Foreign Life Insurance Taxation: Policy FBAR & 8938 Filing
Foreign Life Insurance & IRS FBAR Filing: In many foreign locations such as Hong Kong, Singapore, Jersey, Isle of Man and France, hybrid life insurance/investment vehicles are common types of investments. These types of policies are usually a hybrid of a traditional life insurance policy combined with an active investment component and reportable to the IRS and FinCEN. Oftentimes, you may see the policy referred to as life assurance (such as an Assurance Vie in France or Luxembourg) or ULIP (Unit-Linked Insurance Policy). The complexity in the U.S. tax and reporting arises because in many foreign countries, the earnings within the policy accrue tax free. Unfortunately, the U.S. usually does not recognize the tax-free growth. If the policy is within (or attached to) a retirement plan, such as an Australian Superannuation, the income may be deferred in accordance with the tax treaty laws (if any) between the U.S. and source country on matters involving foreign pension in general — but that is no always the case.
Tax Treatment of Foreign Life Insurance
Let’s review the basics of how foreign life insurance is treated in the U.S.:
Inside Income Build-up “Growth” & U.S. Tax
Under most circumstances, the growth within a foreign life insurance policy is taxable.
For example, if a life insurance policy contains investments, and those investments accrued dividends, capital gain, royalties, or bonus – then that income growth is going to be taxable in the year it was accrued (subject to PFIC rules identified below).
Distributions & U.S. Tax
When income is distributed, that income is going to generally be taxable – even if it is exempt overseas.
To clarify, if income is distributed in 2019, then that income is taxed to the U.S. taxpayer on their 2019 tax return.
When the income is not distributed, then the IRC 7702 rules may apply, but the PFIC rules may trump (or supplement) the immediate taxation laws – especially in the case of when the underlying assets have some PFICs, but are not all PFIC.
Death Benefit & Foreign Life Insurance Taxation
Depending on the type of foreign life insurance policy at play, if it is a traditional life insurance policy then the death benefit paid out to the beneficiary may not be taxable — similar to how a death benefit paid out to a US life insurance policy is not taxable either.
Form 720 Excise Tax
If the taxpayer is making premium payments to a foreign life insurance policy, then they will have to pay 1% excise tax on the premium.
For example, if the taxpayer pays $10,000 in foreign life insurance premiums (USD), 1% would be $100.
Taxpayer reports the excise tax on form 720, and it is filed quarterly.
IRC 7702 & Foreign Life Insurance Taxation
Here is where it gets unnecessarily hard.
Foreign Life Insurance Taxation is further complicated by Internal Revenue Code section 7702. IRC 7702 tends to kick in when the foreign life insurance policy more closely resembles an investment vehicle than a traditional life insurance policy, and the U.S. then may require tax on the increase in value.
But, when the attached investments involve PFIC (passive foreign investment companies) such as foreign mutual funds, SICAV and ETF (or equivalent) it may impact the immediate taxation of the income associated with the PFIC funds and further complicate reporting.
Even further complicating the issue is when the funds are mirror funds. Insurance mirror funds are policy funds designed to mirror an outside mutual fund(s) — that may seem like a PFIC, but may not meet the technical requirements of a PFIC.
FBAR Reporting Foreign Life Insurance & More
The second aspect to foreign life insurance policies are the reporting requirements.
Even though technically most taxpayers do not consider a foreign life insurance policy as either an account or an “asset,” it is reportable on most of the well-known international information reporting forms identified below.
The failure to report foreign life insurance may result in fines and penalties, but most of these can be avoided, minimized, or abated with the IRS offshore voluntary disclosure/tax offshore amnesty programs.
FBAR is the Foreign Bank and Financial Account Form, otherwise known as FinCEN Form 114.
If the foreign life insurance policy has a surrender or cash value, then the current year surrender or cash value (not the future payout value) is generally required to be included on the FBAR.
FATCA Form 8938
FATCA is the Foreign Account Tax Compliance Act.
Taxpayers who are required to file tax returns and meet the threshold requirements for reporting will also include the surrender or cash value of their foreign life insurance policy on IRS Form 8938.
PFIC Form 8621
PFICs are the Passive Foreign Investment Company rules (Form 8621), and the rules are very complicated.
In a nutshell, if the underlying assets of the foreign life insurance policy are considered to be PFIC, then much a more complicated tax reporting may be required.
This is especially true if passive income is being distributed out of the investment and considered “excess distributions.”
Pension Trust Form 3520
Form 3520 and 3520-A are used to report foreign trusts and gifts.
Generally, a foreign life insurance policy is not included on form 3520/3520-A as a trust.
But, if a U.S. person receives a gift of a foreign life insurance policy from a foreign individual or entity — and the value exceeds the threshold filing value for that year — then the 3520 form may be required.
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