IRS and Foreign life insurance and OVDP implications


A few months back, I had a client with a number of foreign life insurance policies from India. The information available from the client regarding their various plans was sparse. Foreign life insurance plans are considered non-qualified insurance by the IRS, and as such, taxpayers are required to calculate and pay tax on what the IRS deems to be “income on the contract." It's not a very well known obligation for foreign filers, and neither professional tax software like ProSeries nor CCH have tools built in for calculating the tax liability on foreign life insurance. Not taking this into account can be a big problem when taking part in an OVDP program.


In order to find out what taxes are owed, you have to use either the cost of each individual policy based on a table prescribed by the IRS or by determining the mortality charge each insurance company assigns to a given policy. Long story short, without the proper tools, it can be a nightmare getting everything sorted.


Making sense of nonsense

Though the IRS has prescribed cost of insurance rates for group-term life insurance, a similar table for individual life insurance has yet to be created. Unfortunately for most people, this means that they don't have any idea what they owe. Is this an unfair reality? Yes, it definitely is.


Insurance companies are not always forthright in disclosing the mortality charge, as a) it gives their customers a look at exactly what percentage of their premiums are actually going towards insuring their life, and b) there isn’t any real reason for it to be disclosed outside of compliance with IRS requirements (which, for many of these foreign insurance providers, is not high on their list of priorities). The sad reality is that this means many taxpayers with foreign insurance aren’t provided with all the information necessary to comply with the IRS’s income tax requirements.


If there's no trail, blaze your own

In the case of my particular client, there were a number of life insurance policies with highly varied terms. I conducted my own outside research into the specific terms of each plan, and in doing so, I was able to compile the information that wasn’t available from the statements from the insurance company, including the mortality charge.


I wanted to streamline the process going forward, so I created a template in Excel that allows us to quickly process many different types of foreign life insurance so that we can determine what kind of income needs to be reported to the IRS. It's become a helpful tool that the entire tax department uses to quickly and accurately compute 7702(g) (which is foreign life insurance in lawyer's terms) liability. It's also useful in that it lets us know exactly what information to look for in the fine print of the insurance policies, something that can often take considerable time – especially when the policies are in foreign languages!


Not only did the tool make this particular case a resounding success, but it gave us the tool to be able to help countless other clients with their life insurance disclosures.


NOTE: An international/foreign insurance company can elect to be treated as a domestic insurance company under tax code 953d, to avoid being treated as a CFC. Since 2014, the rumors are IRS is getting hard on this. There is a risk that the IRS will not recognize the election, thus treat the insurance company as CFC, which a lot of filing requirement will come.