After much anticipation, on September 28, 2020, the U.S.
Department of Treasury ("Treasury") and the Internal
Revenue Service ("IRS") issued final regulations on
income tax withholding on certain periodic retirement and annuity
payments made after December 31, 2020 at https://www.irs.gov/pub/irs-drop/td-9920.pdf,
as detailed in IRS News Release 2020-223 at https://www.irs.gov/newsroom/irs-provides-final-regulations-on-income-tax-withholding-on-certain-periodic-retirement-and-annuity-payments
(for further information on developments related to the Form W-4
and Form W-4P, see our e-alerts dated 3/26/2020, 9/5/2019, 8/30/2019).
The final regulations implement an amendment made by the Tax Cuts and Jobs Act of 2017 ("TCJA") to Internal Revenue Code ("Code") Section 3405, which changed the default rate of withholding (that applies when no withholding certificate is in effect) on periodic payments from being "determined by treating the payee as a married individual claiming three withholding exemptions" to being "determined under rules prescribed by the Secretary." In short, the final regulations update the current regulations to align the default withholding rate on periodic payments with the TCJA in order to provide greater flexibility to the Treasury to react to future legislative changes. The final regulations adopt the proposed regulations issued May 27, 2020, as final with no modifications.
Importantly, the final regulations provide guidance for 2021 and future calendar years and specify that for determining the default rate of withholding on periodic payments, the Treasury and the IRS will provide the rules and procedures in applicable forms, instructions, publications and other guidance (e.g. Publication 15-T and Form W-4P Instructions). However, the IRS did not announce a new default rate as part of this guidance. Instead, the IRS stated its intent that the current default rate of withholding will remain unchanged for 2021. IRS Notice 2020-3 provided that for calendar year 2020, the default rate of withholding on period payments is determined by treating the payee as a married individual claiming three withholding exemptions.
On July 22, 2020, the IRS released an early release draft 2021 Form W-4P, Withholding Certificate for Pension or Annuity Payments and Instructions, which was intended to align with the redesigned Form W-4, Employee's Withholding Certificate, and to provide a new default rate of withholding on periodic payments that begin after December 31, 2020. However, in recognition of comments that the IRS received regarding the time payors need to implement the new Form W-4P and the new default rate of withholding, the IRS announced that it is delaying implementation of the new Form W-4P and will continue to allow the default rate of withholding to be determined by treating the payee as a married individual claiming three withholdings. Therefore, the 2021 Form W-4P will be similar to the 2020 Form W-4P. The Treasury and the IRS intend to continue to work with interested parties and the tax community on the implementation of default withholding under the TCJA and on the redesign of the Form W-4P in order to make the withholding system more accurate and transparent.
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