that the election or filing was made by the payee on behalf of the other payees.
a-37. Q. If a payor makes an error in computing the amount of a designated distribution that is subject to withholding, must the payor make a retroactive correction of the error?
A. No, provided the error was a reasonable one. Thus, if a payor either underwithholds or overwithholds because the amount of the designated distribution (i.e., the taxable portion of the payment) was incorrectly calculated, no retroactive make-up is required if one of the following applies: (1) The payor reasonably relied on information furnished by the plan administrator (including the computation of the amount to be withheld), (2) the payor relied on a payee's representations on the withholding certificate, (3) the payor reasonably relied on the rules of this regulation, or (4) the payor made a mathematical error in computations. However, if the amount of the designated distribution is correctly computed, but the payor makes an error in applying the withholding tables, the normal rules concerning failure to withhold and pay the tax will apply.
b-1. Q. Is the payor of periodic payments required to aggregate such payments with a payee's compensation to determine the amount of tax to be withheld under section 3405(a)(1)?
A. No. Although the payor must withhold from any periodic payment the amount that has to be withheld if the payment were a payment of wages by an employer to an employee for a payroll period, the amount to be withheld under section 3405(a)(1) is calculated separately of any amounts that actually are wages to the payee for the same period.
b-2. Q. Can either the percentage method (section 3402(b)) or the wage bracket method (section 3402(c)) be used to determine the withholding liability on a periodic payment?
A. Yes. Withholding on a periodic payment is accomplished by treating the payment as if it were wages. Therefore, unless the employee has elected not to have withholding apply, any method of withholding that is an appropriate method for withholding on wages is also an appropriate method for withholding on periodic payments. Refer to the Employer's Tax Guide (Circular E) and Publication 493, Alternative Tax Withholding Methods and Tables for the general procedures on withholding, deposit, payment, and reporting of Federal income tax withheld. Note, however, that any specific procedures contained in this regulation take precedence over any contrary rules in Circular E and Publication 493.
b-3. Q. Do rules similar to those for wage withholding applly to the filing of a withholding certificate for periodic payments?
A. Yes. Unless the rules of section 3405 specifically conflict with the rules of section 3402, the rules for withholding on periodic payments will parallel the rules for wage withholding. Thus, if a withholding certificate is filed by a payee, it will generally take effect as provided in section 3402(f)(3) for certificates filed to replace existing certificates. If a withholding certificate is furnished by a payee on or before the date on which payments commence, it takes effect with respect to payments made more than 30 days after the certificate is furnished, unless the payor elects to make it effective at an earlier date. If a withholding certificate is furnished by a payee after the date on which payments commence, it takes effect with respect to payments made on or after the status determination date (January 1, May 1, July 1, or October 1) that is at least 30 days after the date the certificate is filed, unless the payor elects to make it effective at an earlier date. If no withholding certificate is filed, the amount withheld is determined as if the payee were a married person claiming three withholding allowances.
b-4. Q. If no withholding certificate has been filed and the payor is aware that the payee is single, is it still appropriate to base withholding on a married individual claiming three allowances?
A. Yes. If no withholding certificate is filed, the payor is not required or permitted to base withholding on the amount of allowances the payee actually is entitled to claim. Thus, the payor must base withholding on the rates for a married person with three withholding allowances.
b-5. Q. May a payor determine whether payments to an individual are subject to withholding based on the amount of the first periodic payment for the year?
A. No. Periodic payments can vary during a calendar year because of make-up of past due payments, variable rates of payments, or cost-of-living adjustments, so that withholding based on the first payment within a year may be an inaccurate measure of withholding on total payments for the year. Therefore, the amount to be withheld is determined each payment period in the same manner as applies to withholding on wages. See, in this respect, Circular E and the regulations under section 3402.
b-6. Q. If a payment period is specified as by the terms of a commercial annuity contract, must this period be used as the appropriate period for determining the amount to be withheld?
