Zurich Life Insurance Company Hit with Penalties for Unit-Linked Life Insurance Policies

From DOJ press release, excerpts below:

Zurich Life Insurance Company Ltd (Zurich Life), headquartered in Zurich, Switzerland, and Zurich International Life Limited (Zurich International Life), headquartered in the Isle of Man (collectively Zurich) reached a resolution with the United States Department of Justice…As part of the agreement, Zurich will pay a penalty of $5,115,000 to the United States.

According to the terms of the non-prosecution agreement, Zurich agrees to cooperate in any related criminal or civil proceedings, to implement controls to stop misconduct involving undeclared U.S. accounts, and to pay a penalty in return for the Department’s agreement not to prosecute the insurance providers for tax-related criminal offenses.

From Jan. 1, 2008, through June 30, 2014, Zurich issued or had certain insurance policies and accounts of U.S. taxpayer customers, who used their policies to evade U.S. taxes and reporting requirements. In particular, Zurich had approximately 420 U.S. related policies, 127 with Zurich Life and 293 with Zurich International Life, with an aggregate maximum value of approximately $102 million, for which the U.S. taxpayer customers did not provide evidence that they had declared their policies to U.S. tax authorities.

To qualify for favorable tax treatment under the U.S. tax code, insurance must meet certain minimal requirements. The policies offered by Zurich Life and Zurich International Life did not meet these requirements. The increase of the principal in these policies was therefore subject to taxation, and the policies were required to be disclosed to the Internal Revenue Service (IRS) on FinCEN Form 114 Foreign Bank Account Report, commonly referred to as an FBAR. In issuing or having undeclared U.S. related policies, Zurich knew or should have known that they were helping U.S. taxpayers conceal from the IRS ownership of undeclared assets, maintained as insurance policies or accounts.

Zurich International Life, in particular, sold insurance products to U.S. taxpayers that were “unit linked,” meaning the cash surrender value and death benefit amount were linked to the value of specified investments. With such policies, the U.S. taxpayer had a suite of specialized investment options, allowing them to access potentially higher returns by taking on the market risk associated with the policies. Some of these unit-linked policies offered a base death benefit that was nearly equivalent to the cost of the policy itself, and in some instances was fully funded by transfers from offshore bank accounts. Upon redemption, the U.S. taxpayer would receive the premium amount plus any investment earnings on the policy less a very small percentage for putative risk and fees.

Despite knowing that some of these policies, which had minimal-to-no risk mitigation function and specialized investment options, were held by U.S. taxpayers, Zurich International Life failed to act appropriately to ensure timely compliance by the policyholders with U.S. tax laws. In at least one instance, uncovered during the course of Zurich Life’s internal review, a former U.S. citizen, who pled guilty to a federal fraud offense after purchasing a Zurich International Life policy, used that insurance policy to hide substantial assets, despite owing approximately $900,000 in restitution to his victims.

Zurich has conducted a thorough investigation and reported substantial findings to the Tax Division, including dozens of detailed summaries of account information and comprehensive reports for the U.S. related policies.

In addition to these efforts, the Companies have worked closely with non-U.S. regulators to ensure full disclosure to the Department.

Unit-linked foreign life insurance policy

All U.S. persons (citizens, green card holders, and non-immigrants who meet the substantial presence test) must report foreign financial accounts and assets on various international information return forms, including Form FinCEN 114 (FBAR), Form 8938 (FATCA), and Form 8621 (PFIC), as applicable. Oftentimes there is also reportable income from non-qualifying foreign life insurance policies even if there have been no distribution.

It looks like a duck, quacks like a duck…but sometimes it isn’t a duck

The U.S. tax code as it relates to life insurance policies is incredibly complicated. Even more complicated is trying classify foreign life insurance policies under the U.S. tax code. Usually they’re non-qualifying life insurance policies, and sometimes they’re not life insurance policies at all.

A foreign life insurance can be one of the following:

  1. A qualifying life insurance contract under IRC 7702
  2. A non-qualifying life insurance contract under IRC 7702
  3. Investment account

Is it a qualifying life insurance contract?

A life insurance contract can be a qualifying life insurance product under IRC 7702 if it meets the cash value accumulation test and guideline premium requirement.

Cash Value Accumulation Test (CVAT)

The CVAT requires a fairly straightforward determination: does the cash value of the insurance policy exceed the present value of all future premium payments on the policy?

Guideline premium requirement

A contract meets the guideline premium requirements of section 7702(c) if the sum of the premiums paid under the contract does not at any time exceed the greater of the guideline single premium or the sum of the guideline level premiums as of such time.

The guideline single premium is the premium that is needed at the time the policy is issued to fund the future benefits under the contract based on the following three elements:

  1. Reasonable mortality charges that meet the requirements (if any) prescribed in regulations and that (except as provided in regulations) do not exceed the mortality charges specified in the prevailing commissioners’ standard tables (as defined in section 807(d)(5)) as of the time the contract is issued;
  2. Any reasonable charges (other than mortality charges) that (on the basis of the company’s experience, if any, with respect to similar contracts) are reasonably expected to be actually paid; and
  3. Interest at the greater of an annual effective rate of six percent or the rate or rates guaranteed on issuance of the contract.

If the policy does not meet either of the above tests, IRC Code §7702(g)(1)(A) becomes applicable: “If at any time any contract which is a life insurance contract under the applicable law does not meet the definition of life insurance contract, the income on the contract for any taxable year of the policyholder shall be treated as ordinary income received or accrued by the policyholder during such year.” In other words, the policy holder is subject to a tax on the increase in cash value of the policy each year, even if the policy isn’t actually cashed out.

Is it a non-qualifying life insurance contract or an investment account?

Under a life insurance contract, the investor pays premiums and in return receives a death benefit or cash surrender value. Oftentimes, the premiums are invested in foreign mutual funds.

Typically the investor does not have the right to allocate among the funds and otherwise has no control over the firm’s investment decisions. However, if the investor does have a right to allocate the premiums, there could be a PFIC reporting requirement.

Foreign life insurance reporting requirements – FinCEN 114, Form 8938, income

U.S. persons owning foreign financial accounts with values in excess of $10,000 at any point during the year are require to file an FBAR on an annual basis. “Foreign financial account” includes an account that is an insurance or annuity policy with a cash surrender value.

Foreign life policies are also considered “specified foreign financial assets” for Form 8938 purposes and must be reported annually if the value exceeds the applicable threshold.

In addition, there may be taxable income to report.

What should non-compliant taxpayers do?

If taxpayers are non-compliant with the foreign asset and income reporting requirements, they should consider applying to one of IRS’ voluntary disclosure programs:

Why hire us?

We assist taxpayers who have undisclosed foreign financial assets. Schedule an appointment to see how we can help.