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August 30, 2012 The Tax Lawyer

Playing the U.S. Audit Lottery: An Update for Foreign Taxpayers

Vol. 65, No. 3 - Spring 2012

Guillaume H. Goff & Wright H. Schickli


    This Article is an update of an article published in The Tax Lawyer in 1990 entitled New House Rules for Foreign Taxpayers that Play the U.S. Audit Lottery. The original article was published shortly after Treasury and the Service issued proposed regulations under sections 874(a) and 882(c)(2) (the 1989 Proposed Regulations) but before the final regulations were issued in 1990 (the 1990 Final Regulations). These regulations set forth a process and timeframe within which certain foreign taxpayers must prepare and file individual or corporate U.S. federal income tax returns and contain stiff penalties for noncompliance.

    Since 1990, there have been a number of cases involving unfortunate taxpayers who did not win the U.S. audit lottery, and a flurry of Service administrative rulings and guidance. The developments include a set of temporary regulations issued in 2002 (the 2002 Temporary Regulations) and finalized in 2003 (the 2003 Regulations) that, along with a contemporaneous amnesty program, appeared to signal that the Service would be more flexible in granting foreign taxpayers a waiver of the stringent filing deadlines in appropriate circumstances. Nevertheless, the waiver and amnesty provisions have been interpreted very narrowly, and few, if any, foreign taxpayers appear to have benefited from these exceptions to the filing deadlines.

    Twenty-three years later, the rigid filing deadlines of the 1989 Proposed Regulations remain intact, and waivers seem to remain very elusive and restricted to the rare circumstances described in the Regulations. The 1990 Final Regulations have survived invalidation by the Tax Court in Swallows Holding, Ltd. v. Commissioner and taxpayer challenges that the filing deadlines violate U.S. tax treaty obligations for various reasons.

    Case law and administrative rulings reveal that the Service has not been reluctant to use its new-found power to issue a so-called Doomsday Letter to taxpayers, which denies them tax deductions and credits. Given the recent Service victory in the Mayo Foundation for Medical Education & Research v. United States, it appears the 1990 Final Regulations are here to stay and must be reckoned with by all foreign taxpayers who conduct activities in the United States directly or through certain types of agents.

    This Article summarizes the major provisions of the Regulations under section 874(a) and section 882(c)(2) and discusses the various cases and Service administrative guidance that have addressed the application of the 1989 Proposed Regulations and the 1990 Final Regulations, including some situations that involve pre-effective date years to which neither set of regulations applied.

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