A. Yes. Similarly, if the payment period is designated in a plan administrator's report or on an individual retirement account payout schedule agreed to by payor and payee, this period must be used as the appropriate payment period.
b-7. Q. If the payor received no report from the plan administrator or beneficiary concerning the payment period, but knows the frequency of payments, can the known frequency be used as the appropriate payment period?
A. Yes. However, if no report is received and the payor has no knowledge of the frequency of payments, then he must treat the distribution as a nonperiodic distribution. Therefore, a distribution cannot be a periodic payment unless the frequency of payments is known. See, in this respect, questions b-8 and c-2. For rules concerning the plan administrator's failure to provide this information, see questions e-2 and e-3.
b-8. Q. If a payee receives a one-time payment that is a make-up payment resulting from an insurance company's incorrect calculation of a monthly annuity amount, is the one-time payment part of a series of periodic payments?
A. Yes. Because the one-time payment is a catch-up of prior amounts due as periodic payments, it is treated as part of a series of periodic payments. These payments are treated for withholding purposes in a manner similar to the treatment of supplemental wage payments in § 31.3402(g)-1 of the Employment Tax Regulations.
c-1. Q. Must an individual receive a lump-sum distribution within the meaning of section 402(e)(4) to have a qualified total distribution?
A. No. A “qualified total distribution” is any distribution that (i) is a designated distribution, (ii) is reasonable to believe is made within one taxable year of the recipient, (iii) is made under a plan described in section 401(a) or 403(a), and (iv) consists of the balance to the credit of the employee under such plan. Thus, a distribution from a plan described in section 401(a) that does not meet the requirements (such as the minimum 5-year period of participation in section 402(e)(4)(H)) for a lump sum distribution within the meaning of section 402(e)(4) may still be a qualified total distribution for purposes of withholding.
c-2. Q. If a class year plan permits annual withdrawal of participants' vested amounts, are these withdrawals considered periodic payments?
A. No. A class year plan is a plan under which amounts contributed by an employer for a year become vested a number of years (e.g., five years) after the year in which the amounts are contributed. Generally, class year plans permit withdrawals each year of amounts that have vested during the year. However, these distributions are not made with respect to an established frequency of payments, so the withdrawals must be treated as nonperiodic distributions, subject to withholding at the 10 percent rate.
c-3. Q. If a beneficiary receives the balance to the credit of a payee from an annuity contract on account of the payee's death, is this final payment a nonperiodic distribution?
A. Yes. The lump sum death benefit in this situation is a one-time payment that cannot be characterized as a periodic payment. The payment may be a qualified total distribution if the requirements of section 3405(c)(4) are satisfied, but otherwise it will be treated as a nonperiodic distribution other than a qualified total distribution.
c-4. Q. Is it permissible to assume that an individual is a calendar year taxpayer for purposes of determining whether a distribution is a “qualified total distribution?”
A. Yes, unless the payor or plan administrator has reason to believe that the payee is not a calendar year taxpayer. The payor or plan administrator has reason to believe that the payee is not a calendar year taxpayer if the payee tells the payor or plan administrator that he is not a calendar year taxpayer.
c-5. Q. Is a distribution of accumulated deductible employee contributions with earnings that is paid on account of an employee's separation from service treated as a qualified total distribution?
A. Yes. As long as the other requirements for a qualified total distribution are met, a distribution of accumulated deductible employee contributions with earnings is eligible for withholding at the rate applicable to qualified total distributions even though the distribution could never be a lump sum distribution. Because accumulated deductible employee contributions are treated separately in determining whether a distribution is a qualified total distribution, the answer would be the same even if the recipient received none (or a portion) of the vested employer contributions in his account.
c-6. Q. What is meant by the “balance to the credit” of an employee under a plan described in section 401(a) or 403(a)?
A. In general, the balance to the credit of an employee includes any amount credited to the employee under the plan on the date the distribution commences. The balance to the credit of an employee includes an amount credited after the date the distribution commences if it is attributable to services performed before that date or is attributable to earnings on an amount credited to the employee before that date. Additionally, the balance to the credit of an employee includes any amount payable as an annuity with respect to the employee under the plan. Amounts that have been placed in a separate account for the funding of medical benefits under section 401(h) or amounts that are forfeitable under the plan are not included in the balance to the credit of an employee. Finally, accumulated deductible employee contributions (within the meaning of section 72(o)(5)(B)) are not included in the balance to the credit of an employee for the purposes of determining whether a distribution is a “qualified total distribution.”
c-7. Q. Can a payor rely on a plan administrator's report in determining whether a distribution consists of the balance to the credit of an employee under a plan?
