What You Need to Know About How the US Treats Foreign Life Insurance Policies
March 20, 2022
Life insurance provides many income tax benefits, such as death benefits usually being paid out tax-free and a total cash value that can accumulate on a tax-deferred basis. Holders of US (domestic) life insurance policies receive these and many more wonderful tax benefits automatically. However, for US citizens and legal and/or tax residents who may own foreign life insurance policies, the tax advantages, and reporting requirements are not so cut and dried.
In order for a foreign written life insurance policy to be treated the same as a domestic life insurance policy from a taxation standpoint, the foreign policy must qualify as a “life insurance policy” for US income tax purposes under section 7702 of the US Internal Revenue Code. If the foreign policy does not qualify under section 7702, the US owner of the policy may owe US tax annually on the income buildup inside the policy.
The US rules that determine what qualifies as a life insurance policy for US tax purposes are quite rigorous, so it generally requires an actuarial and/or legal analysis to make a determination. It is likely that many, perhaps most, foreign life insurance policies do not constitute life insurance policies for US income tax purposes. The cost of evaluating whether any specific policy qualifies under US tax law may be sufficiently high that it encourages some individuals to simply assume their foreign policy does not qualify under US tax law.
If the foreign insurance policy is not an insurance policy under the applicable law, or if it is an insurance policy under the applicable law but does not qualify as an insurance policy under the rules of section 7702, the US owner must generally report the “income on the contract” annually on his/her US income tax return, as ordinary income.
In addition, the IRS levies a 1% excise tax on the foreign life insurance premiums that you pay each year. The tax is submitted along with IRS Form 720 and is submitted quarterly to the IRS. Therefore, for each year that you pay foreign life insurance premiums, you would submit four (4) Form 720s (one for each quarter).
Furthermore, the IRS and FinCEN require the owners of foreign life insurance policies to disclose the policy information each year and include income the policy generates. While there may be penalties for not properly disclosing the information, the IRS provides various amnesty programs to safely get into compliance.
How AbitOs Can Help
There can be significant ramifications to consider from a taxation standpoint for US holders of foreign life insurance policies.
You can take a deeper dive into the income tax implications of foreign life insurance by reading our full report on the matter here.
The U.S. rules that determine what qualifies as a life insurance policy for U.S. tax purposes are quite rigorous, so it generally requires an actuarial and/or legal analysis to make such a determination. Our international tax experts will be happy to analyze any foreign life insurance policies you may own and make sure you are in complete compliance with US tax law while maximizing your benefits and minimizing your US tax liabilities.
AbitOs specializes in the unique accounting needs of high net-worth individuals with international lifestyles as well as for entities doing business in LATAM and across the globe. Complying with the tax implications of foreign life insurance policies can be quite complex. If you would like to benefit from our expertise in these areas or if you have further questions on this Alert, do not hesitate to contact us.