Effective as of January 1, 2023, payors of qualified plan distributions have been required to use a redesigned IRS Form W-4P for payee withholding elections on periodic payments and a new Form W-4R for nonperiodic payments and eligible rollover distributions. Since then, we have fielded myriad questions on the new forms, from the basic requirements for their use and who is responsible for implementation to interpreting long-standing qualified plan withholding regulations that have not yet been fully updated to align with the new forms.
In light of the recent first anniversary of the mandate to use the new Forms W-4P and W-4R, we share below some of the key issues that have arisen and that might be of interest to many of our plan administrator and payor clients.
Use of New Forms W-4P and W-4R Is Important to Avoid Liability
Internal Revenue Code Section 3405(d)(2) imposes secondary liability on a plan administrator for the withholding and deposit of the federal income taxes that are required to be withheld on periodic and nonperiodic payments. The plan administrator can shift this liability to the payor (often a plan trustee or custodian) provided that the plan administrator has directed the payor to withhold such taxes and furnished the payor with the information required to carry out the withholding.
A payor that applies a withholding election made on an invalid form is at risk of being held secondarily liable for underwithholding and, separately, for penalties. For this reason, it is important that plan administrators and payors implement withholding instructions provided on valid current-year forms (a requirement under the regulations). Absent receipt of a valid withholding certificate using a current year’s Form W-4P or W-4R, the payor should apply the default withholding rules.
Potential Issues
The following are a sampling of the potential challenges with Forms W-4P and W-4R that plan administrators and payors may face and our thoughts on handling them.
Implementing Withholding Exemptions
Older Forms W-4P include withholding exemption elections that were eliminated as part of the Tax Cuts and Jobs Act of 2017. (For 2021 and earlier forms, the default withholding rate was married with three allowances, whereas for 2022 and later forms it is single with no adjustments.) Even if a Form W-4P predates the revised form, it remains valid until revoked or replaced with a new valid form.
How is the correct withholding amount determined when only an old Form W-4P has been provided? IRS Publication 15-T includes a “computational bridge” to assist payors in determining the proper amount of withholding for a given year. At the same time, many payors are taking the opportunity to solicit updated withholding elections on the new forms in order to help payees ensure that they have an appropriate amount of withholding based on their particular tax situation.Substitute Forms W-4P/R
The substitute form requirements were enhanced as part of the transition to the revised Forms W-4P and W-4R. Under the new guidance, a substitute form is still permitted, but such form must have the same fields and identical instructions as the Form W-4P to be considered valid. Strict compliance with these rules is required to avoid potential liability for withholding errors made on account of honoring invalid forms.
Collecting Forms W-4R for Additional Nonperiodic Distributions
It is not necessary to collect a new W-4R for every nonperiodic distribution provided that the subsequent payment is made from the same plan or IRA. However, the payee must still be provided with a Tax Equity and Fiscal Responsibility Act (TEFRA) notice for each subsequent nonperiodic distribution.
A TEFRA notice is the notice that informs a payee of their right to elect zero withholdings in connection with each nonperiodic distribution and the right to revoke any election and includes a statement concerning liability for payment of estimated tax if the payee does not have withholding applied.
In light of this TEFRA notice requirement, the payee may choose to standardize its administration by soliciting a withholding certificate and providing a TEFRA notice for each nonperiodic payment. However, consideration should be given to how the resolicitation will be communicated in order to help avoid payee confusion.
Next Steps
Plan administrators and payors should ensure that payee withholding elections are determined in accordance with the rules for the new Forms W-4P and W-4R. The risk of potential secondary liability for withholding amounts, together with the potential for penalties, should guide decisions on how to interpret existing rules. Please reach out to your Morgan Lewis contact if you have any questions about implementing these forms or fulfilling withholding obligations.