“GOTCHA” — UNANTICIPATED AUDIT ISSUES AFTER QUIET DISCLOSURES

Agostino Pic

Guest post: Attorney Frank Agostino http://www.agostinolaw.com/

I. Introduction

Some taxpayers not willing to pay the 27.5% penalty that otherwise applied under the traditional Offshore Voluntary Disclosure Programs have made quiet disclosures or entered into the Streamlined Filing Compliance Procedures (“Streamlined Program”). Many of these taxpayers rejected the protections of the Offshore Voluntary Disclosure Programs in favor of what they perceived to be a more cost-effective quiet or streamlined disclosure. These taxpayers have subjected themselves to criminal liability and audit adjustments which, depending upon the source of the unreported income, could easily eclipse the 27.5% penalty under the traditional program. In this regard, audits of returns submitted as quiet disclosures or under the Streamlined Program have been (and should be) troubling to both practitioners and clients. This article discusses common audit adjustments that can apply to returns for taxpayers with international activities, including: the disallowance of deductions and credits for U.S. citizens, resident aliens, and nonresident aliens; the disallowance of the foreign earned income exclusion for U.S. citizens and resident aliens; and the Internal Revenue Service’s ability to recharacterize as ordinary income purported gifts and bequests from a partnership or a foreign corporation under Treas. Reg. § 1.672(f)-4.

This article also highlights those taxpayers who are most likely to be negatively affected by each type of adjustment.  Finally, for taxpayers who imprudently made a quiet disclosure, this article discusses how to transition the taxpayer from a quiet disclosure to a traditional Offshore Voluntary Disclosure Program.

II. Audits of Offshore Returns

Generally The audit risk to a taxpayer who corrected errors related to his or her foreign activities often depends upon whether the taxpayer came into compliance under an Offshore Voluntary Disclosure Program, the Streamlined Program, or a quiet disclosure. The authors are unaware of any statistics issued by the Internal Revenue Service (“Service” or “IRS”) in this regard, but there is much to be gleaned from following anecdotal observations.

First, as practitioners likely know, most traditional offshore voluntary disclosures are resolved without a formal audit.2   Thus, the audit risk for taxpayers in a traditional Offshore Voluntary Disclosure Program has been and continues to be relatively low.

Second, the Service does not automatically audit streamlined returns but may select such returns for examination under the existing audit selection process that generally applies to federal tax returns.3 Under the Streamlined Program, eligible taxpayers will not, under the current program, be made liable for failure-to-file penalties, failure-to-pay penalties, accuracy-related penalties, information return penalties, or penalties for failure to file FinCEN Form 114, Report of Foreign Bank and Financial Accounts (“FBAR”).4   Anecdotally, we have seen very few audits of returns submitted under the Streamlined Program. (emphasis mine) Where streamlined returns are audited, those returns have essentially been treated as qualified amended returns in which the revenue agents do not disallow legitimate deductions and credits on the grounds discussed in this article.5 Thus, while there is audit risk for taxpayers in the Streamlined Program, any proposed audit adjustments should not be especially surprising to practitioners.

Third, the Service reviews amended returns submitted as quiet disclosures and can select any return for examination.6 According to a 2013 report by the U.S. Government Accountability Office (“GAO”), upwards of 10,595 quiet disclosures were made between 2003 and 2008, a number much higher than the potential quiet disclosures the Service identified.7 Anecdotally, the Service has taken a much harder line in auditing these quiet disclosures, sometimes disallowing legitimate deductions and credits on the grounds discussed in this article. Thus, for the many returns submitted as quiet disclosures, the risk of audit is high, and the proposed adjustments are potentially sizable.“ (emphasis mine)

Practitioners should understand the various audit adjustments that can apply in deciding the type of disclosure to make or whether to transition from one program (or a quiet disclosure) to another program. The balance of this article discusses the most common and, perhaps, surprising audit adjustments that could apply to taxpayers with international activities.

