Untangling Those Tricky IRA Withholding Rules
By Chad Neumann, CIS, CIP, CISP, CHSP, CPTD, MCCT
Our financial organization does not want to withhold federal income taxes on IRA distributions. Is this allowed?
No, financial organizations must offer federal withholding on all IRA distributions that may be subject to income tax. A financial organization is required to withhold 10 percent of a nonperiodic distribution (i.e., a distribution that is payable on demand) if the IRA owner does not make a withholding election and the aggregate annual IRA distributions will total $200 or more. If an IRA owner makes a withholding election on IRS Form W-4R, Withholding Certificate for Nonperiodic Payments and Eligible Rollover Distributions, or a substitute Form W-4R, then your organization is required to follow that direction. IRA owners do have the option to elect zero percent withholding, in which case the financial organization is not required to withhold. If you administer individual retirement (IR) annuities, the default withholding rate for annuitized payments (i.e., periodic distributions), assumes that the IRA owner is single with no allowances. An IR annuity owner can make a different withholding election using IRS Form W-4P, Withholding Certificate for Periodic Pension or Annuity Payments.
Does our financial organization have to notify IRA owners of their withholding rights?
Yes, financial organizations must notify IRA owners of the right to waive withholding or to make a different withholding election. A best practice is to notify IRA owners who are taking single distributions of the right to waive or elect a different withholding rate with each distribution. This is generally done as part of a withdrawal form. For IRA owners who have elected to take scheduled payments, the frequency of the payments determines how frequently your organization must notify the IRA owner of her withholding rights. If the IRA owner is taking distributions quarterly or more frequently, your organization must send a notice once per year before the first distribution each year. If the IRA owner is taking distributions less frequently than quarterly, your organization must send a notice no earlier than six months before a distribution. This requirement would be met by sending two notices, at six-month intervals. The notice must be provided early enough to allow the IRA owner to change her withholding election.
Is there a penalty if our organization doesn’t provide a withholding notice?
Yes, the penalty is $100 per failure with a maximum penalty of $50,000 per year.
What happens to the money that our organization withholds?
Financial organizations are required to deposit the assets with the federal depository using the Electronic Federal Tax Payment System (EFTPS). The frequency of the deposits is based on a two-year lookback period, which is the calendar year two years before the current calendar year. For example, a financial organization that collected $50,000 or less in withholding during 2022 is considered a monthly depositor for 2024: it must deposit withheld amounts by the 15th day of the following month. A financial organization that collected more than $50,000 in 2022 is considered a semiweekly depositor for 2024: amounts withheld on Wednesday, Thursday, and Friday must be deposited by the following Wednesday. Amounts withheld on Saturday, Sunday, Monday, and Tuesday must be deposited by the following Friday.
If the nonpayroll withholding amount reaches $100,000 for any day, the financial organization must deposit the withheld amount by the end of the next business day.
What happens if we miss the deadline?
The IRS will penalize the financial organization a percentage of the amount that should have been deposited. This starts at 2 percent for deposits that are one to five days late and can increase to a penalty of 15 percent if the deposit is still not made 10 days after an IRS notice.
Does our financial organization have any reporting requirements regarding the amounts withheld?
Yes, any amounts withheld are reported as part of the distribution on the IRA owner’s Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc. Financial organizations are also responsible for reporting withheld amounts on Form 945, Annual Return of Withheld Federal Income Tax. Financial organizations must submit this form to the IRS by the following January 31. If all deposits are made on time, in full, the deadline is extended to February 10. If the financial organization is a semiweekly filer, then it must also file Form 945-A, Annual Record of Federal Tax Liability, with Form 945.
The beneficiary of a deceased IRA owner is from France, does that change the withholding requirements?
Yes, any individual receiving a distribution who is not a US citizen or a resident alien is subject to a 30 percent default withholding rate. Beneficiaries that submit a valid Form W-8BEN, Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding and Reporting (Individuals), or Form W-8BEN-E, Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding and Reporting (Entities), can elect a treaty rate for their country of residence.
This withheld amount will be reported to the beneficiary and the IRS on Form 1042-S, Foreign Person’s U.S. Source Income Subject to Withholding, and on Form 1042, Annual Withholding Tax Return for U.S. Source Income of Foreign Persons, .
