Changes in the Last Loophole

by | Jan 18, 2002 | Archives

Over the past thirty years financial privacy has slowly eroded. There is one loophole left, but now even a new ruling affects this.

Dear International Friend,

Bank privacy is dead. If there were any doubts about this, the introduction of the W9 almost assured this fact. Then came the USA Patriots Act, one more nail in the coffin of bank privacy.

Overseas whole life insurance policies however are still private (even when issued by subsidiaries of U.S. life insurance companies). Insurance policies are not financial accounts as defined for US 1040 tax reporting purposes, so there is no reporting of investments held in such policies Plus there is no taxable or reportable event created by capital appreciation or income within such policies (assuming they are in compliance with tax codes). In other words these policies are private and defer tax. Tax liability is incurred upon redemption of the policy, but there are numerous tax efficient ways to redeem insurance policies. This means they can be excellent estate planning vehicles. They defer tax up front and use redemption options to reduce tax on non taxed compounded returns. This is the only practical legal deferral for many investors.

Yet the policies are not perfect either. There is a cost for the insurance and administration, plus there is an excise tax equal to 1% of the premium that is due. In the past some investors believed there was a way to avoid this tax. This has now changed as eClub advisor, Leslie Share, explained when he wrote:

“Gary–as you know, the United States imposes an excise tax on certainpremiums paid to a foreign insurer or reinsurer. Among other such taxes, a1% tax applies with respect to premiums paid on life insurance, annuity contracts and sickness and accident policies issued for the life or liability of a U.S. citizen or resident, and to premiums paid on reinsurance policies covering such policies or contracts. The 1% tax is generally not imposed if the foreign insurer or reinsurer treats the premium payments as U.S. business income, but relatively few apparently doso.

“In proposed regulations issued on January 4, 2002, the IRS officiallydeclared its position that this tax is due and payable even if the premiums in question are paid by non-U.S. residents.

“In the past it was believed by some that you could avoid this tax if a non-U.S. person paid the premiums instead of the U.S. person insured. A number of practitioners, particularly in the foreign trust area, thought so. The IRS now officially disagrees.

“The IRS also stated that the penalty for the nonpayment of this tax with the intent to evadeis a fine of double the amount of tax, in addition to other potentialpenalties. These rules are proposed to apply to premiums paid on or after the date the final IRS regulations on this issue are published in the Federal Register. The ultimate legal viability of the IRS' position remains to be seen.

“Anyone potentially subject to these new proposed regulations shouldcontact a professional tax advisor to determine how to proceed.”

I agree wholeheartedly with Leslie's points and especially endorse his last statement. There are many promoters of complicated offshore structures that do not comply with tax law and do not work if audited. These programs are recipes for disaster! Always use a tax professional who has experience in this area. We have three eClub advisors who can provide you more advice and information.

Leslie Share, tax attorney, las@pnrlaw.comJoe Cox, tax attorney, jcox@coxnici.comColin Bowen, Isle of Man

Until next message, Good global investing!