Here's How the IRS Can Monitor Clients' Offshore Life, Annuity Arrangements

Investigators at the U.S. Government Accountability Office have come up with a list of federal tax forms and other data sources that could help government agencies track the use of offshore life insurance arrangements.

The GAO developed the list in connection with a report on IRS oversight of micro-captive insurers. The report was prepared for Sen. Charles Grassley, R-Iowa, who is the highest-ranking Republican on the Senate Judiciary Committee.

The GAO concluded that the data sources listed probably could not help the IRS come up with a micro-captive owner audit list.

What It Means

Even though the GAO thinks the data sources are inadequate for micro-captive auditors’ needs, the list in the report could be useful to insurance agents, financial planners, retirement planners and others who want to see how information about clients’ non-U.S. life insurance and annuity arrangements could flow to the IRS.

The Forms

In additional to general personal, corporate and life insurance company tax forms, some of the forms on the GAO offshore insurance data source list include:

IRS Form 8938, Statement of Specified Foreign Financial Assets. Filers use this form to provide information about filers’ non-U.S. cash-value life insurance and annuity accounts.

IRS Form 8966, FATCA Report. Financial institutions use this form to report information about customers’ cash-value life and annuity contracts.

IRS Form 720, Quarterly Federal Excise Tax Return. Filers use this form to report on the premiums paid for non-U.S. life insurance.

FinCEN Form 114, Report of Foreign Bank and Financial Accounts. Filers use this form to report information about non-U.S. insurance accounts to the Financial Crimes Enforcement Network — the federal agency in charge of detecting and tracking criminals’ use of U.S. financial institutions.

Micro-Captive Basics

A captive insurance company is an entity that a company, individual or association forms to provide insurance coverage solely for the owners.

Taxpayers of all kinds use captive insurers for many purposes. Life insurers often use large captive insurers to provide reinsurance.

Companies and associations also form small captives, or micro-captives, to protect themselves against property and casualty risk, especially in situations in which commercial coverage would be very expensive or difficult to find.

Business micro-captive users can deduct the premiums from their taxable income, and micro-captives with a low level of premium revenue need not pay income taxes on their premium revenue.

Because of the possibility that some micro-captive premium payments may be subject to no U.S. federal income taxes, the IRS is concerned that some micro-captives may be part of abusive tax-avoidance strategies.

The IRS now requires micro-captives to report on their activities using Form 8886, Reportable Transaction Disclosure Statement, and it has organized several waves of enforcement actions.

The Life and Annuity Connection

The IRS has strongly discouraged the use of micro-captives to provide ordinary life insurance, although it has allowed some business-related mortality benefits in business interruption arrangements. The mortality provisions could apply if a disaster led to the death of key people needed to run a captive-owning business.

In the past, some micro-captive owners invested the captives’ assets in permanent life insurance policy.

In recent years, the IRS has suggested that putting micro-captive assets in life insurance might be abusive, and captive advisors have recommended that the owners not put the assets in life insurance.

It’s possible, however, that some U.S. micro-captives could be life and annuity micro-captives formed years ago, before the current micro-captive rules evolved.

Analysts working for a Finseca predecessor organization noted, in a copyrighted report posted in July 2015, that (in some cases) a business owner with a genuine need for captive insurance could have a trust own a property and casualty captive, and use the P&C captive-owning trust to transfer wealth to younger generations of the business owner’s family.

(Photo: Allison Bell/ALM)