III. Disallowance of the Foreign Earned Income Exclusion for U.S. Citizens and Resident Aliens

One rule that is often overlooked with respect to late-filed returns submitted by U.S. citizens or resident aliens is that the foreign earned income exclusion may be denied on account of a latefiled return. By way of background, Code Sec. 911(a) authorizes a qualified individual to elect to exclude foreign earned income from his or her gross income.8 The U.S. Department of the Treasury (“Treasury”), pursuant to a specific grant of authority under Code Sec. 911(d)(9), established timing requirements by which an election to exclude foreign earned income must be made.9 Specifically, Treas. Reg. § 1.911-7(a)(2)(i) provides four alternative timing methods by which a taxpayer may make a valid election to exclude foreign earned income, namely: (1) with an income tax return that, including extensions, is timely filed; (2) with an amended return that is filed within three years from the time the original return was filed or within two years from the time the tax with respect to the original return was paid; (3) with an original income return that is filed within one year after the due date of the return (determined without regard to any extension of time to file); or (4) with an income tax return filed after any of the foregoing dates provided that, after taking into account the foreign earned income exclusion, either (i) the taxpayer does not owe federal income tax before or after the Service discovers that the taxpayer failed to elect the exclusion, or (ii) the taxpayer owes federal income tax before the Service discovers that the taxpayer failed to elect the exclusion.10

A recent opinion by the United States Tax Court (“Tax Court”) confirms that the failure to make an election as specified by Treas. Reg. § 1.911-7 can result in total disallowance of the foreign earned income exclusion. Specifically, in McDonald v. Commissioner,11 the Tax Court held that a taxpayer was not entitled to the foreign earned income exclusion because she failed to timely make an election to exclude her income in accordance with Treas. Reg. § 1.911-7(a)(2). The disallowance of the foreign earned income exclusion can be expensive for a U.S. citizen or a resident alien who is otherwise eligible to elect the benefits of such exclusion, but who fails to timely make the election. Thus, especially for taxpayers who made a quiet disclosure, disallowance of the foreign earned income exclusion may be cause for concern.

IV. Reduction in Foreign Tax Credit for U.S. Citizens and Resident Aliens

Another rule that is often overlooked with respect to late-filed returns submitted by U.S. citizens or resident aliens is that a foreign tax credit may be disallowed on account of a late-filed information return reporting an interest in a controlled foreign corporation or a controlled foreign partnership. As practitioners may know, Code Sec. 6038 requires information reporting with respect to ownership interests in certain foreign corporations and partnerships.12 In practice, taxpayers who own an interest in a controlled foreign corporation satisfy the Code Sec. 6038(a) reporting requirement by filing with the Service Form 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations. Taxpayers who own an interest in a controlled foreign partnership satisfy the Code Sec. 6038 reporting requirement by filing with the Service Form 8865, Return of U.S. Persons With Respect to Certain Foreign Partnerships.

Penalties for failing to file required information returns are sizable. Code Sec. 6038(b) authorizes the Service to impose a $10,000 per incident penalty for any taxable year starting after March 18, 2010.13 In addition, Code Sec. 6038(c) generally provides that a failure to timely file a required information return with respect to a controlled foreign corporation or a controlled foreign partnership generally results in a reduction in foreign tax eligible for the foreign tax credit. For the failure to file information returns required by Code Sec. 6038, the amount of foreign taxes paid or deemed paid by the U.S. person for purposes of determining the foreign tax credit under Code Sec. 901 is reduced by 10%.14 The amount of the 10% reduction is increased an additional 5% if the failure to file the information return continues for 90 days or more after the Service notifies the taxpayer of the failure to file.15 Finally, the reduction of the foreign taxes paid is limited to the greater of (i) $10,000, or (ii) the foreign entity’s income for the annual accounting period in which the failure to report occurred.16 For taxpayers who fail to timely file required information returns with respect to an interest in a controlled foreign corporation or a controlled foreign partnership, the reduction of the foreign tax credit can be costly.

