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Many CALU members have clients who are both residents of Canada and U.S. citizens. These clients have complex tax and estate planning needs as they are governed by both Canadian and U.S. income tax rules and reporting requirements. In addition, their estates may potentially be subject to U.S. estate and gift taxes on the fair market value of their worldwide assets.
We have recently learned of another complicating factor when these clients purchase insurance policies from a Canadian insurer. Under the U.S. Internal Revenue Code (IRC 4371), an excise tax is payable where an insurance contract or annuity policy with respect to a "U.S. insured risk" (e.g., a life insurance policy on the life of a U.S. citizen) is issued by a foreign (e.g., Canadian) insurer or reinsurer.
The applicable excise tax rate for life insurance, sickness and accident policies, or annuity contracts is 1% of the gross amount of the premiums. For example, if an annuity policy for $1 million is purchased by a Canadian resident/U.S. citizen from a Canadian insurer, there is excise tax payable of $10,000. The tax is paid with IRC Form 720, which is normally filed quarterly. Note: There is an exception to this tax under IRC 4373; however, this exception generally only applies if the foreign insurer is carrying on a U.S. trade or business and the amount of premium is effectively connected with the conduct of that U.S. trade or business.
The United States has a number of tax treaties which contain exemptions from the excise tax. Unfortunately, the Canada- U.S. Income Tax Treaty does not contain such an exemption.
While the U.S. Internal Revenue Service (IRS) generally holds the person making the premium payments liable for the tax (i.e., the U.S. citizen who is insured), the liability is joint and several. Under the IRC (Section 4374) the tax may be imposed on any of the following persons:
In the past, the likelihood of the IRS determining that the excise tax is payable could be considered remote, assuming the insured and policyholder are both resident in Canada. However, the United States has recently implemented legislation called the Foreign Account Tax Compliance Act (FACTA) that will, unless regulatory exemptions are granted, eventually require Canadian life insurers to provide some level of reporting to U.S. authorities on insurance policies owned by U.S. residents and/or citizens. As a result, in the future the IRS will have the information it requires to enforce the payment of this excise tax, with the noted joint and several liability on the insurance company and insurance advisor. It should be noted that there is no limitation period for failure to file and pay this tax!
Therefore, it is important for CALU members to be aware of these reporting requirements and to ensure that clients who are U.S. citizens are aware of this excise tax obligation. Failure to pay the excise tax could lead to enforcement action by the IRS.
* Special thanks to Gregory J. Papinko, Associate Partner, Tax Services, PricewaterhouseCoopers; and Ron Sanderson, Director, Policyholder Taxation and Pensions, Canadian Life and Health Insurance Association, for their helpful comments on this article.