IRA distributions and federal income tax withholding: New IRS Form W-4R

Overview

Over the last several months there have been a lot of questions about the new Internal Revenue Service (IRS) Form W-4R, Withholding Certificate for Nonperiodic Payments and Eligible Rollover Distributions, and the revised withholding options applicable to certain individual retirement account (IRA) distributions. This article will provide answers to many of those questions.

Withholding remainder of 2022

Since 1975, when IRAs first became available, IRA distribution recipients (i.e., IRA owners and IRA beneficiaries) have been required to address the issue of federal income tax withholding when taking taxable distributions. For most of these years the withholding election was addressed on IRS Form W-4P, Withholding Certificate for Periodic Pension or Annuity Payments. This remains to be the case through 2022 as Form W-4P is applicable to taxable IRA distributions taken in 2022 unless the recipient of such distribution(s) chooses to use the 2022 version of IRS Form W-4R, which is optional to use in 2022.

Withholding beginning in 2023

Beginning in 2023, Form W-4P will be replaced by IRS Form W-4R for IRA distributions that fall under the definition of nonperiodic payments, which is essentially any payment that is payable on demand. This includes any designated distribution except annuity or similar periodic payments. The 2023 version of Form W-4R will be required to be used beginning January 1, 2023, or 30 days after its IRS release date if later. The 2022 version of Form W-4R will be an acceptable option to use for nonperiodic IRA distributions taken in 2023 until the 2023 version is available or required to be used. 

One interesting change with Form W-4R is that it allows for a withholding election between zero and 10 percent, whereas Form W-4P does not. If an IRA distribution recipient fails to make a withholding election, 10 percent withholding will continue to be the default rate for federal income tax withholding. It should also be noted that Form W-4R will be updated annually by the IRS to incorporate then current marginal tax rate tables, which may be used by a recipient to determine the appropriate amount of federal income tax to withhold. Wolters Kluwer has made available Form W-4R (Form IRA-W-4R-LAZ) which will be updated annually, following the IRS’s release of its version, to reflect the appropriate marginal tax rate tables and any other changes.

Annual withholding notification

 A long-standing requirement that will not changes is that a custodian/trustee provide recipients that are set up to receive scheduled distributions with an annual notice reminding them of their ability to change a previous withholding election. Recipients of distributions administered quarterly or more frequently (e.g., monthly, weekly, etc.) must be provided with one notice per year whereas recipients of distributions administered less frequently than quarterly (e.g., semi-annual or annual) must be provided with a notice prior to each distribution. In either case, such notices cannot be sent out more than six months prior to the scheduled distribution(s). Also, remember that unless changed, an IRA distribution recipient’s previous election regarding federal withholding will remain in effect until changed. Moreover, beginning in 2023, Form W-4R will need to be used to make any change to a previously made withholding election. 

Wolters Kluwer’s forms users should note that the Notice of Withholding (Form WK IRA-50-LAZ), which is one of two forms that Wolters Kluwer makes available to remind IRA owners of their ability to change a previous withholding election, has been updated to reference Form W-4R, removing the reference to Form W-4P. Additionally, Wolter Kluwer’s IRA Notice of Withholding for Traditional and SIMPLE IRAs (Form IRA-50W-4PLZ) has been replaced by the IRA Notice of Withholding for Traditional and SIMPLE IRAs (Form IRA-50WITHLZ).

Conclusion

While this may seem like a lot of changes to grasp it can help to remember that most of the withholding rules did not change! What changed is that in 2023 a new election form to address the withholding of federal income taxes on IRA distributions must be used – Form W-4R. And, since the requirements to provide a substitute Form W-4R are quite extensive, Form W-4R will not be included as part of any Wolters Kluwer distribution or election related forms. This means that custodians/trustees using Wolters Kluwer forms will need to include a separate Form W-4R when administering distributions where federal withholding elections are pertinent.

For more information on the federal income tax withholding changes applicable to IRA distributions classified as nonperiodic payments click here.