Are taxpayers properly paying the federal foreign insurance excise tax?

• Author: Mitra, Surjya

With the globalization of the insurance market, U.S. risks are often insured by foreign insurance companies. When estimates of insured loss are calculated after a catastrophic event such as a hurricane, it is not unusual to find a significant portion of that loss is ultimately borne by foreign insurance companies. This generally happens through reinsurance contracts, by which an insurance company lays off risk to another insurance company. However, in today's world, buying insurance/reinsurance coverage from foreign insurance/reinsurance companies is not just the domain of insurers. Risk managers, such as manufacturers or those in the service industry, regularly arrange for some insurance coverage from a number of foreign insurance companies. Some businesses have also established domestic or foreign captive insurance companies, which in turn may be purchasing reinsurance from foreign insurance companies. Aside from the Federal income tax issues of these insurance arrangements, it is also important to understand that the premiums paid to a foreign insurer may be subject to Federal excise tax (FET) under Sec. 4371. Recent experience shows that the IRS has been looking closely at the issue of whether businesses have properly paid the tax.

Background

Sec. 4371 imposes a FET on certain premiums paid to a foreign insurer not engaged in a U.S. trade or business. The tax is imposed on the gross amount of the premium. In general, the liability is 4% of the premiums paid for casualty risks wholly or partly within the U.S., and 1% for a life, sickness or accident insurance policy, or an annuity contract on the life of, or hazards to, the person who is a U.S. citizen or resident. The rate is also 1% of the premium paid on a reinsurance policy (insurance purchased by an insurance company) covering those same risks. A premium payment includes any consideration paid for assuming and carrying the risk or obligation, and includes any additional assessment or charge paid under the insurance contract, whether payable in one sum or installments.

Who Is Liable for the Tax?

The FET must be paid by the person who makes the premium payment to the foreign insurer/reinsurer. Under Regs. Sec. 46.4374-1(b), the liability for the FET attaches when the premium payment is transferred to the foreign insurer or reinsurer (including transfers to any bank, trust fund or similar recipient, designated by the foreign insurer or reinsurer), or to any nonresident agent, solicitor...