A related issue may arise with respect to foreign tax credits claimed by dual citizens (i.e., individuals who are recognized as a resident of both the U.S. and a foreign country). Pursuant to the Model U.S. Tax Treaty, the foreign tax credit is available for dual citizens, but is subject to limitations under U.S. law.17 By way of background, Code Sec. 901 limits the foreign tax credit to “any income, war profits, and excess profits taxes paid or accrued during the taxable year to any foreign country or to any possession of the United States.”18 Code Sec. 903, in turn, extends the foreign tax credit to also include “a tax paid in lieu of a tax on income, war profits, or excess profits otherwise generally imposed by any foreign country or by any possession of the United States.” In order to be creditable under Code Secs. 901 or 903, a “foreign levy” must be a “tax”.19

In general, a foreign levy is a tax only if it requires a compulsory payment pursuant to the authority of a foreign country to levy taxes.20 A payment is not compulsory, and thus not an amount of tax paid for purposes of computing the foreign tax credit, to the extent that the amount paid exceeds the amount of the liability under foreign law.21 Thus, in order for a foreign tax credit to be creditable for U.S. tax purposes, U.S. taxpayers are required to reduce their foreign tax by using all reasonable interpretations and applications of the substantive and procedural provisions of foreign law (including applicable tax treaties).22 The Service takes the position that the amount by which the foreign tax credit could have been reduced – for example, by making an election under foreign law to reduce the taxpayer’s foreign tax liability or by claiming an allowable refund from a foreign tax authority – is a compulsory payment for which no foreign tax credit is allowed.23 As a practical matter, the foregoing limitations on noncompulsory payments tend to fall disproportionately on dual citizens who may lack expertise in tax or the financial means to reduce their foreign tax liability under foreign law. Depending upon the facts of a particular case, to the extent the Service challenges payment of tax to a foreign jurisdiction as noncompulsory, the adjustments as a result of the disallowed foreign tax credit may be sizable.

V. Disallowance of Deductions and Credits for Nonresident Aliens

Still another rule that is often overlooked with respect to late-filed returns submitted by nonresident aliens is that deductions and credits may be disallowed solely on account of the late-filing of the return. For example, in the case of individuals, Code Sec. 874(a) has been interpreted to restrict a nonresident alien taxpayer’s ability to claim deductions and credits with respect to a latefiled return.24 The authority for this interpretation of Code Sec. 874(a) is found in Treas. Reg. § 1.874-1(b)(1), which provides:

(b) Filing deadline for return—(1) General rule. …If no return for the taxable year immediately preceding the current taxable year has been filed, the required return for the current taxable year (other than the first taxable year of the nonresident alien individual for which a return is required to be filed) must have been filed no later than the earlier of the date which is 16 months after the due date, as set forth in section 6072, for filing the return for the current taxable year or the date the Internal Revenue Service mails a notice to the nonresident alien individual advising the nonresident alien individual that the current year return has not been filed and that no deductions or credits … may be claimed by the nonresident alien individual.

The United States Tax Court (“Tax Court”) addressed the nuances of Code Sec. 874 in Espinosa v. Commissioner.25 There, a nonresident alien individual failed to file returns for 1987 through 1991, even though he owned two rental properties in the United States that produced gross rental income totaling approximately $10,000 per year.26 After taking into account the taxpayer’s rental expenses, including depreciation, each property produced an annual loss.27 The Service repeatedly notified the taxpayer of his failure to file returns, but the taxpayer failed to file the requested returns.28 In turn, the Service prepared substitute returns for him under Code Sec. 6020(b) without the benefit of any deductions.29 After the filing of the substitute returns for 1987 through 1991, but before a notice of deficiency was issued, the taxpayer submitted federal income tax returns for all years in issue that reflected net losses on account of the above-described rental expenses.30 The Service declined to process the returns and instead issued a notice of deficiency determining deficiencies on the gross rents received.31

