How to Legally Avoid Foreign Insurance Excise Tax
Some foreign insurance may sometimes lead to an extra federal tax liability in the US. But it should be noted that not all foreign insurance policies are taxable.
There are certain exemptions that are outlined in the Internal Revenue Code and US income tax treaties by the Internal Revenue Service (IRS). It would be beneficial to learn about them to ensure tax-exempt status and compliance with IRS requirements.
What Is Foreign Insurance Excise Tax?
The Foreign Insurance Excise Tax is a tax levied federally under IRC Section 4371 on certain foreign insurance and reinsurance policies written with respect to risks in the United States.
This tax is based on insurance contract premiums and reported quarterly on IRS Form 720, Quarterly Federal Excise Tax Return.
Important Aspects of Foreign Insurance Excise Tax
The tax is normally based on premium payments at statutory rates of $0.04 or $0.01 for each dollar or fraction thereof, depending on the type of insurance.
Who Pays the Foreign Insurance Excise Tax?
IRC Section 4374, along with the Treasury Regulation §46.4374-1, allows foreign insurance excise tax liability to be imposed upon the individuals that were directly responsible for issuing, purchasing, or receiving any taxable insurance contract.
The general rule is that the IRS holds the individual, who is paying the insurance premium, liable for tax payment and reporting.
The following parties may be responsible:
- United States corporations buying foreign insurance: Companies paying foreign insurance companies premiums for coverage of U.S. risks.
- Taxable persons buying foreign insurance: Individuals paying foreign insurance companies premiums for coverage of a nature subject to Section 4371.
- Policyholders: Persons covered by taxable foreign insurance who would take the responsibility in case the tax was not paid by the premium payers.
- Insurance agents/brokers/intermediaries: Persons connected with issuance/selling of taxable foreign insurance policies under Section 4374.
- Insurance companies buying foreign reinsurance: This is where insurance companies pay taxable premiums for reinsurance from foreign insurers, as per the relevant tax laws.
Example: The American construction company that buys casualty insurance for their equipment based in America from a foreign insurer should pay the 4% tax if they paid the taxable premium of $10,000 to buy the insurance coverage.
This tax liability arises upon the payment of the premium to the foreign insurer or reinsurer, or non-resident intermediary as designated by the insurance companies.
Refer to IRS Pub 510 to know more or read our blog on Who Pays Foreign Insurance Tax to get more details
How to Legally Avoid Foreign Insurance Excise Tax
However, not all foreign insurance premiums are taxable for Foreign Insurance Excise Tax purposes. IRC and US treaties provide various exemptions and exclusions from Foreign Insurance Excise Tax liability. Below is the list of eight cases when taxpayers may lawfully evade this excise tax.
1. Claim an Exemption Under a U.S. Tax Treaty
There are certain foreign insurance companies which may obtain treaty exemption status. According to Revenue Procedure 2003-78, in order for such status to be obtained, the insurer must comply with the treaty and generally should have a valid IRS closing agreement. It should be noted that treaty exemption is not automatic.
Example: An American firm buys insurance from a German insurance company that satisfies the provisions of the tax treaty between America and Germany. The premiums may be eligible for the exemption if certain IRS requirements are met.
2. Qualify for the Effectively Connected Income Exemption
According to IRC Section 4373(1), the foreign insurance premiums can be exempt where the income is effectively connected with the conduct of a trade or business within the U.S. by the foreign insurer. This is usually the case when the premium income is taxable as income according to IRC Section 882(a). The exemption does not hold where the income is exempt from IRC 882(a) taxes because of a relevant treaty.
Example: A foreign insurer operating in the U.S. earns premium income that constitutes effectively connected income. The premiums can be exempt from foreign insurance excise tax.
3. Purchase Insurance Covering Risks Outside the United States
According to IRC Sections 4371 and 4372, foreign insurance excise tax usually applies to insurance purchased for risks within the U.S. In cases where the entire insurance purchase is excluded from the provisions of the sections, foreign insurance excise tax does not apply. The place of the insured item, the status of the insured individual, and the kind of insurance determine the applicability of the tax.
