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Late Filings by Individual Partners Preclude Abatement of Penalty for Late Form 1065.

(Parker Tax Publishing September 28, 2015)

Where some partners did not timely file their personal income tax returns, a partnership did not qualify for the reasonable cause exception to the Code Sec. 6698 penalty for late filing of the partnership tax return. The court held that Rev. Proc. 84-35 reasonably interpreted this exception as requiring all partners to timely file their personal returns. Battle Flat, LLC v. U.S., 2015 PTC 340 (D. S.D. 2015).

Battle Flat, LLC, is a partnership with 10 or fewer partners (small partnership) that was assessed a penalty under Code Sec. 6698 for late filing of its Form 1065 for tax years 2007 and 2008. The IRS had previously abated a Code Sec. 6698 penalty against Battle Flat in 2006. When the IRS refused to abate the penalty for 2007 and 2008, the partnership took its case to a district court. Battle Flat and the IRS disputed the amount of deference, if any, owed to Rev. Proc. 84-35, which sets forth the procedures under which small partnerships will not be subject to the penalty imposed by Code Sec. 6698 for failure to timely file a partnership return.

OBSERVATION: Battle Flat received an abatement of a late filing penalty for 2006, even though the LLC apparently did not meet the requirements of Rev. Proc. 84-35. In its correspondence with the taxpayer, the IRS stated that the abatement was based solely on the partnership's compliance history, and that the type of penalty relief granted was a one-time consideration available only for a first-time penalty.

Practice Aid: See Parker ¶ 320,430 for a sample letter requesting abatement of the Code Sec. 6698 late filing penalty under the provisions of Rev. Proc. 84-35.

Under Code Sec. 6698(a), the IRS can assess penalties for each month (or fraction thereof) against a partnership for failing to file a partnership tax return, Form 1065, on or before the filing deadline. The penalty provisions do not apply if the partnership's failure to timely file its tax return is due to reasonable cause. The term "reasonable cause" is not defined in the statute. Instead, the taxpayer bears the burden of proving it meets the reasonable cause exception.

Rev. Proc. 84-35 provides that a domestic partnership composed of 10 or fewer partners will generally be considered to have met the reasonable cause test and will not be subject to the penalty imposed by Code Sec. 6698 for the failure to file a complete or timely partnership return, provided that the partnership, or any of the partners, establishes, if so requested by the IRS, that all partners have fully reported their shares of the income, deductions, and credits of the partnership on their timely filed income tax returns.

Not all Battle Flat partners timely filed their income tax returns in 2007 and 2008. For the 2007 tax year, six partners of Battle Flat failed to timely file their personal income tax returns. For the 2008 tax year, three Battle Flat partners failed to timely file their personal income tax returns. Battle Flat requested that the court not enforce Rev. Proc. 84-35, arguing that reasonable cause exception is satisfied so long as all the partners in a small partnership file their personal income tax returns, timely or otherwise.

The district court found Battle Flat's interpretation of the exception to be unreasonable, siding with the IRS. The court noted that neither Code Sec. 6698 nor its legislative history explicitly impose a requirement that the individual partners timely file his or her individual income tax returns in order for the partnership to qualify for the reasonable cause exception and thereby be exempt from the penalty provisions of Code Sec. 6698. Only Rev. Proc. 84-35 imposes the requirement that the partners timely file his or her individual tax returns, and the court found that requirement to be a reasonable interpretation of the penalty exception. The court noted that the IRS has consistently held the position that the reasonable cause exception to Code Sec. 6698 requires all partners in a small partnership to timely file their individual personal income tax returns, and enforced Rev. Proc. 84-35.

The district court also noted that the Eighth Circuit, to which the district court's decision would be appealable, has not explicitly addressed the level of deference owed to an IRS revenue procedure. The court looked to various Supreme Court decisions and concluded that deference should be given to Rev. Proc. 84-35.

For a discussion of the late filing penalty under Code Sec. 6698, see Parker Tax ¶28,550. (Staff Editor Parker Tax Publishing)

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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