nun

This is perfectly reasonable, but many professionals would not sign up to it because they'd want to look through the policy to the underlying investments. Anyway if we accept that we are going to declare the gain as interest so it's taxed at ordinary income tax rates the next issue becomes how often do we declare that income. The endowment mortgage will get UK tax deferral, but not US.....so do you have to pay US tax annually on the gains. I'd feel uncomfortable deferring US tax until the payout.

JAJ

Which is why it can be simpler to self-file a tax return, if using a professional just leads to unnecessary over-complications.

There are gains (potentially) when the policy is matured, sold or surrendered for cash. It's not clear if/when there is any taxable event before then. And there's no reason to assume so.

If a policy has just matured, paying the tax on profit in current year, and include on FBAR/8938 as applicable, would seem appropriate. As someone else has said, not every foreign investment fits into the U.S. tax code and this is a reasonable/simple approach to deal with the gap. It's unlikely this would cause any problem and after the statute of limitations expires (3/6 years) the issue is closed.

However, I wouldn't normally recommend holding this kind of policy long term. Not only are they terrible investments, but even the U.S. tax treatment that can generally be agreed on (ordinary income on profit, no relief on losses) is unfavorable compared to U.S. based investments, whether stocks (qualified dividends, long term capital gains) or deferred income (IRA, 401k).

So the question of what to do with the policy won't arise over the long term if it is divested. Obviously anyone with one of these needs to consider the whole picture, especially the life cover and whether they can replace it.

JAJ

Another option is to include it as "Miscellaneous Income-Other Reportable Income". It's not really bank interest. This populates line 21 of form 1040.

nun

Avoiding all these issues is why it's important to do your research before you move. I would not feel comfortable doing the reasonable things mentioned because they ignore some annoying principles of tax to come up with a convenient solution. It's a solution, but it's arguable if it's correct and would not be the solution of a professional. Now if I actually had an endowment mortgage I would be tempted by the "reasonable" solution. Still it's the tax deferral aspect that really worries me

Statesider

OK let me start by apologizing for resurrecting this thread and this subject for the umpteenth time - I can hear the collective groaning coming through my speakers...

That said, after having read most of the threads on this forum and elsewhere, I still do not understand the consensus view against the following point - and this is:

Endowment proceeds are free of UK tax if they are a qualifying policy

The USUK treaty has the facility to accept a tax relief granted in one country - in the other.


Now I realize the treaty also says neither state really has to follow any of the rules, the US wants its pound of flesh and that the general consensus of the forum suggests UK endowment proceeds are US taxable - but why?

Has there been any known cases on the forum where the IRS has confirmed not declaring the lump sum from a qualified endowmwnt as income is wrong? That during an audit the above premise was incorrect and that a penalty was invoked for working on the basis of it?

I hardly expect the IRS to come back and declare the inclusion of it as income to be wrong and as mentioned several times its what the IRS thinks that really matters.

I'd really appreciate any insight as to why this 'equivalent tax relief' approach is incorrect in the absense of any definitive rule or evidence to the contrary.

nun

It's all a matter of interpretation......what is an endowment mortgage for the purpose of US taxation. As soon as you ask that question the Pandora's Box of the IRS code opens up. I'll go out on a limb and state that any UK tax relief you get on your endowment mortgage in the UK will not transfer to the US....why should it unless it is explicitly stated in the Treaty and exempted from the saving clause?

Statesider

Thanks Nun for your reply.

If one takes the approach of defining what an endowment is in the US - then I agree the proceeds probably SHOULD be included as income.

However, perhaps I'm reaching a little here (or maybe a lot) but I'm looking at it from the tax relief angle.

http://www.treasury.gov/resource-cen...s/uktreaty.pdf

In that document:

Article 1 para 2 states:

It then goes on to say in

Article 1 para 7:

Without a definitive IRS decree that states Endowment proceeds are taxable income, is it not reasonable that out of all possible interpretations one could use the one that is more favorable?

In the event of a future audit and the result of that audit suggesting the approach used was incorrect, is there precedent that any interpretation used that results in lower tax is automatically tax evasive rather than an honest belief the interpretation was correct?

JAJ

The proceeds of an endowment are not generally taxable income, as far as I understand. The profit on disposal of an endowment - if any - is normally taxable income. Is there any profit involved?

If it's taxable income, the tax treaty doesn't really protect because, except for a few clauses, the U.S. can ignore it as it applies to U.S. residents and citizens.

The tax code doesn't explain exactly what to do and the IRS have never published any specific fact sheet or guidance, so you should simply take a reasonable approach. An audit is unlikely and even if one was to occur, it's not clear they would really have a problem with a reasonable approach.

The statute of limitations normally expires after 3 years, in some cases 6.

Make sure you include it on the relevant information reports, if applicable. Notably FBAR and form 8938.

lansbury

That is how I paid tax on my endowment, on the profit part only.

IRS might not have a problem with a reasonable approach but I would suggest they are still likely to levy interest on the under payment of tax.

Statesider

Thanks for your insights JAJ

If the policy is a TEP, cashed in within 10 years and a host of other events that 'unqualify' it, then I agree the profit is taxable. If it is qualified and remains qualified at the point it is cashed out or comes to term, then I can't see why it wouldn't be tax-free.

While that certainly seems to be possible, if every clause 'can be ignored' then there is little point having a treaty at all. My point is that if there is a reasonable interpretation of the 'spirit' of the treaty, which (to me at least) suggests a tax break in one country is be a tax break in the other, then isn't that as reasonable an approach as any?

Personally, I think this is the key. Not to try to hide the money but to declare it and take the position that it is not taxable.

Statesider

Unfortunately, this seems to be the downside of the gamble.

For that to happen, one needs to be audited and be found to be in contravention of the rules - which of course is not impossible.

However, with the treaty itself 'suggesting' at the very least, that tax-free gains maybe transferable across the pond, its a pretty expensive exercise to voluntarily pay tax on a sizable chunk of money when it is far from definitive that it is necessary to do so.

I'd guess there are many definitive tax rules that people are exploiting. How economic is it for the IRS to expend the resources pursuing people over a ruling that is grey at best?

lansbury

I don't think it is a grey area. A member of BE is a tax professional licenced in both the US and UK and has stated on BE that the profits on an endowment policy are taxable. The tax professional I use, who has a Brit in his office, was of the same opinion.

You can assess the likelihood of getting away with it, but what is your tolerance for risk. Unfortunately paying take on endowment profits is a downside of living in the USA.

Jerseygirl

Our accountant said the same.

Owen778

Yes, our accountant said the same when we he did our 2012 taxes. Luckily, my UK endowment is fairly small.

JAJ

The spirit of the treaty isn't to create cross-border tax breaks, as you suggest. Generally speaking, tax treaties are intended to remove source country tax on a cross-border payment, or impose tax at a standard rate rather than requiring a tax return in the source country. This ensures that recipients, in the receiving country, only have the tax system of their country of residence to deal with. And in some cases, avoid double taxation.

A number of people have already told you that any profit is taxable. This is generally the U.S. tax treatment of endowments and a reasonable approach might be to apply the same tax treatment as would apply to a U.S. policy. If you feel that another tax treatment is appropriate then do your own research, however you can't use a tax treaty clause unless it is one of the few that are open to U.S. residents/citizens. Read the whole treaty and this will become apparent.

You've still not told us if there is any profit. Endowments are not good investments and often there is no profit on redemption.