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ComplianceTax & AccountingJanuary 31, 2023

IRA distributions and federal income tax withholding: IRS Form W-4R mandatory beginning in 2023

Overview

In January of 2022, the Internal Revenue Service (IRS) released new Form W-4R, Withholding Certificate for Nonperiodic Payments and Eligible Rollover Distributions, which was optional to use for traditional (including Simplified Employee Pension – SEP) and Savings Incentive Match Plan for Employees of Small Employers (SIMPLE) individual retirement account (IRA) distributions taken during 2022, and mandatory for IRA distributions taken in 2023 and later. It is without doubt that the changes to the federal income tax withholding process brought about by this new form have caused confusion for some IRA distribution recipients and for many IRA custodians and trustees. Furthermore, the IRS will update Form W-4R annually as it includes Marginal Rate Tables which are subject to annual adjustments.

Background

Prior to 2023, recipients of periodic and nonperiodic payments from pensions, profit-sharing, stock bonus, annuity, certain deferred compensation plans, IRAs, commercial annuities, and eligible rollover distributions used Form W-4P, Withholding Certificate for Pension or Annuity Payments, to make a federal income tax withholding election for such payments. A revised version of Form W-4P will continue to be used for taxable periodic pension and annuity payments. On the other hand, new Form W-4R will be used for taxable nonperiodic payments, of which most IRA distributions are categorized whether taken on demand or scheduled to be administered on an automatic payment basis, and eligible rollover distributions.

Withholding election

New IRS Form W-4R allows a recipient to have any percentage (i.e., zero to 100 percent) of a taxable IRA distribution withheld and remitted to the IRS. Prior to 2023, users of Form W-4P may recall that an election to withhold an amount between zero and 10 percent of a distribution was not an option. It is important to note that going forward a withholding election percentage must be made as a whole number, unless it is zero. Also, keep in mind that absent any previous withholding election the default withholding rate is 10 percent of an IRA distribution, unless the recipient makes an election for a different percentage. Nontaxable IRA amounts, including most Roth IRA distributions, are generally not subject to withholding and therefor an election is not necessary.

Wolters Kluwer forms’ users

Before 2023 and when an IRA distribution recipient’s federal income tax withholding election was made using IRS Form W-4P, Wolters Kluwer provided a substitute version of the form on its traditional and SIMPLE IRA distribution-related forms as it was simplistic and seldom updated by the IRS. As Form W-4R is significantly denser with content, includes the Marginal Rate Tables, and will be updated annually, it is not included on any of the Wolters Kluwer distribution-related forms. Wolters Kluwer has available to it forms’ users IRS Form W-4R, Withholding Certificate for Nonperiodic Payments and Eligible Rollover Distributions (Form IRA-W-4R-LAZ), making it as convenient as possible for an IRA custodian or trustee when administering IRA distributions. It is important to remember, however, that when the updated version is made available annually by the IRS an IRA custodian or trustee must use the updated version. Following is the first page of the IRS’s 2023 version of IRS Form W-4R:


Annual withholding notification requirement

The annual withholding notification requirement that IRA custodians and trustees are responsible for has not changed from previous years. The notification requirement is generally more relevant to IRA owners and/or beneficiaries who are set up to receive scheduled automatic distributions from their IRA or inherited IRA. These individuals will typically make a federal income tax withholding election when initially requesting and setting up the scheduled payments. An IRA distribution recipient’s custodian or trustee keeps the withholding election on file and continues to follow it until the recipient requests a change to his/her withholding election. The purpose of a notice is to remind an individual that he/she has a withholding election on file, perhaps made using IRS Form W-4P, and that the individual can change this previously made withholding election by providing his/her IRA custodian or trustee with an updated election on IRS Form W-4R. In other words, it is not necessary for an IRA distribution recipient to make a new withholding election on the new IRS Form W-4R if an election is already on file and the recipient has no desire to change the amount being withheld.

On a side note, Wolters Kluwer has updated its federal income tax withholding notification forms which now refer to IRS Form W-4R, and not Form W-4P. The Wolters Kluwer Notice of Withholding (Form IRA-50-LAZ) and IRA Notice of Withholding for Traditional and SIMPLE IRAs (Form IRA-50WITHLZ) both have a revision date of 8/1/2022 and either will suffice as the appropriate notification for IRA distribution recipients that have made a previous election.

Conclusion

Federal income tax withholding applies to payments of Nonperiodic Payments and Eligible Rollover Distributions, of which most traditional (including SEP) and SIMPLE IRA distributions are categorized. It is important for IRA custodians and trustees to remember that an appropriate election for federal income tax withholding is the distribution recipient’s responsibility. Lacking a previously made (with proper notification) or a current election, an IRA distribution is subject to federal withholding at a rate of 10 percent, a rule that has not changed.

For additional information on federal income tax withholding see the Wolters Kluwer IRA distributions and federal income tax withholding: IRS issues revised and new 'Withholding Certificates' optional to use in 2022, required in 2023 article posted in March, 2022.

For an opportunity to learn more about IRAs and other tax-advantaged accounts including Health Savings Accounts and Coverdell Education Savings Accounts, consider the Wolters Kluwer IRA Library or our on-demand video training offered on a variety of topics. GO HERE to learn more about training opportunities available to you, or you can call us at 1-800-552-9408.
Mike Schiller
Manager, Specialized Consulting, Tax Advantaged Accounts
With more than 26 years of experience, Mike has worked closely with hundreds of financial organizations to help them create, implement, and maintain their tax-advantaged accounts program.
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