The Tax Court sustained the Commissioner’s deficiency determinations by holding that a nonresident alien may not avoid the sanctions of Code Sec. 874(a) by filing returns after the Service prepared returns for the taxpayer, but before the Service issued a notice of deficiency.32 The Tax Court noted that Code Sec. 874(a), on its face, contained no time limit within which a nonresident alien must file an income tax return. However, the Tax Court looked to the above-quoted Treas. Reg. § 1.1874-1(b)(1) to conclude that Code Sec. 874(a) creates a timely filing requirement. By virtue of the inferred timely filing requirement, the Court ruled that “there is a cut-off point or terminal date after which it is too late to submit a tax return and claim the benefit of deductions.”33 The holding in Espinosa, through a similar reading of Code Sec. 882(c) and Treas. Reg. § 1.882-4(a)(3), has been interpreted to deny deductions and credits to foreign corporations that do not file Federal tax returns within 18 months of the filing deadline.34

Treas. Reg. § 1.874-1(b)(1) and Espinosa clearly can apply to deny otherwise legitimate deductions and credits claimed on nonresident aliens’ late-filed returns. Depending upon the source of the unreported income which prompted the streamlined filing or the quiet disclosure, the cost to a nonresident alien from such disallowed deductions and credits could eclipse the 27.5% penalty that would apply if he or she became compliant with the internal revenue laws through the offshore voluntary disclosure program. Practitioners representing clients who operate a rental activity, a traditional Schedule C trade or businesses, or other expensive-heavy activity, ought to consider whether a quiet disclosure or a submission under the Streamlined Program potentially jeopardizes valuable deductions and credits. For such taxpayers, the traditional Offshore Voluntary Disclosure Program may be the preferred alternative.

VI. Recharacterization of Gifts Through Foreign Partnerships and Corporations

Problems may also arise when taxpayers use partnerships or foreign corporations to make direct or indirect gifts or bequests to U.S. persons. This is because often overlooked Treasury Regulations require a U.S. donee who receives a purported gift or bequest from a partnership or a foreign corporation to include the amount of such gift in his or her income as ordinary income regardless of whether the purported gift or bequest is received directly or indirectly.35 More specifically, in the case of any transfer directly or indirectly from a partnership or foreign corporation which the transferee treats as a gift or bequest, Code Sec. 672(f)(4) authorizes the Service to recharacterize the transfer so as to prevent a foreign grantor from being deemed to own any portion of a trust under the grantor trust rules. Treas. Reg. § 1.672(f)-4(a), in turn, generally requires a U.S. donee who receives a purported gift from a partnership or a foreign corporation to include the amount of such “gift” in his or her income as ordinary income.36

Where a gift is made to a U.S. citizen or a resident alien through a partnership or a foreign corporation, practitioners might be inclined to simply advise clients to not enter into the Offshore Voluntary Disclosure Program and simply file past-due Forms 3520, Annual Return to Report Transactions With Foreign Trusts and Receipt of Foreign Gifts, with an understanding that the failure to file the Form 3520 will be excused under the reasonable cause exception in Code Sec. 6039F(c). Such advice ignores that Treas. Reg. § 1.672(f)-4) can require a U.S. donee who receives a distribution from a partnership or a foreign corporation to include the amount of such distribution as ordinary income. The Service has never raised this argument in a reported decision, and anecdotally, revenue agents are not relying on this regulation in audits of streamlined returns or late-filed Forms 3520. But, the regulation exists, and practitioners should be aware of the adverse impact it may have during an audit of a return submitted as a quiet disclosure or under the Streamlined Program. 

