Internal Revenue Code Section 3405(e)(13) generally requires mandatory withholding on periodic and nonperiodic distributions that are to be delivered outside the United States unless the payee is a nonresident alien or recent expatriate (in which case the withholding rules under Code Sections 1441 and 877, respectively, apply). For such distributions, payees cannot elect zero withholding. The purpose of these rules is to enforce tax compliance among Americans living abroad. In furtherance of this goal, recently finalized regulations expand upon existing requirements to examine payee addresses to determine the applicable withholding rules.
Under the final regulations, payors must also review any payment instructions to determine whether the distribution ultimately is to be delivered abroad such that mandatory withholding is required. Payors may find that they must ignore payee elections of zero withholding to comply with these updated rules. While the final rules apply to distributions made on or after January 1, 2026, taxpayers may rely on the final regulations now.
IRS Notice 87-7 provided rules to enable payors to determine whether they must withhold on distributions under Section 3405 based on the residence address provided by a payee. Proposed regulations issued in 2019 provided additional guidance in scenarios where the payee provides payment instructions directing the payment to a foreign financial institution or other person, or to payees with a military or diplomatic address. The final regulations do not differ from the proposed regulations except as to the effective date.
Issued in the form of Questions and Answers at Treasury Regulation § 31.3405(e)-1, the final regulations assist payors in determining whether mandatory withholding is required based on the residence address and/or any other address or payment delivery information the payee provides:
- If a payee’s residence address is located within the United States, the payor is required to withhold income tax from the distribution unless the payee has made a valid election of no withholding. Such an election must be treated as invalid if the payee instructs the payor to:
- Send the distribution to a financial institution or other person located outside the United States;
- Send the distribution to a financial institution or other person located within the United States but with further instructions directing that the funds be forwarded to a financial institution or other person located outside the United States; or
- Send the distribution to a financial institution or other person pursuant to payment instructions that include identifiers linked to a financial institution or entity outside of the United States, such as an International Automated Clearing House Transaction (IAT), International Bank Account Number (IBAN), Society for Worldwide Interbank Financial Telecommunication (SWIFT), or Business Identifier Code (BIC).
- If a payee’s residence is located outside the United States, the payor is required to withhold income tax from the distribution without regard to any delivery instructions or payee request to elect zero withholding. This is the case even if the payee instructs that the distribution be delivered to a financial institution or other person located within the United States.
- If a payee has not provided the payor with the payee’s residence address, or if the payee has provided an address for the payee’s nominee, trustee, or agent without also providing the payee’s residence address, these scenarios are treated as if the payee’s residence is located outside the United States; the payor is required to withhold income tax from the distribution without regard to any delivery instructions or payee request to elect zero withholding and even if the payee instructs that the distribution be delivered to a financial institution or other person located within the United States.
- Payees with military or diplomatic post office addresses (Army Post Office (APO), Fleet Post Office (FPO), or Diplomatic Post Office (DPO)) are treated as addresses located within the United States. Per the final regulations, APO is associated with Army or Air Force installations. FPO is associated with Navy installations and ships. APO/FPO addresses are utilized by US Department of Defense personnel, their family members, and other authorized users. DPO provides global mail service to authorized personnel assigned to designated posts abroad.
These rules do not apply to a US-source distribution to a nonresident alien; such a distribution would be subject to the Section 1441 rules that generally require withholding at 30%, or at a rate determined under a tax treaty.
Payors should review payee-provided addresses and payment instructions to confirm whether withholding is required and whether elections for zero withholding must be ignored. Please contact the authors with any questions, including for assistance with any payee communications about these rules.