ULIP & PFIC – Is a Unit-Linked Insurance Policy a PFIC?
ULIP & PFIC: Is a Unit-Linked Insurance Policy a PFIC? The concept of a PFIC is already difficult. And, by adding the concept of a foreign ULIP (Unit-Linked Insurance Plan) to the PFIC equation — the analysis can become infinitely more complex.
Technically, a PFIC is a Passive Foreign Investment Company. The purpose of the PFIC rules are anti-deferral in nature – which means to avoid U.S. persons from deferring foreign income and corresponding U.S. tax liability.
The ULIP is a Unit-Linked Insurance Plan). The concept of a ULIP is to correlate insurance premiums and investment funds, to create a hybrid insurance policy and investment plan.
ULIP & PFIC Analysis
Just because a ULIP has a foreign passive investment income component, does not per se make it a PFIC. Rather, each investment has to be analyzed separately.
Some common examples, include:
Friends Life (aka Aviva)
Personal Pension in the UK or UK Offshore, such as Guernsey.
It generally will contain funds and shares, so at the end of the day, this may be considered a PFIC.
These are common life insurance policies, but they are not necessarily linked to an investment per se. There many flavors (linked and non-liked) and while some tend to take the shape more of “Life insurance” with some accrued interest — others are more investment focused linked insurance policies.
India LIC or Prudential
These may or may not have an investment component to it.
They can vary greatly depending on the type of policy.
When a U.S. Person is invested in these types of policies, and subject to U.S. Tax, they are referred to as “Expat Life Insurance.”
Expat Life Insurance Policies
There are many different types of policies, but some of the more common policies for U.S. Person Expats.
- Friends Life
Some of the more common countries in which U.S. Person expats purchase overseas life insurance, include:
- The United Kingdom
- Hong Kong
How to Determine if PFIC Rules Apply?
If the PFIC meets either the passive asset test, or passive income test, it will be classified as a PFIC. If the IRS classified the foreign investment company as a PFIC, the tax and reporting rules become much more complicated.
We are providing you a basic summary of PFIC tax and reporting.
First, it is important to understand what a PFIC is. Technically, a PFIC is a Passive Foreign Investment Company:
By passive, the rules are referring to investment income (such as dividends) vs. earned income (such as employment)
Foreign refers to the fact that the company is “foreign-based.”
By investment, it means the foreign company must operates as an investment company, such as a BVI holding company.
The ownership must be an entity in order to qualify as a PFIC.
Is Your ULIP a PFIC?
In order to qualify as a PFIC, the company must meet either the asset or investment test:
75% or more of the corporation’s gross income for its tax year is passive income (as defined in section 1297(b)).
At least 50% of the average percentage of assets (determined under section 1297(e)) held by the foreign corporation during the tax year are assets that produce passive income or that are held for the production of passive income.
How to Report the ULIP?
PFIC reporting primarily involves filing an annual IRS Form 8621. Taxpayer files an 8621 form in any year in which the taxpayer either meets the threshold filing requirements (based on the value of the PFICs) or has an excess distribution.
ULIP & PFIC Filing Requirements
The PFIC Filing Requirements are determined by the aggregate value of all PFIC in a reportable year and by the total income generated by the PFICs.
PFIC Tax Treatment
The PFIC regime is incredibly complex. In order to try to boil it down to its barest form, we have prepared a simple example (noting, this example is for conceptual purposes only.)
Example: David has a moving box, and in the box is a mutual fund.
While the investment grows within the box, it is not taxed.
- Once the investment is taken out of the box, it becomes taxable.
- The first distribution is the worst, because it is an excess distribution (unless within the 1st year of investment)
- The excess distribution is taxed as the highest tax rate available (including interest).
- The next year, an excess distribution calculation is performed to allocate excess vs. non-excess
- Excess is taxed at the maximum tax rate, except the current year, which is taxed at the progressive tax rate.
- Non-excess distribution is (generally) taxed under non-PFIC rules.
Electing out of PFIC Tax Treatment
The IRS permits the owners of PFICs to make certain elections to reduce or minimize tax liability. Most people do not make these elections, because it is difficult to get the foreign investment fund to comply, in addition to the fact that most individuals do not want the information reported to the IRS – aka “Why they made the foreign investment to begin with”
Essentially, there are two types of elections that can be made: Qualified Elective Fund or Mark-To-Market. Each election comes with its own set of pros and cons, and before making any such election you should speak with a qualified international tax lawyer to evaluate the facts and circumstances of your case, along with whether you have been in compliance with reporting responsibilities of having a PFIC in prior years.
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