I cut and paste from the Introduction and the Conclusion so that those interested will know whether to read the article.
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.
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.