Old U.S. tax raises new concerns

What you need to know about the premium excise tax

The Internal Revenue Code (IRC) imposes an excise tax on the premiums paid on a policy issued on the life or health of a U.S. person to a foreign insurer for any life insurance policy, sickness or accident insurance policy or annuity that’s issued on the life or health of a U.S. person. The tax is 1% of the gross premiums paid and applies to U.S. persons, wherever they live.

The IRC’s definition of a foreign insurer includes non-U.S corporations. The IRC treats most Canadian life insurance companies as foreign corporations. The IRS officially holds the following persons or entities liable for paying the excise tax, in this order:

• the policyholder,
• the insured,
• the insurance company, and/or
• the broker/advisor who obtains the insurance.

But it doesn’t have to pursue the policyholder first for the tax, and could hold the life insurance company and brokerage that sold the policy responsible for paying the amount due.

FATCA

FATCA became law in 2010. Its purpose is to help the IRS identify U.S. persons who own financial accounts outside the United States. Understandably, many U.S. citizens living in other countries outside the U.S. would own such accounts.

In February 2014, Canada entered into an intergovernmental agreement (IGA) with the U.S. to implement the reporting provisions of FATCA. The Canadian government later incorporated the IGA into the Income Tax Act (Canada). Canadian financial institutions, including life insurance companies, must now report relevant information about many of their U.S. clients’ accounts to the Canada Revenue Agency (CRA). The CRA then shares that information with the IRS through the provisions in the Canada-U.S. Tax Convention. Once the IRS has the information it needs, it can take steps to collect any tax it’s owed — including the premium excise tax.

Ultimately we can’t predict when and if the IRS will proceed with more aggressive collection efforts. Nor do we know why they haven’t done so up to this point. It’s possible that in the past, it’s been too difficult to identify those who owe the tax, or the amount due was considered too low to pursue. But now with FATCA and the IGA, it’s likely the IRS may renew its interest in this tax.

How you can help clients

It’s a good idea to recommend that clients see their tax advisor for a detailed explanation of their U.S. tax obligations. According to Sun Life Financial’s Director of Tax and Insurance Planning, Stuart Dollar, there’s not much U.S. persons living in Canada can do to avoid the premium excise tax, but at the very least, they could review their policies to see if there are ways to structure ownership in a more tax-efficient way.

Watch Sun Life Financial’s Director of Tax and Insurance Planning, Stuart Dollar, as he talks about who’s subject to the tax, what it means and the FATCA implications:

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U.S. estate tax

If a U.S. person owns a life insurance policy on their own life, the death benefit is included in their estate at death. It’s not an issue if the taxable estate is expected to be less than US$5.45 million (2016 exemption equivalent limit) or if both spouses of a married couple are U.S. citizens and their combined estate value is expected to be less than US$10.9 million.

“For those who exceed the thresholds, an irrevocable life insurance trust (ILIT) provides a way to exclude the death benefit from the insured’s taxable estate. Generally the trust is structured to make sure the insured has no rights to the trust assets during life. (The IRS won’t be able to say the insured owned the policy at death and won’t be able to include it in the insured’s taxable estate.) Since the premium excise tax applies to insureds, even if they don’t own the policy, they’ll still have to pay the excise tax. But the ILIT at least helps them plan for the estate tax,” Dollar says.

Although FATCA may make it easier for the IRS to identify U.S. persons who own Canadian life insurance policies, there are limits. Under the IGA, the following types of life insurance policies aren’t reportable:

• a cash value insurance contract with a balance or value of $250,000 or less as of June 30, 2014,
• a cash value insurance contract held by an individual on or after July 1, 2014 with a cash value less than or equal to $50,000 at the end of any calendar year or other appropriate reporting period.

It follows that term life insurance policies would also be non-reportable, since they don’t have cash value. Still, Dollar cautions that just because a policy is not a reportable asset, it doesn’t mean a U.S. person won’t have to comply with their other U.S. tax obligations.

Next steps

Education is the key. Make your clients aware of the tax, keep them informed and consult tax professionals for help. Here are some more resources to consider:

• Review the U.S. premium excise tax bulletin written by Sun Life Financial’s Director of Tax and Insurance Planning, Stuart Dollar.
• Across its Insurance and Wealth business, Sun Life Financial’s Advanced Planning services deliver professional expertise and insights through a team of chartered accountants and lawyers. If you want to learn more, please talk with a Sun Life Sales Director.

Use Sun Life Financial’s Estate Planning and Asset Protection Plan brochures when speaking with clients about preserving their legacy.

You might also like…

• Beware of U.S. tax traps – especially when your clients are U.S. citizens
• Canadians with U.S. retirement plans: Minding that money when they come home
• What Canadian clients need to know about U.S. taxes – part 1

¹ Sun Life Financial’s study of high net worth clients, conducted by Ipsos, 2016.