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OOOps! Excise Taxes Count Toward 5 Years of Expatriation “Tax Compliance”

Many US persons living abroad have foreign life, sickness or accident insurance or a foreign annuity. Yet, only a handful have any knowledge of the US Foreign Insurance Excise Tax provisions affecting these policies.  A significant problem lies in wait for US persons who are “expatriating” when they lack knowledge of the excise tax rules.  As used in this post, expatriating refers to giving up one’s US status whether by relinquishing US citizenship or, a green card held for a certain number of years (generally 8 tax years out of the past 15 tax years).  An individual can inadvertently become a“covered expatriate” unless he or she has met their US tax obligations, including excise tax obligations, with regard to these policies.

Who is a “Covered Expatriate”?

A “covered expatriate” is an individual who was a former US citizen or long-term permanent resident if the individual met certain requirements at the time of his “expatriation”.

Generally , an individual will qualify as a so-called “covered expatriate” if he meets any one of the following conditions:

  • The individual’s average annual net income tax liability (this means, tax paid) for the 5 years ending before the date of expatriation is more than a specified amount that is adjusted for inflation (for 2018, the amount is over $165,000). Remember, this means his average income tax paid, not his income.
  • The individual’s net worth is $2 million or more on the date of expatriation. Remember this is based on the fair market value of WORLDWIDE assets; this amount is not indexed for inflation.
  • The individual fails to certify on Form 8854 that he or she has complied with all US federal tax obligations for the 5 years preceding the date of expatriation.

Internal Revenue Code Section 877A(g) (referencing Section 877) makes clear that in order for an individual to be fully tax compliant for the 5 years preceding expatriation, it means the individual has met the requirements “of this title”.  The “title” referred to is Title 26 of the United States Code. The United States Code is the official compilation and codification of the general and permanent federal statutes of the US. It contains 53 “titles”.  Title 26 is the portion of the United States Code in which the US Internal Revenue Code is contained.

The excise tax provisions are part of Title 26 of the US Code. If the expatriate was required to comply, but has not complied with the excise tax provisions, he or she can fall into the trap of being a “covered expatriate”.

Foreign Life Insurance, Annuities and other Foreign Policies Subject to Excise Tax

Generally, an excise tax of 1% is imposed on premiums paid for foreign life insurance, sickness or accident insurance or for a foreign annuity contract when the same is issued with respect to a US citizen or resident.  See Internal Revenue Code Sections 4371 and 4372.  Thus, if a US citizen takes out a foreign life insurance policy and pays $5,000 in premiums annually, he must pay the IRS an excise tax of $50 each year.

Under Section 4372(e), the term ‘‘policy of life, sickness, or accident insurance, or annuity contract’’ means any policy or other instrument by whatever name called whereby a contract of insurance or an annuity contract is made, continued, or renewed with respect to the life or hazards to the person of a citizen or resident of the United States.

Foreign Casualty Insurance

Casualty insurance is subject to a 4% excise tax. With regard to casualty insurance the foreign policy must insure against, or with respect to, hazards, risks, losses, or liabilities within the United States. For example, a foreign entity’s insurance against destruction of a building located within the United States would meet this test for taxability. However, casualty insurance of a building physically located in Germany would not meet the location test for taxability.  Obviously, the location of the risk plays a key role in determining whether a policy is subject to the foreign insurance excise tax. There is a distinct difference as to the location of risk requirement between domestic and foreign insureds. However, determining where the location of the risk is (i.e., within or outside of the United States) is sometimes less clear. Various rulings and cases provide guidance on some of these issues, but are beyond the scope of this blog posting.

The relevant form for payment of these excise taxes is Form 720See Part 1, IRS # 30 (on p 1). The excise tax is reported quarterly on this form.

Has Another Party Paid the Excise Tax?

Liability for the excise tax is joint and several among various parties, including the broker and the foreign insurance company. If the excise tax already has been paid for a premium, then the US person need not pay it again.  The broker who placed the policy with the insurance company would likely know if the tax was paid and inquiry of the broker would be a good place to start.

Tax Treaty May Eliminate or Reduce the Excise Tax

In some cases, the excise tax may be reduced or eliminated by treaty. See the table below.

When a tax treaty is used to justify non-payment of a tax or the non-filing of a return, the taxpayer is required to file Form 8833 – Treaty Based Returns Position Disclosure.  Many tax treaties with a qualified exemption contain an anti-conduit’ provision which can eliminate the excise tax exemption if the foreign insurer reinsures the risks with another entity that itself would not be entitled to an excise tax exemption under a treaty with the United States.  In other words, if an insurer located in a qualified treaty country reinsures with a reinsurer located in a non-treaty country, the excise tax exemption is lost to the extent of the amount reinsured and the amount of premium payment which was reinsured is then subject to excise tax.  This rule prohibits the qualified treaty country insurer from acting as a straw man or kind of “front” for non-exempt country insurers.

More information from the IRS available here.

Countries Having Treaty Exemptions with the United States are:

Treaty Country Effective Date Treaty Country Effective Date
Cyprus 1-1-86 Japan 1-1-05
Finland 1-1-91 Luxembourg 1-1-01
France 2-1-96 Mexico 1-1-94
Germany 1-1-90 Netherlands 1-1-94
India 1-1-91 Spain 1-1-96
Ireland 1-1-98 Sweden 1-1-98
Israel 1-1-95 Switzerland 1-1-98
Italy 1-1-85 United Kingdom 1-1-04*

 

Information Reporting FBAR (FinCen Form 114) / Form 8938

Having foreign insurance policies means additional US tax burdens and potential penalties for improper tax filings. In addition to the excise tax rules, don’t forget that information reporting may be required with regard to such assets. Foreign life insurance and foreign annuities having a cash surrender value are treated as financial accounts and must be filed on a so-called FBAR; they must also be reported on Form 8938, assuming the threshold for filing these forms is otherwise met.

Learn more about FBAR and FinCen Form 114 here and here.

Learn more about Form 8938 in my earlier blog post here.

See IRS comparison chart for FBAR and Form 8938 here.

 

All the US tax information you need, every week — Just follow me on Twitter @VLJeker (listed in Forbes, Top 100 Must-Follow Tax Twitter Accounts 2017 and 2018)

 


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