Foreign Life Insurance Taxation (Common Reporting Examples)

Foreign Life Insurance Taxation

U.S. Taxpayers who own foreign accounts, assets, and investments, may be required to report this information to the U.S. government each year on various international information reporting forms. Some of the more common forms taxpayers may be familiar with are the FBAR and Form 8938. While taxpayers may be aware that they are required to report investments such as bank and investment accounts, many taxpayers are surprised to learn that they are also required to file less common assets such as foreign life insurance policies. However, not all foreign life insurance policies are reportable, and it generally requires that the life insurance policy have a surrender value or cash value to be reported on forms such as the FBAR and Form 8938. In addition, there may be income tax implications for owning foreign life insurance policies. Taxpayers may also be required to file an additional Form 720 and pay a 1% excise tax on the foreign premiums paid. Let’s look at some of the more common issues involving foreign life insurance policies from a tax and reporting perspective.

*For all examples, please note that the Taxpayers are U.S. persons for tax purposes who have not made any treaty elections to be treated as a Non-Resident Alien (NRA). Also, these examples are for illustrative purposes only and Taxpayers should consult with a Board-Certified Tax Law Specialist if they have specific questions about their reporting requirements and not rely on this article for legal advice.

Income Taxes

In general, income associated with an insurance policy is taxable. If the life insurance policy distributes income, then this income would be taxable and reportable on a U.S. tax return even if the income is generated overseas. It can also depend on whether the income is vested or not. Life insurance income will oftentimes include year-over-year growth of the value of the policy, accumulated income, distributions from the policy, and certain bonus payments — presuming that the bonus is vested in the taxpayer has received the bonus as part of the insurance policy (it does not mean that the taxpayers received cash in hand, but that no additional vesting is required for the owner to access the bonus).

• • • Example:  William is a U.S. person who owns a foreign life insurance policy in Singapore. The life insurance policy pays out $5,000 a year of bonus income to William and therefore William must report this income on his U.S. tax return.

    • Example: Wendell is a U.S. person who also owns a foreign life insurance policy. His policy does not pay out any income, but there is annual growth beyond the amount of the annual premiums paid. Wendell may have to report the year-to-year income growth minus any premiums paid as income on his U.S. tax return.

    • Example:  Wendy is a U.S. person who owns a foreign life insurance policy in Malaysia. The policy does not distribute any income, but she accrues bonus of $9,000 a year. The kicker is that Wendy is not entitled to the bonus unless the policy matures through completion which is another 20 years. Since she has not actually earned the money and may never earn that money, Wendy may not have to report that income on her U.S. tax return.

FBAR and Form 8938

• • • Example:  Brian is a U.S. citizen who owns a foreign life insurance policy in Germany. The policy has a face value of $1,000,000 and a current surrender value of $400,000.  Brian May have to report the life insurance policy on both his FBAR and Form 8938.

    • Example: Brenda a U.S. Person who owns a foreign life insurance policy in Taiwan. The policy has a face value of $600,000, but there is currently no cash or surrender value for the policy. In other words, unless Brenda completes the policy to term, the policy will have no value. Brenda may not have to report this policy on her tax return because there is currently no cash or surrender value.

Form 3520

Form 3520 is not generally used to report foreign life insurance policies, because Form 3520 is used to report a foreign gift, trust, or inheritance distribution — along with ownership of foreign trusts. Technically, if a life insurance policy issues a gift to the taxpayer, then they could have a Form 3520 filing requirement, but this is not common.

Form 8621

The Form 8621 is used to report passive foreign investment companies. While a life insurance policy itself may not be considered a Passive Foreign Investment Company, the policy may own certain funds, and those funds may be considered PFIC. It is a gray area as to whether the taxpayer would parse out the insurance policy funds to report them on form 8621 or not — noting, that oftentimes the funds owned by an insurance policy are mirror funds and not technically mutual funds or ETFs and thus not technically PFIC.

• • • Example: Penelope is a U.S. person who has a foreign life insurance policy which contains funds within the policy. The insurance company confirmed the Penelope that the funds are not actively traded but rather they are mirror funds designed to mimic other funds that are available in the marketplace. Penelope may be able to take the position that these are not PFIC.

    • Example:  Peter is a U.S. person who has ownership of a foreign life insurance policy. Peter tries to inquire with the insurance company as to whether his investment has PFICs, but they refuse to provide Peter with sufficient information necessary to report the life insurance policy as a PFIC. Peter may still consider filing a Form 8621 for the policy as a whole, that but that may be taking a big leap of faith that the policy has PFIC and since PFIC can result in significant tax implications, Peter should consult with the specialist first.

    • Example: Paul is a U.S. person who has ownership of a foreign life insurance policy. Paul contacts the insurance policy company, and he confirms that while there are various bonds and stocks within the investment there are no funds held within the life insurance policy. Presumably, Paul would not have to file a Form 8621 (typically, the life insurance policy itself will not be considered a PFIC because it will not meet the technical definition of PFIC).

Form 720

Taxpayers who make payments to foreign life insurance policies for premiums may be required to file a form 720 to report the premium payments to the IRS and pay a 1% excise tax on the value of the annual premiums.

Late Filing Penalties May be Reduced or Avoided

For Taxpayers who did not timely file their FBAR and/or other international information-related reporting forms, the IRS has developed many different offshore amnesty programs to assist Taxpayers with safely getting into compliance. These programs may reduce or even eliminate international reporting penalties.

Current Year vs. Prior Year Non-Compliance

Once a Taxpayer missed the tax and reporting (such as FBAR and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, Taxpayers should consider speaking with a Board-Certified Tax Law Specialist who specializes exclusively in these types of offshore disclosure matters.

Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)

In recent years, the IRS has increased the level of scrutiny for certain streamlined procedure submissions. When a person is non-willful, they have an excellent chance of making a successful submission to Streamlined Procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead. But, if a willful Taxpayer submits an intentionally false narrative under the Streamlined Procedures (and gets caught), they may become subject to significant fines and penalties. 

Need Help Finding an Experienced Offshore Tax Attorney?

When it comes to hiring an experienced international tax attorney to represent you for unreported foreign and offshore account reporting, it can become overwhelming for Taxpayers trying to trek through all the false information and nonsense they will find in their online research. There are only a handful of attorneys worldwide who are Board-Certified Tax Specialists and who specialize exclusively in offshore disclosure and international tax amnesty reporting. 

*This resource may help Taxpayers seeking to hire offshore tax counsel: How to Hire an Offshore Disclosure Lawyer.

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, specifically IRS offshore disclosure. 

Contact our firm today for assistance.