Taxation of Foreign
Life Insurance
By Vernon K. Jacobs, CPA 
& J. Richard Duke, J.D., LLM		 Offshore Tax Strategies

 
Tax Rules For International Investing - Foreign Life Insurance
 

The general rule for investing in foreign life insurance contracts is that the tax treatment for a U.S. investor is substantially the same as a life insurance contract issued by a U.S. insurance company -- but only if the foreign policy contains provisions that comply with the U.S. law definition of life insurance. Basically, amounts earned by the cash value of a life insurance policy will accumulate, tax deferred,  until the policy is surrendered. At that time, the amount in excess of the total premiums paid would be taxable as ordinary income. However, if the policy remains in force until your death and the face amount is paid to your beneficiary, the benefit is generally not taxable as income to the beneficiary.

If the policy is not a modified endowment contract (MEC), the policyowner can borrow against the cash value without paying a tax on the amount of the loan. Generally, a life insurance contract that requires a minimum of seven or more equal annual premium payments will not be a MEC. A single premium life insurance policy is a MEC and the tax treatment will be similar to an annuity contract. Loans against a MEC policy will be taxed like annuity distributions.

The face value of a life insurance policy that is paid to a named beneficiary will normally be included in the gross estate of the policyowner and insured and will be subject to estate taxes if the estate is larger than the lifetime estate tax exemption. This result occurs when the insured is also the owner of the policy and has the power to surrender the policy, to exchange the policy or to change the beneficiary. If the policy is owned by the beneficiary - or by a trust in which the heirs are  beneficiaries - then the policy face amount (the death benefit) will usually not be included in your estate.

One key difference between a foreign life insurance policy and a domestic policy is that there is an excise tax on the premiums paid to a foreign life insurance. The tax is 1% of the amounts paid to the foreign company and it must be paid with a quarterly return (Form 720) that is intended for an assortment of excise taxes. A treaty with Switzerland exempts Swiss life insurance policies from this excise tax. However, use of the treaty to avoid payment of the excise tax requires that the policyowner include Form 8833 with his or her tax return in each year when premium payments are made.

Until the 1997 Taxpayer's Relief Act, it was legal to make a tax deferred exchange of a U.S. life insurance contract for a foreign life insurance contract. The 1997 law included a provision that some commentators believe prohibits tax free exchanges of life insurance or annuity contracts from a U.S. to a foreign insurer. Section 1131(b)1(c)(1) of the 1997 act amended IRC Section 1035(c) by changing it to read:

Subsection (a) is the section that permits a tax free exchange of life insurance and annuity policies.

One commentator has pointed out that this rule does not apply until the IRS issues regulations, which they haven't done at this time. Another commentator believes that the term property does not include policy cash values, but we find it difficult to agree with that in light of the reference to the code section that explicitly permits tax deferred exchanges of policy cash values. Until the IRS gets around to issuing regulations or rulings on this provision, there will be some dispute and uncertainty about it.   
 


The preceding comments are a very brief and non-technical summary of the key tax rules that apply to a person who is a citizen of another country and is not a permanent resident of the U.S. This information is an excerpt from Offshore Tax Strategies, by Vernon Jacobs and Richard Duke.
  About the authors:

Vernon Jacobs is a CPA who provides tax accounting and consulting services for clients with international interests.   J. Richard Duke, JD, LLM is an attorney who specializes in international tax law and is an Adjunct Professor of international tax law.


Sponsored by Offshore Press, Inc. Copyright, 2006, All rights reserved. Offshore Press, Inc., Box 8194, Prairie Village, KS 66208. (913) 362-9667. Email to Offshore Press  Vernon K. Jacobs, Webauthor.