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Plan Distributions to Foreign Persons Require Withholding

Does your U.S. retirement plan make distributions to foreign persons? If so, you must generally withhold 30% of the payment for federal income tax (IRC Section 1441(a)).

How do I document the status of a payee?

You must generally withhold 30% from a plan distribution paid to a foreign payee unless you can reliably associate the payment with valid documentation that establishes the payee is:

  • a U.S. person, or
  • a foreign person entitled to a rate of withholding lower than 30%.

Documentation can include Form W-9, Form W-8BEN, or other appropriate sources.

If you don’t have documentation, you may be able to apply a lower withholding rate but only if you can verify that the recipient is a presumed U.S. person under the tax regulations.

How do I determine a payee’s status if I don’t have documentation?

If you can’t reliably document the status of a retirement plan distribution recipient as a U.S. person or a foreign person entitled to lower withholding, you should apply the presumption rules in the tax regulations (Treasury Regulation Section 1.1441-1(b)(3)(iii)(C)).

Who can I presume is a U.S. person?

A retirement plan distribution is presumed to be made to a U.S. person only if the withholding agent:

  • has a record of a Social Security number for the payee, and
  • relies on a payee mailing address that’s
    1. in the United States, or
    2. in a foreign country with which the United States has an income tax treaty in effect giving its residents exemption from U.S. tax on payments of this type.

A payment that does not meet these rules is presumed to be made to a foreign person. See Treasury Regulation Section 1.1441-1(b)(3)(iii)(C) for the complete rule.

Examples of withholding errors

Plan sponsors and third party administrators are withholding agents and may be liable for taxes and penalties for improper withholding.

No withholding on distribution to a presumed foreign person

The Employee Plans Examinations group has seen situations in which the plan withholding agent didn’t withhold federal income tax on plan distributions that constitute U.S. source income to participants residing in foreign countries, specifically when:

  • The participant resides in a country with which the United States doesn’t have an income tax treaty in effect that entitles the payee, if a resident in the treaty country, to a U.S. tax exemption on their qualified plan distributions;
  • The plan sponsor didn’t secure Form W-8BEN, Form W-9 or other documentation to determine the payee’s status as a U.S. person; and
  • The plan sponsor reported the distribution on Form 1099-R.

These participants are presumed to be foreign persons and their distributions should be reported on Forms 1042-S with 30% federal income tax withheld.

Improper withholding at a reduced rate

IRS auditors have also seen situations in which a reduced rate of federal income tax (less than 30%) was improperly withheld on qualified plan distributions that constituted U.S. source income to participants residing in foreign countries, specifically when:

  • The participant resides in a country with which the United States doesn’t have an income tax treaty in effect that entitles the payee, if a resident in the treaty country, to a U.S. tax exemption on their qualified plan distributions; and
  • The plan sponsor didn’t secure Form W-8BEN, Form W-9 or other documentation to determine the payee’s status as a U.S. person or foreign person.

In this situation, the participant is presumed to be a foreign person (Treasury Regulation Section 1.1441-1(b)(3)(iii)(C)).

A withholding agent who makes a payment to a person presumed to be a foreign person may not reduce the 30% withholding on it unless the beneficial owner furnishes a Form W-8BEN withholding certificate (Treas. Regs. Sections 1.1441-1(b)(3)(iii)(C) and 1.1441-1(e)(2)(i)). Because the withholding agent didn’t secure Form W-8BEN from the participant in this situation, federal income tax should have been withheld at the 30% rate.

Additional resources

Page Last Reviewed or Updated: 22-Feb-2016