VII. Late Entry Into the Offshore Voluntary Disclosure Program

Taxpayers who unadvisedly filed returns as a quiet disclosure without considering the financial impact of the foregoing adjustments are not without recourse. As applied to taxpayers who made a quiet disclosure, the Service instructs that such taxpayers are still encouraged to participate in the Offshore Voluntary Disclosure Program by “submitting an application, along with copies of their previously filed returns (original and amended), and all other required documents and information … to the IRS’s Voluntary Disclosure Coordinator.”37 Importantly, for a taxpayer to be eligible to transition to the Offshore Voluntary Disclosure Program, the Service may not have initiated a civil examination for any year, regardless of whether the audit relates to undisclosed foreign financial assets.38 Thus, it is important that taxpayers who made quiet disclosures contact the Service before the Service contacts the taxpayer. As applied to taxpayers who submitted returns pursuant to the Streamlined Program, these taxpayers may generally not transition to an Offshore Voluntary Disclosure Program.39 But, as noted above, revenue agents have generally treated such returns as qualified amended returns that do not warrant the same hard line as quiet disclosures. Thus, as a practical matter, the inability to transition from the Streamlined Program to a traditional Offshore Voluntary Disclosure Program is less concerning.

VIII. Conclusion

Practitioners worry about audits of returns submitted as quiet disclosures for good reason. The Service has been far less draconian in submissions under a traditional Offshore Voluntary Disclosure Program or the Streamlined Program, but revenue agents have taken a hard line in disallowing otherwise deductions and credits with respect to quiet disclosures. In this regard, the Service is granted broad authority to deny legitimate deductions, credits, and income exclusions, and to recast transactions to not only prevent the avoidance of U.S. tax but to impute income to U.S. donees and legatees. Practitioners should consider these issues when advising taxpayers to submit returns as quiet disclosures, pursuant to the Streamlined Program, or under the traditional Offshore Voluntary Disclosure Program. Finally, it is important for practitioners to reevaluate whether the quiet disclosure was in fact a more cost-effective alternative than the traditional Offshore Voluntary Disclosure Program before being contacted by the Service.

