U.S. Taxation of  Foreign Annuities By Vernon K. Jacobs, CPA  & J. Richard Duke, J.D., LLM

Until the IRS issued some new regulations in January, 1998, it was widely understood that U.S. investors who purchased annuity contracts issued by non U.S. insurance companies would be essentially taxed on such annuities the same as on annuity contracts issued by a U.S. insurance company. Generally, income accumulated within a deferred annuity would be tax deferred until the policyholder began to take distributions. At that time, a portion of the distributions would be taxable and a portion would be treated as a non-taxable return of the payment for the annuity contract.

However, in January, 1998, the IRS issued final regulations that it had previously issued as proposed regulations in April, 1995. While the regulations were primarily written to address a perceived problem with respect to certain deferred payment debt obligations that were being treated as annuity contracts (called Retirement C.D.s), the impact of the regulations was to also eliminate the tax benefits of fixed return, deferred annuities issued by foreign insurance companies. Among those who have studied the matter in some detail, there is some disagreement as to whether the regulations eliminated the tax deferral for all annuities issued by a foreign insurer or just for fixed return deferred annuities issued by a foreign insurer. Thus far, the IRS has not issued any rulings on this matter.

Annuities can be classified as (1) immediate or (2) deferred, with respect to when payments begin to the annuitant.

Annuities can also be classified as (1) fixed return or (2) variable return. A fixed return contract provides a set rate of return to the annuitant that is guaranteed by the insurance company. A variable annuity policy is one where the assets are invested in various investment pools such as stock funds and the rate of return to the annuitant depends on the returns realized from the underlying investments.

The IRS regulation did not alter the tax treatment (deferral) of variable annuities, whether immediate or deferred. Nor did their regulation alter the tax treatment of fixed return annuities that provided immediate payments (within one year) to the annuitant. Except for the fixed return deferred annuity, the tax treatment for a U.S. person who buys an annuity from a foreign insurance company is basically the same as for a U.S. person who buys an annuity from a U.S. insurance company.

One significant exception to the general rule is that a U.S. person who buys a foreign annuity must pay an excise tax of 1% of the premium paid for the contract. The excise tax is paid quarterly on Form 720. There is a tax treaty with Switzerland whereby the 1% excise tax does not apply to the purchase of Swiss annuity contracts. (If the treaty is used to avoid paying the excise tax, then the taxpayer must file a Form 8833 in each year when premium payments are made.)

Another area of some dispute relative to annuity contracts involves the treatment of "private annuity" contracts issued by persons other than an insurance company or by any other company that is engaged in the business of issuing annuity contracts. It's our opinion that the effect of the IRS regulation was to deter the use of deferred payment private annuities and private annuities that included special provisions to limit the amount of the payments by the annuity payor or to require a minimum amount of payments to the annuity recipient.

In any event, there aren't many informed observers who would argue that the subject of foreign annuity contracts and private annuities issued by foreign persons has become far more complicated and unsettled than before the IRS issued their regulations. We have prepared an extensive report on the tax treatment of foreign annuities. Copies of the report are available in printed form -- or in digital form for our paid subscribers (at no extra cost).

About the authors: Vernon Jacobs is a CPA who provides tax accounting and consulting services for clients with international interests.   J. Richard Duke, JD, LLM is an attorney who specializes in international tax law and is an Adjunct Professor of international tax law. Sponsored by Offshore Press, Inc. Copyright, 2006, All rights reserved. Offshore Press, Inc., Box 8194, Prairie Village, KS 66208. (913) 362-9667. Email to Offshore Press ., Vernon K. Jacobs, Webauthor.