A. Yes. If the plan administrator does not inform the payor that the distribution consists of the balance to the credit of the employee, the payor may not assume that the distribution is a qualified total distribution and must treat the distribution as a nonperiodic distribution that is not a qualified total distribution. However, the payor may rely on the payee's representations that a distribution does consist of the balance to the credit of the employee under the plan.
c-8. Q. What table must be used to calculate the amount to be withheld from a “qualified total distribution?”
A. The table to be used for withholding on “qualified total distributions” will be published by the Secretary in the near future.
d-1. Q. May a payee elect not to have Federal income tax withheld from a designated distribution?
A. Yes. Withholding is not required on any periodic payment or nonperiodic distribution if the payee elects not to have withholding apply. If the payee makes this election, it is effective until revoked. The payor is required to provide each payee with notice of the right to elect not to have withholding apply and of the right to revoke the election.
d-2. Q. In the case of a designated distribution made on account of the death of an employee, who makes the election not to have withholding apply?
A. The election may be made by the beneficiary of plan benefits specified by the decedent in accordance with plan procedures or, if there is no designated beneficiary, by the beneficiary specified under the terms of the plan. If there is not a designated beneficiary and the terms of the plan do not specify a beneficiary, then the election may be made by the executor or the personal representative of the decedent.
d-3. Q. Who is required to provide notice to the payee of the payee's right not to have withholding apply?
A. Section 3405(d)(10)(B) requires the payor to provide notice to the payee of the payee's right to elect not to have withholding apply. Thus, even if the plan administrator has failed to transfer liability for withholding to the payor, the payor must provide notice to the payees.
d-4. Q. When must notice of the right to elect not to have withholding apply be given for periodic payments?
A. In the case of periodic payments, notice of the election must be provided not earlier than six months before the first payment and not later than when making the first payment. However, even if notice is provided at a date before the first payment,notice must also be given when making the first payment. Thereafter, notice must be provided at least once each calendar year of the right to make the election and to revoke the election.
d-5. Q. Must notice of the right to elect not to have withholding apply be provided to those payees whose annual payments are less than $5,400?
A. Yes. However, under the statute, notice is only required to be provided when making the first payment. Therefore, a payor may provide notice to a payee with annual payments less than $5,400 by indicating to the payee when making the first payment that no Federal income tax will be withheld unless the payee chooses to have withholding apply by filing a withholding certificate, if the payor also provides information concerning where a withholding certificate may be obtained.
d-6. Q. Must notice of the right to elect not to have withholding apply be provided in the same manner to all payees?
A. No. If the payor provides notice to all payees when making the first payment, the payor may, in addition, provide earlier notice as provided in section 3405(d)(10)(B)(i)(I) to selected groups of payees, such as those payees whose annual payments are over $5,400.
d-7. Q. Must notice be attached to the first payment to satisfy the requirement that notice be provided “when making” the first payment?
A. No. Because many payees utilize electronic funds transfer to deposit their pension or annuity checks, notice does not have to be attached physically to the check.
d-8. Q. If a payee utilizes electronic funds transfer and notice is mailed directly to the payee at the same time the check is issued, is the notice requirement satisfied even though the payee receives the notice fifteen days after the check is deposited?
A. Yes. Although it is desirable that the notice reach the payee immediately prior to or concurrent with receipt of the check, the notice requirement is deemed to be satisfied if the payee receives the notice within 15 days before or after receipt of the first payment.
d-9. Q. When is the payor required to notify the payee of his right to elect not to have withholding apply to a nonperiodic distribution?