Footnotes:
1. Frank Agostino, Esq. is a principal of, and Lawrence A. Sannicandro, Esq. is an associate at Agostino & Associates, P.C.
2. See, e.g., IRS, Offshore Voluntary Disclosure Program, Frequently Asked Questions and Answers 2014, Q&A-1, https://www.irs.gov/Individuals/International-Taxpayers/Offshore-Voluntary-Disclosure-Program-Frequently-AskedQuestions-and-Answers-2012-Revised (last updated Feb. 8, 2016) (noting that the 2009, 2012, and 2014 Offshore Voluntary Disclosure Programs have “enabled the IRS to centralize the civil processing of offshore voluntary disclosures and to resolve a very large number of cases without examination”).
3. See IRS, Streamlined Filing Compliance Procedures, https://www.irs.gov/Individuals/International-Taxpayers/ Streamlined-Filing-Compliance-Procedures (last updated Aug. 6, 2015). Of course, in the context of the Offshore Voluntary Disclosure Program, an audit will normally not be made, though the Service reserves the right to conduct an examination. See IRS, Offshore Voluntary Disclosure Program Frequently Asked Questions and Answers, FAQ 27, https://www.irs.gov/Individuals/International-Taxpayers/Offshore-Voluntary-Disclosure-Program-FrequentlyAsked-Questions-and-Answers (last updated June 10, 2015).
4. See IRS, U.S. Taxpayers Residing Outside the United States, https://www.irs.gov/Individuals/ InternationalTaxpayers/U-S-Taxpayers-Residing-Outside-the-United-States (last updated Aug. 12, 2015). Of course, if streamlined returns are selected for audit, and it is determined that the original tax compliance was fraudulent or willful, then the Service reserves the right to assert such penalties. Id.
5. The qualified amended return procedure is designed to address civil violations of the Internal Revenue Code in a manner that protects the taxpayer from certain accuracy-related penalties. A qualified amended return is an amended return that is filed after the original properly extended due date of the return but before any of the following events:
(1) The date the taxpayer is first contacted by the IRS for any examination, including a criminal investigation;
 (2) The date any person is contacted for a tax shelter promoter examination under section 6700 with respect to any tax benefit claimed on the return;
(3) The date the IRS issues a John Doe summons under section 7609(f) relating to the tax liability of a person, group, or class that includes the taxpayer;
(4) The date the Commissioner announces a settlement initiative to compromise or waive penalties with respect to a listed transaction; and/or
(5) With respect to a pass-through item, the date the pass-through entity is first contacted by the IRS for any examination with respect to the entity’s return.
See Treas. Reg. § 1.6662-2(c)(3). The qualified amended return procedure allows a taxpayer to treat the amount of tax reported as the tax reported on the original return so that the accuracy-related penalty will not apply. Treas. Reg. § 1.6664-2(c)(2). However, if the IRS determines that the failure to report is due to fraud, the taxpayer is potentially liable for criminal prosecution, or at the very least a fraud penalty equal to 75% of the underpayment of tax. In addition, the QAR procedure does not protect the taxpayer from other civil penalties. For a discussion of qualified amended returns, see Correcting an Incorrect Tax Return: Amended Returns and Voluntary Disclosure, AGOSTINO & ASSOCIATES, P.C. NEWSLETTER, (Jan. 2014), available at https://drive.google.com/file/ d/0B719qAMBEjGQeGNxN3Q1Umx5Ums/edit.
6. IRS, Voluntary Disclosure: Questions and Answers, Q&A-49, https://www.irs.gov/uac/Voluntary-Disclosure:- Questions-and-Answers (last updated Dec. 2, 2015). A quiet disclosure typically involves the taxpayer filing amended returns, including delinquent FBARs and international information returns, and paying the resulting tax and interest on previously unreported offshore income without otherwise notifying the Service. A taxpayer who makes a quiet disclosure does not receive immunity from potential criminal prosecution or from the assessment of civil and criminal monetary penalties.
7. U.S. GOV’T ACCOUNTABILITY OFFICE, GAO-13-318, OFFSHORE TAX EVASION: IRS HAS COLLECTED BILLIONS OF DOLLARS, BUT MAY BE MISSING CONTINUED EVASION, 24 (2013). The GAO was clear that the Service should pay attention to these quiet disclosures, because “[i]f taxpayers are able to quietly disclose and pay fewer penalties than they would have in an offshore program, the incentive for other noncompliant taxpayers to participate in a program is reduced.” Id. at 23.
