965 / Can a life insurance policy or annuity contract issued to a U.S. person by a foreign life insurance company qualify for the tax benefits traditionally afforded to U.S. life insurance policies?

Generally, foreign insurance companies cannot sell insurance products to U.S. persons without becoming subject to U.S. regulation. Despite this, if a U.S. person resides in a foreign country for an extended period of time, it is possible that he or she may choose to purchase a life insurance or annuity product from a foreign insurance company in that country. In order for a foreign-issued life insurance or annuity product to qualify for the same tax preferences given to domestic products, it will be required to comply with the U.S. requirements for these products (including, for example, the definition of “life insurance contract” under Section 7702 or the annuity provisions of Section 72).

Further, under the IRC, most annuity contracts issued by domestic insurance companies are exempt from the original issue discount (OID) rules (discussed in Q 495 to Q 501).¹ An annuity contract issued by a foreign insurance company will be subject to the OID rules, however, unless that insurance company is subject to tax under subchapter L with respect to income earned on the annuity contract. If the insurance company is not subject to tax under subchapter L, the annuity contract will be included in the definition of a debt instrument and the growth on the annuity cash value can be subject to tax as interest income even if payouts under the annuity contract have not yet begun.²

In the context of variable life insurance contracts, a contract will not qualify as a variable life insurance contract unless it is a “variable contract” for purposes of IRC Section 817(d). Under this provision, the amounts received under the variable contract must be segregated into an account that is separate from the company’s general asset accounts under state law or regulation.³ The question that arises in this context is whether an insurance company that segregates its assets pursuant to foreign law will qualify. The IRS has found that a foreign insurance company that elects to be taxed as a domestic company under IRC Section 953(d) (meaning it will be subject to subchapter L taxation), and that segregates amounts received under life insurance contracts from general company assets under foreign law, can meet the requirements of Section 817(d).⁴

This, however, leaves open the possibility that variable contracts issued by a foreign insurance company that has not elected to be taxed as a domestic company will not qualify for treatment as such under the IRC.