A. Section 3405(d)(10)(B)(ii) requires that notice must be provided to the payee at the time of a nonperiodic distribution. Since notice provided at the time of the distribution could result in delay of receipt of the benefit check if the payee elects out of withholding, notice for nonperiodic distributions should be given not earlier than six months prior to the distribution and not later than the time that will give the payee reasonable time to elect not to have withholding apply and to reply to the payor with the election information. What is reasonable time depends upon the facts and circumstances of each case.
d-10. Q. What is a “reasonable time” for notice with respect to a nonperiodic distribution from a qualified plan?
A. The “reasonable time” requirement is satisfied with respect to a nonperiodic distribution if the notice is included in the basic claim for benefits application that is provided to the participant by the plan administrator.
d-11. Q. If the payor of a periodic payment provides notice of the election not to have withholding apply within the time specified by section 3405(d)(10)(B)(i)(I), may the payor specify a time prior to distribution by which the election must be made?
A. Yes. The election not to have withholding apply is generally given effect as provided in section 3402(f)(3) for a certificate filed to replace an existing certificate. However, the payor may require that the election is made up to 30 days before the first payment to be effective for the first payment. See question b-3.
d-12. Q. If the payor of a nonperiodic distribution provides notice of the election not to have withholding apply within a reasonable time prior to the distribution, may the payor specify a time prior to distribution by which the election must be made?
A. No. The payee has the right to make or revoke an election at any time prior to the distribution. Therefore, the payor may place a deadline on the time to elect without delaying payment of the distribution, but must accept any election or revocation made up to the time of distribution.
d-13. Q. What is a “reasonable time” for notice with respect to a distribution from an individual retirement account?
A. A payor may provide notice of the election not to have withholding apply at the time the beneficiary requests a withdrawal from his individual retirement account. This rule also applies to distributions from bank sponsored prototype plans and other plans that permit withdrawals on request.
d-14. Q. If notice is provided to a payee prior to the first payment of a periodic payment, why must it also be provided at the time of the first payment or distribution?
A. Section 3405(d)(10)(B)(i)(II) of the Internal Revenue Code requires such notice. In addition, because the payee has the right to make an election or to revoke a prior election at any time prior to the beginning of the payment period, notice must be provided when making the first payment in order to offer the payee ample opportunity to make or revoke an election not to have withholding apply even if the election will not be effective until later payments.
d-15. Q. If a payee who has been receiving periodic payments is rehired by the same employer, has his benefits suspended, and then recommences receiving periodic payments, must notice again be provided to the payee?
A. Yes. Upon recommencement of benefits, the first payment thereafter is treated as the first payment for purposes of the notice requirements.
d-16. Q. Must a payor provide notice if it is reasonable to believe that the entire amount payable is excludible from the payee's gross income?
A. No. Amounts which it is reasonable to believe are not includible in gross income are not designated distributions. Therefore, no notice is required of the ability to elect not to have withholding apply.
d-17. Q. If the payor of a periodic payment under a qualified plan knows that an employee's investment in an annuity contract will be recovered within three years, must he provide notice of the right to elect out of withholding at the time the first payment is made?
A. No. The first payment is not a designated distribution, and, therefore, is not a periodic payment subject to the notice requirements of section 3405(d)(10)(B)(i). There is no withholding obligation until the employee's investment in the contract is recovered because those amounts that equal the investment in the contract are not includible in gross income and, therefore, are not designated distributions. Therefore, the first payment after the employee's investment in the contract is recouped is the first payment for purposes of the notice requirements.
d-18. Q. What information concerning the election not to have withholding apply must be provided by the payor to the payee?
A. Notice to a payee must contain the following information:
(1)
Notice of the payee's right to elect not to have withholding apply to any payment or distribution and how to make that election,
(2)
Notice of the payee's right to revoke such an election at any time and a statement that the election remains effective until revoked,
(3)
A statement to advise payees that penalties may be incurred under the estimated tax payment rules if the payments of estimated tax are not adequate and sufficient tax is not withheld from the payment or distribution.
In the event that the payor does not know what part of a distribution is includible in gross income and treats these payments as provided in question a-33, the following additional statements must be included with the notice: