Is Foreign Annuity Income Taxable and Reported to the IRS?

U.S. Taxation of Foreign Annuities Income and Reporting

U.S. Taxation of Foreign Annuities Income and Reporting

There are many different types of investments that a U.S. Taxpayer may make depending on the type of return they are seeking and how close they are to reaching their retirement goals — and there is no shortage of retirement income supplements. Some Taxpayers are content with generating some interesting income while others prefer to expand their portfolio to include mutual funds and ETFs. Since the United States follows a worldwide income tax model for individuals, whether that income is generated in the United States or abroad, the income is still taxable and reportable on a U.S. tax return — noting, that foreign passive income may be subject to the harsh PFIC tax regime. One common type of investment that many Taxpayers may make is an annuity.  There are several types of annuities depending on the risk tolerance of the investor and desired outcome (jumbo payment vs monthly income), but whether the annuity is based in the United States or overseas it is still (usually) taxable by the IRS. Let’s go through the basics of what is an annuity and how it is taxed and reported under U.S. tax law.

First, What is an Annuity?

From a baseline perspective, an annuity is generally a product from an insurance company. It is a contract for the Taxpayer to receive payments over a certain period. Some annuities will offer lower payments at first with increasing distributions as time goes on whereas others may offer tax-deferred distributions or even a lump sum distribution depending on this specific annuity contract. When it comes to an annuity, there are various types of benefits with the main benefits being tax-deferred treatment on the growth of the investment, distributions during the lifetime of the investor, and even death benefit payouts to the beneficiaries of the investor.

Foreign Annuities and Reporting to the IRS

Taxpayers may be presented with financial products by foreign life insurance companies and other foreign financial institutions that offer annuity investments to U.S. persons. These foreign investment firms will try to sell you on the fact that the U.S. government does not regulate them and thus they can offer a higher rate. But, there is a flip side — which is that if they are not being regulated then who’s to know whether the company is as liquid and profitable as it claims to be? Likewise, if the company goes under, the Taxpayer may have a difficult time trying to get their money back since there are no regulations. Finally, it is also important to note that even though the company may be overseas, as a U.S. person investor they are still required to report the income on their U.S. tax return as well as report the asset itself on various international information reporting forms such as the FBAR and Form 8938. You may also have an IRS Form 720 excise tax payment in any year that foreign premiums are paid

What Are the Different Types of Annuities?

In general, annuities can be broken down into three different types of categories:

Fixed Annuities

• • • A fixed annuity is a straightforward type of investment in which an insurance company will guarantee the interest rate/rate of return and the amount of payout for the investor. While the structure of the annuity will typically remain constant, the fixed interest rate along with the monthly payouts can vary over the lifetime of the investment. Sometimes, the investor will seek a payoff for a lifetime, and other times it will be for a set amount of time. Some annuities will allow the investor to modify the investment over time whereas others are locked in and will not allow any changes (aka Fixed).

Variable Annuities

• • • Unlike a fixed annuity, a variable annuity may vary over time and provides less stability for many investors. Like investing in the stock market, sometimes the growth will increase and other times it will decrease which puts the investment at a higher risk than a fixed annuity. Oftentimes variable annuities are less preferred because one of the key purposes of the annuity is to ensure that there is a set amount of income coming in over a lifetime or a specific number of years and if the investment is going to vary and possibly vary significantly then the Taxpayer may be better off putting their money into low-risk funds such as VTSAX, VYM or SCHD.

Equity-Indexed Annuities

• • • Equity index annuities are simply annuities that are tracked on a specific index such as the S&P 500. Some specific EIA funds may track one index, while others may track several indexes. One of the biggest risks with equity index annuities is that if the index significantly drops in value, annuity will drop as well.

Know the Risks of Foreign Annuities

It is very common for Taxpayers who we represent to tell us that they have been contacted by companies in the U.S. and abroad trying to sell them on annuities. The reason why Taxpayers must be very careful with annuities is they can get thrown off by the word ‘guaranteed.’ For example, a fixed annuity may provide a guaranteed return on investment, but that presumes that the life insurance company does not go out of business.

Life insurance companies have different ratings and before investing in an annuity Taxpayers should check the ratings to ensure that the company has a high rating. Noting, that there could be other issues with the company itself that has not been picked up yet by the marketplace so realize that even if the annuity is claiming a fixed common guaranteed payment for a lifetime for example that only matters if the life insurance company remains in business.

Late Filing Penalties May Be Reduced or Avoided

For Taxpayers who did not timely file their FBAR and other international information-related reporting forms, the IRS has developed many different offshore amnesty programs to assist Taxpayers with safely getting into compliance. These programs may reduce or even eliminate international reporting penalties.

Current Year vs. Prior Year Non-Compliance

Once a Taxpayer missed the tax and reporting (such as FBAR and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, Taxpayers should consider speaking with a Board-Certified Tax Law Specialist who specializes exclusively in these types of offshore disclosure matters.

Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)

In recent years, the IRS has increased the level of scrutiny for certain streamlined procedure submissions. When a person is non-willful, they have an excellent chance of making a successful submission to Streamlined Procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead. But, if a willful Taxpayer submits an intentionally false narrative under the Streamlined Procedures (and gets caught), they may become subject to significant fines and penalties. 

Need Help Finding an Experienced Offshore Tax Attorney?

When it comes to hiring an experienced international tax attorney to represent you for unreported foreign and offshore account reporting, it can become overwhelming for Taxpayers trying to trek through all the false information and nonsense they will find in their online research. There are only a handful of attorneys worldwide who are Board-Certified Tax Specialists and who specialize exclusively in offshore disclosure and international tax amnesty reporting. 

*This resource may help Taxpayers seeking to hire offshore tax counsel: How to Hire an Offshore Disclosure Lawyer.

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, specifically IRS offshore disclosure. 

Contact our firm today for assistance.