Question about amending tax return to add foreign income

[German_in_US]

I am a dual citizen of the United States and Germany living in the U.S. and had a life insurance policy in Germany that I had paid out to me in 2021. The payout in Germany is fully exempt from taxes, so I did not have to pay anything there. I was initially under the impression that the money paid out to me was simply the sum of all premiums I had paid since the start of the policy in 2004. I now became aware that this might not be the case and that a part of the payout might have been funds on top of the sum of the premiums. It is my understanding that I have to pay income tax on this ‘extra’ money in the U.S.. My question is whether I can simply file an amended return or would this would be considered a quiet disclosure of foreign income? I filed my taxes in February 2022 and did not become aware of the potential foreign income until July 2022. The amounts are correctly reported on my FBAR. I am worried that the IRS would not consider this an honest mistake, but rather think that I am trying to clean up a fraudulent tax situation (which is not the case - I absolutely would have declared the income on my return had I known about it.). Does anyone have any advice how to best handle this? Simply file an amended tax return or does this require something like one of the offshore penalty amnesty programs?

[tagteam]

Since @pk is around, maybe you will get a response.

[pk · Accepted solution]

@German_in_US  a foreign life insurance is generally not "qualified"  -- not regulated per US laws ( on how they use the premiums to invest ).  Thus  this would be like an annuity  where you pay in  an amount per year/month  during the collection phase - obviously there are differences.  In any case this means that when liquidated, the growth is taxable and  because it is foreign , the cash value ( present value )  is reportable  under FBAR and FATCA  regs.

I don't know when you became a US person ( citizen/GreenCard / Resident for tax purposes)  since the  FBAR ?FATCA reporting eligibility ( if you met the threshold ) would have started from then.

Since you liquidated the account  (and recognized the  foreign asset by reporting on FBAR ) in 2021  ( hopefully you have done this since becoming a US person ), the  only issue here is whether  you should have recognized the gain on the account--- your basis being the sum of all the payments you have made  ( converted to US dollars of the day / yearly average ).   Yes , you need to recognize and pay the taxes on the gain.

Because this "investment" was not transferable ( i.e. you could not sell this freely ), the gain is not eligible for Capital gain treatment.  Thus it is ordinary passive gain , most likely earned interest like  a CD.  The fact that it is foreign sourced  really does not change the tax treatment or character of it ( the earnings/ gains ).

Bottom line, just file an amended return recognizing  foreign sourced interest  income and since this was not taxed in Deutschland, there is no foreign tax credit involved.

Since FBAR was already filed for the whole value of the account , while resting in Foreign account, there is no violation of FBAR/FATCA rules.   The transfer through your  foreign bank and to your US bank would have created a SAR ( temporary ) and that's all.  So not to worry.  

Just recognize the interest earning by filing an amended  2021 return and pay the taxes  ( perhaps penalty -- ask for abatement ) and interest.  That is all.

Does this make sense ?

[German_in_US]

@pk Thank you very much for the information! This makes a lot of sense. I was just worried that the IRS would consider this tax evasion of foreign income since I am reporting it late (even if it is just by a few months and not years). The cash surrender value has been reported on the FBAR for 2021 (I did not have to file FATCA because we were way under the threshold for this form.) and on the FBARs for previous years. I actually missed filing these on time because I thought we were under the $10,000 threshold for FBAR, but I was able to file them later under the IRS’ Delinquent FBAR Submission Procedures because we had no foreign income during any of these years and had marked on schedule B that we have foreign accounts (just marked ‘no’ for the requirement to file FINCEN 114 / FBAR because we thought we were under the threshold). All of these FBARs are acknowledged by FINCEN though and this year’s FBAR was filed before the automatic extension deadline of October 15. My understanding is that we never had to pay income tax on the life insurance policy until we decided to liquidate it in 2021 (so no tax requirement for prior years, just a reporting requirement on FBAR).

Again, thank you very much for the information! This is what I thought we have to do, but it’s great  and very helpful to read your explanation.