On October 18, 2024, the IRS issued final regulations on withholding for qualified retirement plan payments made to United States taxpayers living outside of the country.  The final regulations come five years after the IRS issued proposed regulations on the topic and almost four decades after the IRS issued Notice 87-7, the previous authority on withholding obligations for these types of distributions.  Moving forward, Notice 87-7 will be obsolete for payments and distributions made after December 31, 2025, and instead, the new regulation will apply.

The final regulation clarifies tax withholding obligations under the federal law for periodic and nonperiodic payments from qualified retirement plans, individual retirement accounts, and annuities.  Under the Internal Revenue Code, a payee may not elect to waive withholding for payments delivered outside of the United States and outside the possession of the United States.  Generally, this means that payee elections provided for under section 3405—which generally allow for a payee to elect to waive withholding for distributions other than eligible rollover distributions—do not apply for individuals residing outside of the United States.

Specifically, the final regulation describes when payors of periodic and nonperiodic distributions from pensions, annuities, and certain other deferred income must withhold federal income tax from distributions to (a) payees with a military or diplomatic Post Office address; (b) payees with a residence address inside the United States; and (c) payees with a residence address outside the United States or who have not provided a residence address.  Furthermore, the final regulation clarifies the withholding requirements for distributions to nonresident aliens and foreign corporations under chapter 3 of the Code.

Beginning January 1, 2026, payors must implement the following:

• Payees with Military or Diplomatic Post Office Address.  The 2019 proposed regulations requested comment on the treatment of those with Army Post Office (APO), a Fleet Post Office (FPO), or Diplomatic Post Office (DPO) addresses.  Under the final rules, an APO, FPO, or DPO address is considered an address located within the United States.  This means that a payor must withhold from payments to payees at any such addresses unless the payee makes a valid election under section 3405 to waive withholding.
• Payees with a Residence Address Located Within the United States.  Generally, an individual with an address located within the United States may make elections under section 3405 to waive withholding and a payor must honor that election.  However, the final regulation specifies that if the payee “provides payment instructions indicating that the [distribution is] to be delivered outside of the United States,” then the payor must withhold, regardless of the payee’s election.  Examples of payment instructions that indicate that the distribution will be delivered outside of the United States include requests to:
• Send the distribution to a financial institution or person located outside of the United States;
• Send the distribution with instructions to later forward the distribution to a financial institution or person located outside of the United States; or
• Send the distribution to a financial institution or person with instructions referencing an International Automated Clearing House Transaction (IAT), International Bank Account Number (IBAN), Society for Worldwide Interbank Financial Telecommunication (SWIFT) Business Identifier Code (BIC), or similar identifier linked to a financial institution or other person located outside of the United States.
• Payees with a Residence Address Located Outside the United States.  A payor is required to withhold income tax from any periodic or nonperiodic distributions to payees with a residence address located outside the United States, without regard to any delivery instructions and without regard to any attempt to elect no withholding.  Similarly, a payor is required to withhold income tax for distributions when the payee has failed to provide residence address or only provided an address for the payee’s nominee, trustee, or agent.
• Payments to Nonresident Aliens Under Chapter 3 of the Code.  Chapter 3 of the Code specifies the requirements for withholding of tax on nonresident aliens and foreign corporations.  The final regulation clarifies the interplay between Chapter 3 and section 3405 by providing that the withholding rules under Section 3405 do not apply to such distributions, and instead withholding for such payments is governed by Sections 1441 through 1446 of the Code.

Takeaway

Payors should review the addresses of current payees and consider what steps, if any, must be taken to align with the new regulation.  Although the final regulation applies to payments and distributions made after January 1, 2026, payors may implement the regulation now for any future payments and distributions.