Taxation of Indian Life Insurance Corp (LIC) policies in the US

[goyal_raj]

I am a US resident and have Endowment Life Insurance policies from LIC, India. It is the biggest insurer in India and i purchased these policies when i lived in India many years back. The proceeds from these are tax free in India.

Link to the new plans (mine is an old plan and i cant find it on the site) - LIC India Insurance Plans - Comprehensive Coverage for a Secure Future | Official website of Life In...

These policies provide life insurance on death and also provide bonus at maturity, if the insured person lives. There is no official communication of the bonus amount added every year and it is not fixed/guaranteed. It is paid only on maturity and a reduced amount if surrendered early.

I report these under FBAR and form 8538 in Turbo tax.

My questions are as under:

1. Do I need to report the change in bonus balance every year as income to IRS in form 1040? If yes, where, and would that be taxed?

2. What happens on maturity from a tax point of view? Is the bonus taxable to the extent that it is more than the total premiums paid? Example, I paid 200000 rupees over 20 years as premium (10k a year for an assured policy amount of 200k on death) and got back 300000 on maturity as basic amount 200k plus bonus 100k. Is 100k taxable in US? How and where should this income be reported in Turbo tax, if taxable? Would it be a long term gain?

thanks for your help.

[DaveF1006]

No, you do not need to report a change in bonus value each year. Once it matures and you take the distribution, you will pay tax on the proceeds minus your premiums paid.

This is taxed as ordinary income, not subject to the capital gains rate. This will need to be reported in US Dollars and not rupees on your US tax return.

[goyal_raj]

Thanks DaveF1006.

Any insights on why this is ordinary income given that the policy lasted 20 years. Any IRS resources I can refer to?

And where should i report this income in Turbo tax?

Thanks

[DaveF1006 · Accepted solution]

Even after holding the policy for 20 years, it doesn’t qualify for the lower Long-Term Capital Gains tax rates (0%, 15%, or 20%). Here’s how the rules apply:

The “Sale or Exchange” Rule: For capital gains treatment under IRC Section 1222, there has to be a “sale or exchange” of a capital asset. When an insurance policy matures, you aren’t selling it to someone else—the contract is just being completed by the insurer. The IRS and courts have made it clear that a policy maturing is considered an “extinguishment” of the contract, not a sale.

IRC Section 72(e): This part of the tax code covers life insurance and endowment contracts. Any lump-sum payout you receive (that isn’t an annuity) counts as gross income, but only the portion above what you paid in premiums. Since this is included in “gross income” under Section 72 and not as a capital asset under Section 1221, it’s taxed at your ordinary income rate.

IRS Reference: IRS Publication 525 (Taxable and Nontaxable Income), under “Life Insurance Proceeds,” confirms this: “If you surrender a life insurance policy for cash [or it matures], you must include in income any proceeds that are more than the cost of the life insurance policy.” It is still taxed at ordinary income rates.

To report this in TurboTax

1. Open your return and go to the Federal tab. 
2. Go to Wages & Income and scroll down to Less Common Income.
3. Select Miscellaneous Income, 1099-A, 1099-C (Start/Revisit).
4. Scroll to the very bottom and select Other reportable income.
5. Answer Yes to "Any other taxable income?"
6. Description: Enter "Gain on Maturity of Foreign Life Insurance (LIC India)".
7. Amount: Enter the USD equivalent of your profit (Total Payout minus Total Premiums) in US Dollars