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Passive income and the strict reporting requirements

While the taxes you pay concerning foreign investments may not always be large, the failure to comply with rules pertaining to reporting of this income can result in severe consequences. The rules for reporting such income are also highly complex.

Most importantly, it is important to understand how serious the penalties for noncompliance with these rules can be. For example, the minimum penalty to simply not filing a Foreign Bank Accounting Report (FBAR) can exceed $10,000 or 10 percent of the value of the foreign account.

Additionally, there are fees related to filing forms related to filing foreign investment information that can prove costly as well. These foreign investment fees can result in you receiving a much smaller return.

A number of years ago, it was possible to place money into foreign mutual funds without having to pay taxes on the growth of such accounts. This resulted in the U.S. government passing of the Passive Foreign Investment Company (PFIC) rules under Section 1291. The Section 1291 rules require yearly reporting of PFIC income if amounts held in accounts are more than $25,000. However, these rules do not apply to pension accounts.

Under 26 U.S. Code § 1297, passive income concerns income regarding an activity in which you, the taxpayer, are not materially involved in maintaining. This could include income from rental property or from mutual funds. In any case, taking a distribution regarding this passive income can result in harsh penalties under the rules.

A simple review of these rules should tell any Michigan taxpayer how stringent the requirements are, and how confusing the language regarding tax regulations can be. Again, mistakes in reporting will be extremely costly for you and your family. For this reason, it's always a good idea to speak to experienced tax representation should you have any questions regarding reporting requirements.

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