Life Insurance And 8938: What's The Connection?

Foreign life insurance policies are reportable on Form 8938, but the requirements are complex. Introduced in 2011, Form 8938 is an international reporting form that must be included with a US tax return when filers have certain specified foreign financial assets and meet the threshold requirements for filing under FATCA (Foreign Account Tax Compliance Act). While a foreign life insurance policy is not considered a deposit account for Part I of the form, it could be considered a Foreign Financial Asset for Part II if the policy has a cash surrender value. The surrender value, rather than the face value, is reported on Form 8938.

Foreign life insurance policies and FATCA reporting

FATCA Reporting Requirements

FATCA, or the Foreign Account Tax Compliance Act, requires individuals to report their foreign financial assets and income to the IRS. This includes reporting the surrender or cash value of foreign life insurance policies on Form 8938. The requirement to report foreign life insurance policies on Form 8938 came into effect in 2011 when individuals filed their 2011 tax returns.

Who Needs to File Form 8938?

US persons, including US citizens, legal permanent residents, and foreign nationals meeting the substantial presence test, are required to report their worldwide income if they are already required to file a US tax return. This means that even income earned overseas or income that is not distributed or taxable in the country of origin must be reported.

Reporting Thresholds

Form 8938 has different reporting thresholds depending on the person's residency status and marital status. For example, a single person residing in the US (or married and filing separately) must file Form 8938 if their foreign assets exceed $50,000 on the last day of the year or exceed $75,000 at any time during the year. On the other hand, married individuals filing jointly and residing overseas have a higher threshold of $400,000 on the last day of the year or more than $600,000 at any time during the year.

Reporting on FBAR vs Form 8938

While foreign life insurance policies must be reported on Form 8938, they may also need to be reported on an FBAR (FinCEN Form 114). The FBAR is a separate form used to report foreign bank and financial accounts. The reporting requirements for FBAR are different from Form 8938, and the thresholds for reporting depend on the type of account and the person's relationship to the account. For example, a foreign life insurance policy with a surrender or cash value generally needs to be included on the FBAR.

Reporting Income and Distributions

The income generated from foreign life insurance policies, such as dividends, capital gains, royalties, or bonuses, must be reported as taxable income on the individual's tax return for the year it was accrued. When income is distributed, it is generally taxable, even if it is exempt from tax overseas. If the income is not distributed, the IRC 7702 rules may apply, and the increase in value may be subject to tax.

Passive Foreign Investment Companies (PFIC)

Some foreign life insurance policies may include a Passive Foreign Investment Company (PFIC) component, such as foreign mutual funds or ETFs. PFICs have complex reporting and taxation rules. If the underlying assets of the foreign life insurance policy are considered PFICs, additional reporting on Form 8621 may be required, and excess distributions may be subject to immediate taxation.

Death Benefits and Excise Tax

Death benefits paid out to beneficiaries from traditional life insurance policies may not be taxable, similar to US life insurance policies. However, if a taxpayer is making premium payments to a foreign life insurance policy, they may have to pay a 1% excise tax on the premium, reported on Form 720.

Compliance and Penalties

The IRS takes an aggressive position on foreign accounts compliance and unreported offshore income. Failure to report foreign life insurance policies and income can result in significant fines and penalties. However, these penalties may be reduced or avoided through voluntary disclosure programs, especially if the failure to report was non-willful.

FBAR reporting for foreign life insurance

The Foreign Account Tax Compliance Act (FATCA) requires individuals to report their foreign financial assets, including foreign life insurance policies, on Form 8938. Introduced in 2012, the form must be filed with an individual's tax return.

The FBAR (Foreign Bank and Financial Accounts) rules for reporting foreign life insurance policies are complex. The IRS considers foreign life insurance policies as foreign accounts, and requires US person owners of such policies to report them annually on an FBAR.

The FBAR reporting revolves around the surrender value of the policy. If a foreign insurance policy does not have a surrender or "cash" value, it may not need to be reported. The surrender value is the current "cash" value of the policy that the owner can get if they were to surrender the policy.

If the foreign life insurance policy has a surrender or cash value, then the current year's surrender or cash value (not the future payout value) is generally required to be included on the FBAR. This value is also reported on Form 8938 (FATCA) and Form 720.

Foreign life insurance policies that are "unit-linked" and include an investment component may be designated as a PFIC (Passive Foreign Investment Company), requiring additional reporting on Form 8621.

The failure to report foreign life insurance may result in fines and penalties, but these can often be avoided or reduced through IRS offshore voluntary disclosure/tax amnesty programs.

Surrender value of foreign life insurance policies

Foreign life insurance policies are often more of an investment than a death benefit policy. They are popular investment vehicles in many countries, including the UK, Singapore, India, France, and Australia. These policies are typically a hybrid of a traditional life insurance policy and an active investment component. The earnings within these policies accrue tax-free in many countries, but the US does not usually recognise this tax-free growth.

The surrender value of a foreign life insurance policy is the current "cash" value of the policy. In other words, it is the value that the owner of the policy would receive if they were to surrender or turn in the policy to the insurance company. This is different from the face value of the policy, which is the payout at the time of the resulting event.

