Relief from Partnership Late-Filing Penalties

If a partnership files its return after the original due date, either without a timely extension request or after the extension period expires, the IRS will likely assess a late-filing penalty under Sec. 6698, assuming the partnerships failure to file the return was not willful (thus, Sec. 7203 criminal penalties would not apply). As will be discussed, Rev. Proc. 84-35 may assist partnerships in avoiding the Sec. 6698 late-filing penalty in certain circumstances.

Filing Rules

Under Sec. 6031(a), a partnership is required to file a return annually and, according to Sec. 6031(b), provide partners with a Schedule K-1. Regs. Sec. 1.6031(a)-1(e)(2) states the due date is the 15th day of the fourth month following the close of the partnerships tax year. Accordingly, for calendar-year partnerships, the returns due date is April 15 of the following year. Partnerships can automatically extend this date initially for three months by filing Form 8736, Application for Automatic Extension of Time To File U.S. Return for a Partnership, REMIC, or for Certain Trusts, on or before the original due date. Because this extension is automatic, the partnership does not have to provide a reason. The first extended due date is July 15 of the following year.

A partnership needing a second extension has to file Form 8800, Application for Additional Extension of Time To File a U.S. Return for a Partnership, REMIC, or for Certain Trusts, by the end of the first extension period, to request an extension of up to another three months. According to Form 8800s instructions, the partnership has to provide reasonable cause for requesting the second extension. If the full three-month period is granted, a calendar-year partnership can extend its return until October 15 of the following year.

If the partnership does not follow these rules (but is not willful), the Service will likely assess a Sec. 6698 penalty, which is $50 per month (or fraction of a month)not to exceed five monthsmultiplied by the number of partners in the partnership during any part of the tax year.

Example: A calendar-year partnership with 10 partners discovers on Aug. 1, 2004, that its 2003 Form 1065, Partners Share of Income (Loss) From an Electing Large Partnership, was not timely extended by April 15, 2004. It files that form by the end of August 2004. The IRS assesses a penalty of $2,500 (10 partners x 5 months x $50).

Late-Filing Relief

According to Sec. 6698(a), the Service will waive the late-filing penalty for reasonable cause, provided the partnership can meet that standard. Moreover, one districts interpretation of reasonable cause may not be consistent with that of other districts or employees, resulting in potential relief being granted only to some partnerships. Thus, reasonable cause is something to rely on only as a last resort.

Many tax advisers may not realize that Rev. Proc. 84-35 grants automatic relief from Sec. 6698s late-filing penalties, in certain circumstances. If a partnerships facts are covered by the ruling, the IRS will withdraw the Sec. 6698 penalty assessment. Rev. Proc. 84-35 was discussed in detail in Service Center Advice (SCA) 200135029.

Rev. Proc. 84-35 applies to partnerships not covered by the special rules in Secs. 62216234, on the tax treatment of partnership items, added to the Code by the Tax Equity and Fiscal Responsibility Act of 1982. Under Sec. 6231(a)(1)(B), these provisions do not apply to partnerships having 10 or fewer partners each of whom is an individual (other than a nonresident alien), a C corporation, or an estate of a deceased partner. However, Rev. Proc. 84-35 was issued prior to the Taxpayer Relief Act of 1997, which significantly amended Sec. 6231(a)(1)(B). When the procedure was issued, this section only exempted partnerships if (1) the partnership had 10 or fewer partners, each of whom was a natural person (other than a nonresident alien) or an estate and (2) each partners share of each  partnership item was the same as his or her share of every other item. Apparently, the Service takes the position that Rev. Proc. 84-35 applies only to partnerships exempt under the original version of Sec. 6231(a)(1)(B).

Accordingly, under Rev. Proc. 84-35, the following partnerships will qualify for an automatic waiver of the Sec. 6698 late-filing penalty for a partnership return, if:

• The partnership has 10 or fewer partners, all of whom are natural persons (other than nonresident aliens) or estates;

• Each partners share of each partnership item is the same as such partners share of every other item;

• The partnership can establish, if requested by the IRS, that all partners have fully reported their shares of income, deductions and credits on their timely filed returns.

More Notice?

In SCA 200135029, the Assistant Chief Counsel for Administrative Provisions and Judicial Practice, at the urging of a community organization, recommended that the IRS adopt procedures to inform partnerships of the relief granted by Rev. Proc. 84-35. It suggested that the Service include information on the possible application of the ruling with any late-filing penalty notice issued. The Service is not consistently providing this notice to partnerships; when it is, partnerships and their advisers are still generally unaware of the potential for relief.

Conclusion

If a partnership fails to qualify for relief under Rev. Proc. 84-35, it will have to rely on reasonable cause to avoid late filing penalties. If it fails to qualify under the procedure because, for example, it has one or more corporate (or other nonqualifying partners) that own only a small percentage of partnership equity, it might help to argue that the affected partnership should not be treated materially differently from a qualifying partnership simply because of the minimal amount of nonqualifying ownership. However, such partnerships will be at the mercy of the reviewer of the abatement request.

From Thomas A. Boman, CPA, J.D., Advantage Capital Partners, St. Louis, MO (Not affiliated with Baker Tilley International)