8. To qualify for the foreign earned income exclusion, the taxpayer must generally satisfy a three-part test: (1) the taxpayer must be a U.S. citizen who is a bona fide resident of a foreign country for an entire taxable year or physically present in a foreign country at least 330 days out of a 12-month period, see Code Sec. 911(d)(2); (2) the taxpayer must have earned income from personal services rendered in a foreign country, see Code Sec. 911(d)(2); and (3) the taxpayer’s home for the period must be outside of the United States, see Code Sec. 911(d)(3).
9. See generally Treas. Reg. § 1.911-7.
10. Treas. Reg. § 1.911-7(a)(2)(i). Additionally, a taxpayer filing an income tax return pursuant to Treas. Reg. § 1.911-7(a)(2)(i)(D) (i.e., under either of the fourth alternatives) must type or legibly print at the top of the first page of the Federal income tax return claiming the exclusion: “Filed Pursuant to Section 1.911-7(a)(2)(i)(D).” Treas. Reg. § 1.911-7(a)(2)(i)(3).
11. T.C. Memo. 2015-69. The taxpayer in McDonald challenged the validity of Treas. Reg. § 1.911-7(a)(2), but the Tax Court upheld the regulation as meeting steps one and two of the two-step test articulated by the U.S. Supreme Court in Chevron, U.S.A., Inc. v. Nat’l Res. Dev. Council, 467 U.S. 837, 842-43 (1984).
12. Code Sec. 6038(a). Moreover, Code Sec. 6046(a) require the following persons, among others, to file a Form 5471 information return: (1) a U.S. citizen or resident who is an officer or director of a foreign corporation in which a U.S. person acquires 10% or more of the stock’s value or voting power or an additional interest that brings his or her interest in the foreign corporation to 10% or more; (2) a U.S. person who acquires a 10% or greater interest in a foreign corporation, or an additional interest that brings his or her interest in a foreign corporation to 10% or more; (3) each person who becomes a U.S. person while owning 10% or more of the value or voting power of a foreign corporation; and (4) a U.S. person who disposes of enough stock in the foreign corporation to reduce his or her ownership to less than 10%. See Treas. Reg. § 1.6046-1(c)(1). Code Sec. 6046A requires the following persons to file a Form 8865 information return: (1) a U.S. person who acquires an interest in a foreign partnership; (2) a U.S. person who disposes of an interest in a foreign partnership; or (3) a U.S. person whose “proportional interest in a foreign partnership changes substantially. See Treas. Reg. § 1.6046A-1. A partner’s proportional interest in a foreign partnership may change for a number of reasons, including by operation of the partnership agreement by reason of changes in other partners’ interests resulting from a partner withdrawing from the partnership. Treas. Reg. § 1.6046A-1(b)(3). Finally, it is worth noting that the period of limitations on assessment with respect to an information return does not begin to run until three years after the date on which the Commissioner is furnished with the information required to be reported on such return. Code Sec. 6501(c)(8). 13. Code Sec. 6038(b)(1). Once the Service has notified the taxpayer of a delinquent filing, Code Sec. 6038(b)(2) authorizes an additional $10,000 penalty for each 30-day period (or fraction thereof) that the taxpayer fails to cure the delinquent filing after receiving notice thereof, up to a maximum of $50,000.
14. Code Sec. 6038(c)(1)(B).
15. Code Sec. 6038(c)(1).
16. Code Sec. 6038(c)(2), (3). A domestic corporation which desires to avoid a reduction in the foreign tax credit must make an affirmative showing of all facts alleged as reasonable cause for such failure in the form of a written statement containing a declaration that is made under penalties of perjury. See Treas. Reg. § 1.6038-1(j)(4). No similar exception is available for individuals. See generally Treas. Reg. § 1.6038-1.
17. See UNITED STATES MODEL INCOME TAX CONVENTION OF NOVEMBER 15, 2006, Art 23.
18. Code Sec. 901(b)(1).
19. See Treas. Reg. § 1.901-2(a)(1).
20. Treas. Reg. § 1.901-2(a)(2)(i).
21. Treas. Reg. § 1.901-2(e)(5)(i).
22. Id.
23. See, e.g., id.; IRS Chief Counsel Advice 2009040714014556 (Apr. 7, 2009); IRS Chief Counsel Advice 200622044 (Sept. 5, 2006); see also IRS Tech. Adv. Mem. 200807015 (Nov. 7, 2007). To the extent the statute of limitations for claiming the refund in the foreign jurisdiction has expired, the taxpayer has no effective and practical remedies to reduce his or her tax, and the amount otherwise available to be refunded is a compulsory payment that is creditable. See Treas. Reg. § 1.901-2(e)(5)(ii), Ex. 4.
24. Code Sec. 874(a), entitled “Return prerequisite to allowance,” provides as follows:
