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I was just informed that our partnership failed to file tax returns for a number of years. All partners received pro forma Schedules K-1, timely filed our individual tax returns, and reported all of our income from the partnership. What should we do?

Even though partnership tax returns are furnished for information purposes, i.e., no tax is due with this return, substantial penalties can apply for failure to timely file these returns.  Aside from potential criminal penalties for willful failures to file, see Internal Revenue Code (“I.R.C.”) § 7203, a simple late filing can result in substantial civil penalties.  Pursuant to I.R.C. § 6698, an untimely or incomplete Form 1065 will result in a monthly penalty equal to $195 multiplied by the number of partners in the partnership.  The penalty is capped at 12 months.  Consequently, a 10-partner partnership that files its Form 1065 over a year late will face an automatically assessed penalty of $23,400.

Fortunately, I.R.C. § 6698 provides that these penalties will not apply if it is “shown that such failure is due to reasonable cause.”  In other words, after the partnership receives a shocking notice from the Internal Revenue Service for trying to rectify past mistakes, the partnership may make a case to eliminate these penalties.  While “reasonable cause” is usually predicated on the facts and circumstances of the case, the Internal Revenue Service has a long-standing procedure whereby small partnerships will be granted relief from I.R.C. § 6698 penalties, without specific factual showings.  Under Rev. Proc. 84-35, 1984-1 C.B. 509, if the partnership satisfies the following elements, reasonable cause will be established:

(1) a domestic partnership;

(2) composed of 10 or fewer partners;

(3) all partners are natural persons (other than nonresident aliens) or an estate of a deceased partner;

(4) each partner’s share of partnership items is allocated in proportion to the partner’s interest in the partnership;

(5) all partners timely filed their income tax returns; and

(6) all partners fully reported their share of income, deductions, and credits of the partnership.

Even if relief is unavailable under Rev. Proc. 84-35, partnerships may still qualify for relief from these penalties through First Time Abatement (Internal Revenue Manual 20.1.1.3.6.l (08-15-2014)) or by establishing other grounds for reasonable cause.  As lingering penalties may result in unwelcome collection action, such as levies and Notices of Federal Tax Lien, they should be addressed as soon as possible.  And while I.R.C. § 6699 imposes similar penalties for failures to file S-corporation returns (Forms 1120S), relief is technically unavailable under Rev. Proc. 84-35; however, S-corporations may still advance analogous arguments to establish reasonable cause.

If your partnership has not filed returns or has been assessed penalties for late filing, you should contact a tax professional. For a free consultation, please call Brandon Mourges at 410.951.1149 or e-mail at bmourges@rosenbergmartin.com.

Rosenberg Martin Greenberg

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Phone: 410-727-6600
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Rosenberg Martin Greenberg

705 Melvin Avenue Annapolis, MD 21401
Phone: 410-727-6600
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