In 1987, the IRS released Notice 87-7 providing guidance on whether certain recipients of payments from employer deferred compensation plans, individual retirement plans, and commercial annuities are subject to federal income tax withholding under section 3405.  The notice provided that:

  • payors must withhold on periodic and nonperiodic payments under section 3405(a) or 3405(b), respectively, to payees that provide a residence address outside the United States;
  • payors must withhold on periodic and nonperiodic payments under section 3405(a) or 3405(b), respectively, to payees that provide a residence address inside the United States, unless the payee has elected no withholding in accordance with section 3405; and
  • payors must withhold on periodic and nonperiodic payments under section 3405(a) or 3405(b), respectively, to payees that provide a residence address outside the United States.

However, if the payee certifies under penalties of perjury that he or she is not a U.S. citizen, is a bona fide resident of a foreign country, and is not a person subject to the tax on expatriates under section 877 of the Code, withholding under section 3405 is not required even if the residence address provided is outside of the United States.  Notice 87-7 indicates that regulations will be promulgated setting forth these rules and will be effective as of January 1, 1987, with any changes to be effective prospectively.  The notice warns that regulations could include a limitation on the payor’s ability to rely on a residence address within the United States as a basis for not withholding.

Some 32 years later, the Treasury has promulgated the promised rules, largely incorporating the framework laid out in the notice with some clarifications and a limitation as foreshadowed by the notice.  The proposed regulations provided that payors must withhold on periodic and nonperiodic payments under section 3405(a) or 3405(b), respectively, even if a payee provides a residence address inside the United States and elects no withholding in accordance with section 3405, provided that the payee instructs the payor to:

  • send the distribution to a financial institution or other person located outside of the United States;
  • send the distribution to a financial institution or other person located within the United States with further instructions (such as “for further credit to” instructions) directing that the funds be forwarded to a financial institution or other person located outside of the United States; or
  • send the distribution to a financial institution or other person pursuant to payment instructions that reference an International Automated Clearing House Transaction (IAT), International Bank Account Number (IBAN), or Society for Worldwide Interbank Financial Telecommunication (SWIFT) Business Identifier Code (BIC), linked to a financial institution or other person located outside of the United States.

In addition, the proposed regulations would clarify that APO/FPO/DPO addresses are treated as addresses within the United States for purposes of section 3405.  The proposed regulations also make clear that if the payee is known or presumed to be a nonresident alien individual subject to Chapter 3 withholding, those rules trump the rules under section 3405.  Accordingly, nonresident alien individuals that are not subject to withholding under section 3405 may alternatively be subject to 30% withholding unless treaty relief is appropriate.

Photo of S. Michael Chittenden S. Michael Chittenden

Michael Chittenden practices in the areas of tax and employee benefits with a focus on the Foreign Account Tax Compliance Act (FATCA), information reporting (e.g., Forms 1095, 1096, 1098, 1099, W-2, 1042, and 1042-S) and withholding, payroll taxes, and fringe benefits. Mr. Chittenden…

Michael Chittenden practices in the areas of tax and employee benefits with a focus on the Foreign Account Tax Compliance Act (FATCA), information reporting (e.g., Forms 1095, 1096, 1098, 1099, W-2, 1042, and 1042-S) and withholding, payroll taxes, and fringe benefits. Mr. Chittenden advises companies on their obligations under FATCA and assists in the development of comprehensive FATCA and Chapter 3 (nonresident alien reporting and withholding) compliance programs.

Mr. Chittenden advises large employers on their employment tax obligations, including the special FICA and FUTA rules for nonqualified deferred compensation, the successor employer rules, the voluntary correction of employment tax mistakes, and the abatement of late deposit and information reporting penalties. In addition, he has also advised large insurance companies and employers on the Affordable Care Act reporting requirements in Sections 6055 and 6056, and advised clients on the application of section 6050W (Form 1099-K reporting), including its application to third-party payment networks.

Mr. Chittenden counsels clients on mobile workforce issues including state income tax withholding for mobile employees and expatriate and inpatriate taxation and reporting.

Mr. Chittenden is a frequent commentator on information withholding, payroll taxes, and fringe benefits and regularly gives presentations on the compliance burdens for companies.

Photo of Michael M. Lloyd Michael M. Lloyd

Michael Lloyd practices in the areas of tax and employee benefits with a focus on information reporting and withholding on cross-border payments (e.g., Forms 1042 and 1042-S) and Foreign Account Tax Compliance Act (FATCA), backup withholding, employment taxation, the treatment of fringe benefits…

Michael Lloyd practices in the areas of tax and employee benefits with a focus on information reporting and withholding on cross-border payments (e.g., Forms 1042 and 1042-S) and Foreign Account Tax Compliance Act (FATCA), backup withholding, employment taxation, the treatment of fringe benefits, cross-border compensation, domestic information reporting (e.g., Forms W-2, 1099, 1095 series returns), penalty abatement, and general tax planning and controversy matters. Mr. Lloyd advises large U.S. and foreign multinationals regarding compliance with information reporting and withholding issues, as well as a range of other federal and state tax issues.