Foreign Life Insurance: BEWARE

Feb 06 2016

As a U.S. citizen residing abroad you have to be particularly careful with respect to your investments and assets.  One particular “thorny” issue is that of foreign life insurance.  Specifically, life insurance issued by a non-U.S. insurance company.

The problem with foreign life insurance policies is there is an excise tax to pay every time you pay a premium on a foreign life insurance policy, annuity or accident/sickness insurance.  In addition, investments in life insurance policies are subject to reporting on Form 8938 and FinCen Form 114 (FBAR) and they are likely PFICs…which means even more reporting.  And then there’s estate tax issues.

Excise Tax

Every time you pay a premium on a foreign life insurance policy, annuity, or sickness and accident insurance, you owe an excise tax.  Code § 4371 requires three elements for the foreign excise tax to apply.  They are:

  • A policy of insurance,
  • Insurance of a United States risk, and
  • Policy issued by a foreign insurer or reinsurer

Therefore, a life insurance policy issued by a foreign insurance company on the life of a U.S. citizen qualifies for the excise tax.  The tax is 1% of the premium paid and is required to be calculated and reported on Form 720.

  • 1% of Premium Paid. A U.S. person who buys such a policy is taxed. The tax is 1% of the premium paid.

  • Form 720. You are required to file Form 720 to report the premium payment and remit your excise tax.  Every year you pay a premium.

Form 8938

Life insurance and annuity policies with cash value are reportable on this form. They are “specified foreign financial accounts”.

FinCen Form 114 (FBAR)

“But I thought the Foreign BANK Account Report was for reporting foreign BANK accounts.”  It is.  And other stuff too.  See 31 CFR § 1010.350(c)(3)(ii) if you are having a hard time sleeping.  Otherwise, click here for a helpful chart the IRS publishes regarding reportable assets.

PFIC Reporting

In some circumstances, you might have been sold a financial product that is called an “insurance policy”, but from the point of view of the U.S. tax system, it is not an insurance product at all.

If this is the case, you are treated (by the U.S. tax system) as owning an investment account full of assets. That “insurance policy” you bought will contain assets of various types, some of which are almost certainly mutual funds. Foreign mutual funds. These are Passive Foreign Investment Companies, or PFICs. This means:

  • You have to file Form 8621 to report all of the mutual funds held as part of the investment account in that insurance policy. By the way, that is a separate Form 8621 for EACH investment in a fund.  And, the IRS estimate it will only take 9 hours and 14 minutes to complete each form and send it to the IRS.  Of course, this does not include the 13 hours and 37 minutes of recordkeeping or the time spent familiarizing yourself with the law and form.
  • If, during the time the life insurance policy is active and you are alive, the insurance company buys and sells mutual funds, you will have actual taxable sales under the excess distribution rules.
  • When you die, your estate will be treated as having sold the PFICs inside the "insurance policy" for fair market value, again triggering tax under the excess distribution rules.

Estate tax

Worse yet, the death benefit when you die could be taxable.

If this is not an "insurance policy" under the definitions in the Internal Revenue Code, then you have an asset that will be subject to estate tax. The account is just an investment account with stuff in it. When you die it owns the death benefit from the insurance policy. That could be a big number -- big enough to cause estate tax problems.

Your heirs, instead of receiving cash tax-free (from the U.S. tax system, that is), will face the possibility of filing Form 706 for you, and paying an estate tax.

What do I do now?

Have foreign life insurance policies or other questions about U.S. taxation of U.S. persons abroad?  Contact us today for a free consultation.

©2017 SDC, LLC
This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult tax, legal and accounting advisors before engaging in any transaction.

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