Small Partnerships Are Not Automatically Exempt From Filing Returns

UILC: 6031.04-02, 6698.00-00
Release Date: 8/18/2017

Date: July 12, 2017

CC:PA:01 - POSTU-119552-17

to:
Julie A. Schwoebel
Senior Attorney
TEGEDC:GL:CHI
(TEGE Division Counsel)

from:
Blaise Dusenberry
Senior Technician Reviewer
Branch 1
CC:PA:1
(Procedure & Administration)

subject:
Rev. Proc. 81-11 and Rev. Proc. 84-35

This Chief Counsel Advice responds to your request for assistance. This advice may not be used or cited as precedent.

ISSUE

Whether Rev. Proc. 84-35, 1984-1 C.B. 509, superseding Rev. Proc. 81-11, 1981-1 C.B. 651, provides an automatic exemption to partnerships from the requirement of filing a Form 1065, U.S. Return of Partnership Income.

SUMMARY CONCLUSION

No. Neither I.R.C. § 6031 nor I.R.C. § 6698 contain an automatic exception to the general filing requirement set forth in I.R.C. § 6031(a). Although the I.R.C. § 6698 penalty may be avoided if it is shown that the failure to file a complete or timely return was due to reasonable cause, such relief may be granted under Rev. Proc. 84-35 if the partnership meets its requirements and examiners follow the procedures set forth in IRM 20.1.2.3.3.1.

BACKGROUND

You have asked if Rev. Proc. 84-35 provides an automatic exemption to partnerships from the requirement of filing a Form 1065. Those revenue procedures provide that a domestic partnership with 10 or fewer partners that falls within the exceptions in I.R.C. § 6231(a)(1)(B) is deemed to have met the reasonable cause test, and, therefore, would not be liable for the I.R.C. § 6698 penalty. You contend that although the partnership is not relieved of the filing requirement, there is almost automatic reasonable cause relief for the failure to file a partnership return.

LAW AND ANALYSIS

Partnership Return Filing Requirement

Section 6031 of the Code requires every partnership (as defined in section 761(a)) to file a return for each taxable year.¹ The return must include all items of gross income and deductions allowable under subtitle A. In addition, the return must provide the names of all the partners and their distributive share of partnership income.

The Section 6698 Failure to File Penalty

Partnerships that fail to timely file a complete partnership return as required by section 6031(a) are subject to a penalty under section 6698, unless the failure to comply with the section 6031(a) is due to reasonable cause.² The section 6698 penalty is imposed for each month, or fraction thereof, during which the failure to comply with section 6031(a) continues, but not to exceed five months.³ The penalty is computed at a rate of $195 multiplied by the total number of partners in the partnership during any part of the tax year for which the return was due.⁴ The amount of the penalty is adjusted for inflation for partnership returns required to be filed after the 2014 calendar year.⁵ The penalty is assessed directly against the partnership.⁶ It may be imposed in addition to the criminal penalties under section 7203.⁷ Deficiency procedures do not apply.⁸

Generally, when a partnership fails to file a partnership return as required by section 6031(a), the partnership is subject to the section 6698 penalty.⁹ The penalty can be assessed either automatically or manually when the partnership fails to timely file a complete Form 1065 or when a substitute for return is prepared by the Internal Revenue Service (Service) and reasonable cause is not established.¹⁰ The penalty may be assessed before the partnership has an opportunity to assert reasonable cause or after the Service has considered and rejected the taxpayer's claim. In either case, the Service will generally reconsider the penalty either upon the taxpayer's request or when the delinquent return is filed or selected for examination.¹¹

Reasonable Cause Relief

Neither section 6031 nor section 6698 contains an exception to the general filing requirement set forth in section 6031(a). As noted above, however, the section 6698 penalty may be avoided if it is shown that the failure to file a complete or timely return was due to reasonable cause.¹² In relevant part, the legislative history of section 6698 provides as follows:

Revenue Procedure 84-35

With the Congressional intent in mind, the Service published guidance in the form of a revenue procedure containing criteria under which partnerships with 10 or fewer partners will not be subject to the penalty under section 6698. See Rev. Proc. 84-35, 1984-1 C.B. 509, superseding Rev. Proc. 81-11, 1981-1 C.B. 651. In relevant part, the revenue procedure provides:

Rev. Proc. 84-35 § 3.01.

Rev. Proc. 84-35 Does Not Provide Automatic Relief In Every Case

Although Rev. Proc. 84-35 does provide some relief for failure to file a partnership return, we disagree that the guidance provides for almost automatic reasonable cause relief for the failure to file a partnership return. Generally, the Service does not know whether the partnership meets the reasonable cause criteria or qualifies for relief under Rev. Proc. 84-35 unless and until the partnership files a partnership return or some other document with the Service. The individual partners' income tax returns, even if timely filed and complete, are not linked together during their initial processing. Thus, the Service generally does not know how many partners are in the partnership or whether all of the partners timely filed their income tax returns unless and until the partnership (or one of its partners) is selected for an audit.

Moreover, partnerships having a trust or corporation as a partner, tier partnerships, and partnerships where each partner's interest in the capital and profits are not owned in the same proportion, or where all items or income, deductions, and credits are not allocated in proportion to the pro rata interest, do not come within the exception of section 6231(a)(1)(B) and, as such, are not covered by Rev. Proc. 84-35.¹⁴ In addition, the revenue procedure provides that “[a]lthough a partnership of 10 or fewer partners may not be automatically excepted from the penalty imposed by section 6698 . . . under section 3.01 [of the revenue procedure], the partnership may show other reasonable cause for failure to file a complete or timely partnership return.”¹⁵ In that case, the determination of reasonable cause must generally be made on a case-by-case basis, taking all of the relevant fact and circumstances into consideration.¹⁶