A nonresident alien individual shall receive the benefit of the deductions and credits allowed to him in this subtitle only by filing or causing to be filed with the Secretary a true and accurate return, in the manner prescribed in subtitle F (sec. 6001 and following, relating to procedure and administration), including therein all the information which the Secretary may deem necessary for the calculation of such deductions and credits. This subsection shall not be construed to deny the credits provided 
For a thorough analysis of the history of Code Sec. 874(a), and the corollary rules that applies to foreign corporations under Code Sec. 882(c), see Guillaume H. Goff, Playing the U.S. Audit Lottery: An Update for Foreign Taxpayers, 65 TAX LAW. 511 (2012).
25. 107 T.C. 146 (1996).
26. Id. at 147.
27. Id.
28. Id. at 148.
29. Id.
30. Id.
31. Id.
32. Id. at 150, 158.
33. Id. at 157.
34. See, e.g., Code Sec. 882(c), Treas. Reg. § 1.882-4(a)(3); see also Swallows Holding, Ltd. v. Commissioner, 515 F.3d 162, 172 (3d Cir. 2008), vacating 126 T.C. 96 (2006). Treas. Reg. § 1.882-4(a)(3)(i) requires that a foreign corporation file a return within 18 months of the filing deadline set forth in Code Sec. 6072 to claim deductions and credits.
35. See generally Treas. Reg. § 1.672(f)-4.
36. Treas. Reg. § 1.672(f)-4(a)(1), (2). Numerous exceptions to the general rule are available. First, a transfer will not be recharacterized as ordinary income if the U.S. donee establishes to the satisfaction of the Service that: (1) a U.S. citizen or resident alien individual who directly or indirectly held and interest in the partnership or foreign corporation treated and reported the purported gift or bequest for federal tax purposes as a distribution to such individual and a subsequent gift or bequest to the U.S. donee; or (2) a nonresident alien individual who directly or indirectly held an interest in the partnership or foreign corporation treated and reported the purported gift or bequest for purposes of the tax laws of the nonresident alien’s individual country of residence as a distribution to such individual and a subsequent gift or bequest to the U.S. donee, and to the extent applicable, that the U.S. donee timely complied with the reporting requirements of Code Sec. 6039F (i.e., the U.S. donee filed a Form 3520, Annual Return to Report Transactions With Foreign Trusts and Receipt of Foreign Gifts) See Treas. Reg. § 1.672(f)-4(b)(1). Second, a gift or bequest from a domestic partnership will not be recharacterized as ordinary income if the U.S. donee establishes to the satisfaction of the Service that all beneficial owners of the partnership are U.S. citizens or residents or domestic corporations. See Treas. Reg. § 1.672(f)-4(b)(2). Third, the transfer will not be recharacterized as ordinary income if the U.S. donee is a corporation which can establish that the purported gift or bequest was treated for U.S. tax purposes as a contribution to the capital of the corporate donee. Treas. Reg. § 1.672(f)-4(b)(3). Fourth, the transfer will not be recharacterized as ordinary income if the U.S. donee is a taxexempt charitable, religious, educational, scientific, or other similar organizations described in Code Sec. 170(c) or one that received a ruling or determination letter under Code Sec. 501(c)(3). See Treas. Reg. § 1.672(f)-4(b)(4). Fifth, under a catch-all provision that generally applies to all instances in which a donee seeks to avoid U.S. taxes, Treas. Reg. § 1.672(f)‑4(e) grants the Service broad discretion to recharacterize the transaction in accordance with the form or economic substance of the transfer. Fifth, irrespective of the foregoing rules, a transfer will not be recharacterized as ordinary income if the amount of the transfer did not exceed $10,000. See Treas. Reg. § 1.672(f)-4(f).
37. See IRS, Offshore Voluntary Disclosure Program, Frequently Asked Questions and Answers 2014, Q&A-1, https:// www.irs.gov/Individuals/International-Taxpayers/Offshore-Voluntary-Disclosure-Program-Frequently-AskedQuestions-and-Answers-2012-Revised (last updated Feb. 8, 2016).
38. IRS, Offshore Voluntary Disclosure Program, Frequently Asked Questions and Answers 2014, Q&A-14, https:// www.irs.gov/Individuals/International-Taxpayers/Offshore-Voluntary-Disclosure-Program-Frequently-AskedQuestions-and-Answers-2012-Revised (last updated Feb. 8, 2016).
39. See IRS, Streamlined Filing Compliance Procedures, https://www.irs.gov/Individuals/International-Taxpayers/ Streamlined-Filing-Compliance-Procedures (last updated Aug. 6, 2015) (stating that once a taxpayer makes a submission under the Streamlined Program, the taxpayer may not participate in the Offshore Voluntary Disclosure Program).