US Tax Implications of Foreign Life Insurance

The U.S. tax code contains excellent tax benefits for U.S. (domestic) life insurance companies, and the owners of their life insurance policies. However, for U.S. citizens and U.S. residents to obtain those tax benefits with respect to a foreign life insurance policy, the foreign policy must qualify as a “life insurance policy” for U.S. income tax purposes under section 7702 of the U.S. Internal Revenue Code. If the foreign policy does not qualify under section 7702, the U.S. owner of the policy may owe U.S. tax annually on the income buildup inside the policy.  Section 7702 applies 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.

The U.S. rules that determine what qualifies as a life insurance policy for U.S. tax purposes are rigorous, so it generally requires an actuarial and/or legal analysis to make a determination. It is likely that many foreign life insurance policies do not constitute life insurance policies for U.S. income tax purposes.

If any contract which is a life insurance contract does not meet the definition of life insurance contract under section 7702, the excess of the amount paid by the reason of the death of the insured over the net surrender value of the contract shall be deemed to be paid under a life insurance contract for purposes of section 101.

IS YOUR FOREIGN LIFE INSURANCE POLICY A PFIC?

It is important to know if his/her ownership interest in the foreign life insurance policy is treated under U.S. tax law as being an ownership interest in the insurance company itself. If so, the owner may be treated as owning a PFIC. The ownership of a PFIC by a U.S. individual may result in adverse current annual U.S. income tax consequences, as well as adverse U.S. income tax consequences on the death of the owner. For example, any actual or deemed disposition of a PFIC during lifetime, possibly including relinquishing U.S. citizenship or U.S. residency, gifting the policy, or even pledging the policy for a loan, may result in adverse U.S. income taxation under the excess distribution regime. Further, the death of the policy owner may also trigger a deemed disposition and result in adverse U.S. income taxation under the excess distribution regime. See IRC 1291(a) and Proposed Treasury Regs.§1.1291-3(b)(2) and §1.1291-3(b)(1).

The owner’s interest in the foreign insurance company will not be treated as a PFIC, if the entity is:  A “qualifying insurance corporation”, and It derives its income in the active conduct of an insurance business. IRC §1297(b)(2)(B)

Some foreign insurance companies issue insurance contracts “products”, that may be called wealth insurance contracts, capital insurance contracts, or even life insurance contracts, which an individual uses to own his/her investments. When these contracts are not compliant with section 7702 they are often referred to as “insurance wrappers”. The policy is intended mainly for investment (and perhaps tax) purposes, but not primarily for life insurance purposes. Accordingly, any U.S. person who owns such a policy may be subject to annual U.S. income tax on the income on the contract, like any other investment, including PFIC treatment.

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