Foreign Life Insurance IRS Rules can be difficult. Typically, when it comes to Foreign Life Insurance and Internal Revenue Service, the main issues will be involving the Taxation, Reporting & Penalties associated with Foreign Life Insurance can be severe.
Foreign Life Insurance IRS
U.S. Taxation of Foreign Life Insurance Policies involves a comprehensive and detailed analysis of the policy. In many different countries, there are various different types of life insurance policies that people purchase, which may also have an investment component to it, which may also be called “Life Assurance“
Foreign Life Taxation
Foreign Life Insurance Taxation is not easy to understand, and its impact on U.S. tax and reporting requirements are highly complex issues to evaluate. Taxation may include issues such as:
- Excise Taxes
- PFIC Issues
The reason it can be so daunting, is because oftentimes when individuals have foreign life insurance, they don’t necessarily see it as an asset, or consider that it would need to be reported on an FBAR.
For most individuals, Foreign Life Insurance is merely a type of leverage investment, wherein the investor purchases the Foreign Life Insurance Policy(s) in the earlier part of their life hoping to either cash-in during the later years (aka Annuity) — or designate a beneficiary to inherit the benefit.
- India: LIC, Prudential or ICICI – dual investment/term policies
- U.K./Isle of Mann: Friends Life policies – dual investment/term policies
- Singapore: AXA – dual investment/term policies
Different Components of Life Insurance Policies
A Foreign Life Insurance policy has different components to it. They typically include:
Foreign Life Insurance – Non-Interest Bearing Policy
If you own an overseas foreign life insurance policy that does not have a cash-out value and does not have any interest or bonus being earned on the money, then you may not need to report the policy on your FBAR – but this is not always the case. If you otherwise reported your foreign accounts and the only asset you did not report was a non-interest-bearing foreign life insurance policy that does not have a cash value or surrender value, you may be able to simply amend your prior FBAR and avoid any penalty.
*If your non-interest bearing insurance policy is being held in a foreign corporation or a foreign trust that was not previously reported, you should speak to an experienced international tax lawyer before taking any action.
Foreign Life Insurance – Income and Bonus
Foreign Life Insurance Policies in particular come in all different shapes and sizes. Some of them earn interest or payments that are categorized as “bonus” payments. Just as with a bank account, the life insurance policy earns interest on an annual basis. When a life insurance policy earns interest, it will have to be reported. In addition, when a foreign life insurance policy earns interest, then most of the time it will also have a surrender or cash-out value, since the interest or bonus is being generated off of a “Value.”
Foreign Life Insurance – Surrender Value
A Surrender Value is generally defined as what price the insurance company will pay the policyholder if there is a voluntary termination or other cancellation of the policy before it becomes due. Not all insurance policies have a surrender value, and if the insurance policy does not have a surrender value (in other words, the beneficiary of the life insurance policy will only receive a payout if the policyholder dies) then there are generally no reporting requirements under FBAR and FATCA. That is because at this moment, the policy has no value and therefore, there is nothing to report.
Potential Tax Requirements
Just because a person is not actually receiving interest income, dividends, or bonus being generated from the policy does not mean it is exempted from reporting. In other words, if you have a policy that has investment component to it and it generates income, even if it is reinvested and not distributed to you, it still must be reported.
This is where it gets very complex: whether or not your life insurance policy is considered a PFIC, and whether you actually received any distributions or not will impact whether you have to file a Form 8621 and either report the income that was distributed now (possibly) as an excess distribution, or whether you do not have to report the income now, but either may have to report it in the future under the excess distribution rules and/or whether you can make a mark-to-market election.
While the standard life insurance policy may not be a PFIC, in many countries linked to the fact that the life insurance is more of an investment vehicle than a life insurance policy or maybe other PFIC issues to contend with.
Some of the Potential Reporting Requirements
Depending on the facts and circumstances surrounding the type of investment your life insurance policy really is (e.g., how much of it is life insurance and how much it is investment) you may have other forms to file other than just reporting income.
Here’s a summary of a few of those forms:
Reporting Foreign Accounts (FBAR)
There is a lot of information online regarding the FBAR (Report of Foreign Bank and Financial Account Form) due to the extremely high penalties involved with this form. We have written countless articles, which you can find in our International Tax Library, by clicking here.
If you are a U.S. Person, it does not matter whether or not you have to file a US tax return to determine if you have to file an FBAR. The threshold question is whether you have an annual aggregate total of foreign/offshore bank accounts, financial accounts, retirement accounts, etc. that when combined, exceed $10,000. If so, you are required to file the FBAR Form and report all of the accounts.
It does not matter if the money is all in one account, or in 15 different accounts. It also does not matter if the majority of the money is in one account, with minimal amounts of money in the remaining accounts – rather, once you meet the threshold requirements, you have to report all the accounts.
Penalty: The civil penalty for willfully failing to file an FBAR can be as high as the greater of $100,000 or 50 percent of the total balance of the foreign financial account per violation. See 31 U.S.C. § 5321(a)(5). Non-willful violations that the IRS determines were not due to reasonable cause are subject to a $10,000 penalty per violation.
FATCA Form (8938)
FATCA is the Foreign Account Tax Compliance Act. For individuals, it requires reporting of financial accounts and certain specified foreign assets (ownership in businesses, life insurance, etc.). There are different threshold requirements, depending on whether a person is Married Filing Jointly (MFJ) or Married Filing Separate (MFS)/Single, and whether a person resides in the United States or outside of the United States.
Penalty: The penalty for failing to file each one of these information returns is $10,000, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000 per return.
Passive Foreign Investment Company (PFIC) or Form 8621
One of the most vilified type of financial assets/investments (from the U.S. Government’s perspective) is the infamous PFIC. A PFIC is a Passive Foreign Investment Company. The reason the United States penalized this type of investment is because it cannot oversee the growth of the investment and income it generates. In other words, if a U.S. person invests overseas in a Foreign Mutual Fund or Foreign Holding Company — the assets grows and generates income outside of IRS and U.S. Government income rules and regulations.
As a result, the IRS requires annual disclosure of anyone with even a fractional interest in a PFIC (unless you meet very strict exclusionary rules)
Penalty: The Penalties for not filing an 8621 run concurrent with the 8938 penalties (see above).
Foreign Trust (3520-A)
A Foreign Trust is another type of Foreign Investment that is frowned upon by the IRS. From the IRS’ perspective, the only purpose behind a Foreign Trust is to illegally avoid US reporting and income tax requirements by moving money offshore. While there are many people who may operate illegally in this fashion, there are various legitimate reasons why you would be a trustee or beneficiary of a Foreign Trust (Your cool grandma really loves you and placed $5 million in trust for you overseas). Form 3520-A is a relatively complex form, which must be filed annually by anybody that owns a foreign trust.
Penalty: The penalty for failing to file each one of these information returns or for filing an incomplete return, is the greater of $10,000 or 5 percent of the gross value of trust assets determined to be owned by the United States person.
Golding & Golding Resources: Form 3520-A Foreign Trust Penalties
The IRS has the right to issue excessive fines and penalties against you for failing to report. W