Example: An American company buys insurance from a foreign insurance company only for equipment used out of the country. The premiums could be exempt from Section 4371 in such a case.
Refer to the IRS Technical Guidance page to get a deeper knowledge.
4. Obtain Insurance Coverage for Exported Goods
The premium for insurance coverages on goods shipped out of the country through transit is generally exempted from foreign insurance excise tax in compliance with the Export Clause of the Constitution in Article I, Section 9 and the court ruling of the United States v. International Business Machines Corp. (1996).
Example: Foreign insurance coverages that are purchased by a U.S.-based manufacturing companies for machinery to be shipped from the United States to Japan are not taxable.
5. Check for IRC Section 953(c) or 953(d) Elections
There exist some foreign insurance companies, including qualified captive insurance companies, which can be exempted from the foreign insurance excise tax under the IRC sections 953(c) and 953(d). The section 953(c) offers a protection to the qualifying insurance income of related persons while section 953(d) provides a protection for some foreign insurance companies which can choose domestic corporation status.
Example: A qualified foreign captive insurance company makes a successful election under IRC section 953(d) and is considered to be a domestic corporation. The premiums paid on its policies do not constitute the foreign insurance excise tax.
6. Qualify for Certain Indemnity Bond Exemptions
According to IRC 4373(2), indemnity bonds associated with U.S. Government securities are exempt from the foreign insurance excise tax. This exemption applies to such bonds that are related to certain government payments or the substitution of certain government-issued financial instruments.
For instance, an indemnity bond that is required to ensure the replacement of a lost U.S. government-issued check may be exempt from foreign insurance excise tax provided that statutory criteria are fulfilled.
7. Review Foreign-to-Foreign Reinsurance Transactions
Some foreign insurance premium reinsurance arrangements between foreign insurers are exempt from foreign insurance excise tax. The exemptions have been made clear in IRS Revenue Rulings 2008-15 and IRS Revenue Rulings 2016-03, which hold that the tax is not applicable to specified foreign-to-foreign reinsurance premiums as per IRC Section 4371(3), but other taxable reinsurance arrangements remain taxable under IRC 4371(2).
For example, in the case where a foreign insurer cedes an insured risk to a foreign reinsurer, the foreign insurance premiums are exempted from the specified 1% tax.
8. Claim a Tax Adjustment for Refunded Insurance Premiums
Foreign insurance premiums that result in a refund because of the cancellation of the policy or any other kind of adjustment can have their excise tax adjusted for the taxpayer. According to IRS rules, the tax can be considered either as an overpayment of tax liability of other premiums or a refund.
Example: A company makes a payment of $10,000 for its casualty insurance premiums and pays $400 in excise taxes. If the company receives a refund of $5,000 from the premium payments, it can claim a $200 tax adjustment.
For more details regarding the conditions for exemptions you can refer to Foreign Insurance Audit Guide and IRS Section 4371 Exemption Page
How to Claim a Foreign Insurance Excise Tax Exemption
To claim an exemption under IRC Section 4371, businesses should verify their eligibility and maintain the required supporting documents.
1. Identify the foreign insurer: Confirm the insurer's country of residence and insurance policy details.
2. Check exemption eligibility: Review applicable U.S. tax treaties, IRC Section 4373, and other qualifying exemptions.
3. Verify IRS closing agreements: For applicable treaty exemptions, confirm that the insurer has a valid IRS closing agreement.
4. Maintain documentation: Keep insurance policies, premium payment records, and supporting exemption documents.
5. Meet reporting requirements: Complete any required IRS disclosures, including applicable treaty-based reporting obligations.
For step-by-step guidance refer to IRS page on FET Exemption Program
Conclusion
It is possible to legally avoid Foreign Insurance Excise Tax if the insurance policy/ premium is exempt under the Internal Revenue Code, any US tax treaty, or other such exclusion. Examining the insurance transaction and retaining records will help you avoid paying additional taxes while remaining IRS compliant.
In case of taxation, one can use Simple720 that’s an IRS Authorized e-filing portal, to prepare and file Form 720.
File your Foreign Insurance Tax Online using Simple720 Now!
