What Is the Section 4371 Foreign Insurance Excise Tax?
Understand the federal excise tax under Section 4371 for premiums paid to foreign insurers and the significant role of tax treaties in claiming an exemption.
Section 4371 of the Internal Revenue Code establishes a federal excise tax on premiums paid to foreign insurance companies for policies covering risks within the United States. This tax is intended to address a competitive imbalance between U.S.-based insurers, who are subject to federal income taxes, and foreign insurers, who may not be. By imposing this tax, the provision seeks to place domestic and foreign insurance transactions on a more similar tax footing.
Scope of the Federal Excise Tax
The federal excise tax applies when insurance premiums are paid to a foreign insurer. For tax purposes, a foreign insurer is any insurance company, association, or underwriter that is not incorporated under the laws of any state in the United States. The tax is triggered by the payment of a premium for specific types of insurance policies that cover U.S.-based risks or individuals. The location of the risk is a determining factor for certain policies.
This excise tax covers a defined range of insurance products. It applies to premiums for casualty insurance policies and indemnity bonds that protect against hazards or losses located within the U.S. The tax also extends to life insurance, sickness and accident policies, and annuity contracts issued to a U.S. citizen or resident. Finally, it includes reinsurance policies.
The legal liability for paying the tax falls on the person or entity that makes the premium payment to the foreign insurer. This is the U.S. policyholder. If that person fails to remit the tax, the liability can shift to any party involved in issuing or selling the policy.
Tax Rates and Calculation
The calculation of the foreign insurance excise tax uses rates that vary depending on the type of insurance policy purchased. The tax is applied to each dollar of the premium paid, including any fractional part of a dollar.
For casualty insurance and indemnity bonds, the tax rate is 4% of the premium paid. To illustrate, if a U.S. company pays a $100,000 premium to a foreign insurer for a casualty policy covering its U.S. operations, the excise tax owed would be $4,000 ($100,000 x 0.04).
A lower rate of 1% applies to premiums for life insurance, sickness and accident policies, and annuity contracts. For instance, a U.S. resident paying a $5,000 premium for a foreign life insurance policy would owe a $50 excise tax. The same 1% rate also applies to premiums paid for reinsurance policies that cover any of the taxable insurance categories.
Treaty-Based Exemptions
An exception to the excise tax arises from international income tax treaties. The United States has agreements with many countries that include a provision waiving this excise tax. To qualify for this exemption, the premium must be paid to a foreign insurer that is a resident of a country with such a treaty and meets the requirements of the treaty’s “limitation on benefits” article.
The excise tax does not apply to premiums paid by one foreign insurer to another for reinsurance. Therefore, if a U.S. policyholder pays a premium to a treaty-exempt foreign insurer, and that insurer then reinsures the policy with another foreign company, the policyholder’s exemption is not affected.
To claim a treaty exemption, the U.S. person paying the premium is responsible for verifying the foreign insurer’s eligibility. This involves obtaining a properly completed Form W-8BEN-E from the foreign insurer. This form certifies the insurer’s country of residence and their status under the relevant tax treaty, serving as documentation to substantiate the exemption claim.
Filing and Paying the Tax with Form 720
The foreign insurance excise tax must be reported and paid to the IRS using Form 720, the Quarterly Federal Excise Tax Return. This form is used to report a variety of federal excise taxes, and foreign insurance premiums are one specific category.
The tax is paid on a quarterly basis, with specific due dates following the end of each calendar quarter. The returns are due on April 30 for the first quarter, July 31 for the second, October 31 for the third, and January 31 for the fourth. Taxpayers must file a return for each quarter in which a taxable premium payment was made.
When completing Form 720, the tax is reported under Part I. The IRS assigns specific abstract numbers to different types of taxes, and for foreign insurance policies, the relevant line is IRS No. 30. Payments can be made through various methods, including electronic funds transfer or by mailing a check with the completed form.