Last updated: 06 Jan 2026

Section 871(m) & QDD — Good-Faith (through 2026) & Net-Delta (from 2027)

Practical operational guidance on Section 871(m) withholding, including Qualified Derivatives Dealer (QDD) status, the good-faith proxy regime effective through 2026, and the net-delta methodology effective from 2027. Includes decision logic, control points, typical pitfalls and reconciliation checkpoints.

1) Overview — What 871(m) is about

Section 871(m) targets payments on equity derivatives that economically replicate U.S. source dividends. In practice this includes both direct (listed option/dividend equivalent) and synthetic exposures via instruments such as swaps and options. Qualified Derivatives Dealers (QDDs) introduce a special withholding status with associated reporting and backup withholding relief for payees under certain conditions.

2) Decision logic for 871(m) applicability

1. Instrument classification: Is the instrument within scope (e.g., equity derivatives, synthetic dividend exposure)?
   • No: Document rationale; no 871(m) withholding applies.
   • Yes: continue.
2. QDD consideration: Are you a Qualified Derivatives Dealer (QDD) with a QDD election on file?
   • Yes: Apply QDD rules (withholding & reporting relief where eligible).
   • No: proceed with standard non-QDD treatment (withholding on dividend equivalents may apply).
3. Withholding trigger: Determine whether a payment is a dividend equivalent requiring withholding.
   • No: Record and monitor; keep supporting analysis available.
   • Yes: proceed to calculation approach.
4. Calendar period: Are we in the good-faith proxy period (through 2026) or the net-delta era (from 2027)?
   • Through 2026: use documented good-faith dividend equivalent proxy.
   • From 2027: use net-delta calculation rules; maintain logic documentation for audit.

3) Good-faith proxy (through 2026): controls

• Dividend records — ingest authoritative dividend declaration data with ex-date, record date and pay date.
• Proxy logic — capture your chosen good-faith proxy assumption and maintain versioned documentation.
• Template evidence — for each proxy event, store the calculation snapshot, inputs used and validation sign-offs.
• Reason-to-know — control contradictions (e.g., conflicting data feeds) and define escalation paths.
• Updating logic — plan for rollback or gap analysis where proxy logic updates occur mid-year.

4) Net-delta methodology (from 2027): controls

Starting in 2027, the net-delta method will become the standard determination method for dividend equivalent amounts on derivatives. Net-delta measures the sensitivity of the instrument to the underlying equity dividends.

• Delta feeds — receive reliable delta data or calculate via approved models; maintain audit logs.
• Aggregation logic — group trade positions, net positions by underlying, and apply delta summation rules.
• Threshold monitoring — flag exposures approaching triggering thresholds for dividend equivalence.
• Documentation — store per-instrument net-delta summaries with timestamps for audit and reconciliation.
• QA testing — quarterly QA tests comparing net-delta outputs to expected outcomes on sample sets.

5) Qualified Derivatives Dealer (QDD) status — practical controls

• Election filing — ensure the QDD election is filed in accordance with IRS rules and retained (with expiration/renewal monitoring).
• Documentation stack — for each counterparty, confirm QDD relief eligibility and store evidence.
• Backup withholding — validate when QDD relief waivers apply vs. when standard withholding applies.
• Periodic review — schedule QDD status refresh per instruction set, and test against actual trade / dividend activity.

6) Common operational pitfalls

• Misclassification: treating non-equity derivatives as 871(m) relevant.
• Data drift: stale dividend or delta inputs create incorrect withholding bases.
• Documentation gaps: missing archive of proxy logic assumptions or QDD filing evidence.
• Control disconnect: tax ops logic not aligned with trading system settlement/position data.
• Reconciliation gaps: withheld amounts not traced back to calculation snapshots and validations.

7) Next steps

• Convert this decision logic into a formal SOP or system rule backlog item.
• Build reconciliation reports that tie source data to withholding outputs and GL posting.
• Develop QA tests for both good-faith proxy and net-delta methods ahead of the 2027 transition.