The surrender value of foreign life insurance policies must be reported on the FATCA Form 8938. This requirement came into effect in 2011, and it applies to individuals who are considered US persons and are required to file a US tax return. The reporting threshold for Form 8938 varies depending on the filer's residency status and marital status. For example, the baseline threshold for a single person residing in the US is $50,000 on the last day of the year, while for a married couple filing jointly and residing overseas, the threshold is $400,000.

It is important to note that the failure to report foreign life insurance policies on Form 8938 can result in significant fines and penalties. Additionally, the IRS has taken an aggressive position on matters involving foreign accounts compliance, so it is crucial for individuals with foreign life insurance policies to ensure they are meeting the reporting requirements.

Compliance and penalties

Compliance with FATCA (Foreign Account Tax Compliance Act) is important to avoid offshore fines and penalties. Introduced in 2011, Form 8938 is an information-only report of a US person's ownership of specified foreign financial assets. This includes foreign life insurance policies with a cash value.

The failure to report foreign life insurance may result in fines and penalties, but most of these can be avoided, minimized, or abated with the IRS offshore voluntary disclosure/tax offshore amnesty programs. If you are out of compliance for not filing the current year and/or prior-year returns and Form 8938, you could be subject to hefty fines and penalties. The IRS has approved certain offshore voluntary disclosure programs which can significantly reduce or eliminate international reporting penalties.

The penalty for not reporting assets on Form 8938 starts at $10,000 for failure to disclose and an additional $10,000 for every 30 days of non-filing after an IRS notice, up to a maximum of $50,000. If you have underpaid your taxes due to an omission of taxable income related to foreign financial assets, you may be subject to a 40% understatement penalty on the underpaid tax. In certain cases, criminal charges may apply if non-compliance is found to be intentional.

If you are married and you and your spouse file a joint income tax return, the failure-to-file penalties apply as if you and your spouse were a single person. Your and your spouse's liability for all penalties is joint and several. If you are required to file Form 8938 but do not file a complete and correct form by the due date (including extensions), you may be subject to a penalty of $10,000. If you do not file a correct and complete form within 90 days after the IRS mails you a notice of failure to file, you may be subject to an additional penalty of $10,000 for each 30-day period (or part thereof) during which you continue to fail to file Form 8938 after the 90-day period has expired. The maximum additional penalty for a continuing failure to file is $50,000.

If the IRS determines that you have an interest in one or more specified foreign financial assets and asks you for information about the value of any asset, but you do not provide enough information for the IRS to determine the value of the asset, you are presumed to own specified foreign financial assets with a value of more than the reporting threshold that applies to you. In such a case, you are subject to the failure-to-file penalties if you do not file Form 8938. No penalty will be imposed if you fail to file Form 8938 or to disclose one or more specified foreign financial assets on Form 8938 and the failure is due to reasonable cause and not willful neglect. You must affirmatively show the facts that support a reasonable cause claim.

Under Internal Revenue Code Section 7203, the intentional (willful) failure to file a required Form 8938 can, if successfully prosecuted, result in a prison sentence of up to one year and a penalty (for individuals) of up to $25,000. Under IRC 7206, any person who filed a Form 5471 filing that was fraudulent or false may, if successfully prosecuted, be sentenced to up to three years in prison and face a penalty (for individuals) of up to $100,000.

International tax lawyers

Form 8938, introduced in 2012, is a requirement by the Internal Revenue Service (IRS) for individuals with certain specified foreign financial assets. It is part of the Foreign Account Tax Compliance Act (FATCA) and must be filed along with an individual's tax return. The form aims to ensure that individuals with foreign assets disclose them to the IRS.

Now, when it comes to foreign life insurance policies, the reporting requirements can be complex. Firstly, it's important to understand that a foreign life insurance policy with a surrender or cash value is generally considered reportable. This means that if an individual has the option to sell their policy before it reaches maturity, they must report the surrender or cash value on Form 8938. The failure to do so can result in significant fines and penalties.

The calculation of the value to be reported on Form 8938 is not based on the face value of the policy but on the surrender or cash value. The face value refers to the future payout upon a resulting event, while the surrender value is the amount the policy owner can get if they surrender the policy at the current time.

For example, let's say David purchased a foreign life insurance policy with a face value of $1,000,000 and pays $2,000 in annual premiums. After a decade of payments, David can surrender the policy for $25,000. In this case, the $25,000 surrender value, not the face value, is what needs to be reported on Form 8938.

In addition to the value, there are key pieces of information that must be reported on Form 8938, including income generated and the type of income (royalties, interest, dividends, bonus, capital gains, etc.). It's worth noting that if the foreign life insurance policy has underlying assets that are considered Passive Foreign Investment Companies (PFICs), the reporting and tax computation become more intricate.

Furthermore, international tax lawyers provide valuable expertise in navigating the tax treatment of foreign life insurance policies. They advise on the tax implications of income distributions, the applicability of IRC 7702, and the potential impact of PFIC rules. By seeking their counsel, individuals can ensure they meet their reporting obligations and avoid unnecessary fines and penalties.

Frequently asked questions