IRS Clarifies that Rev. Proc. 84-35 Still Applies to Small Partnerships
It’s always good to get answers to unresolved questions, and it’s even better when the answer provides good news. IRS recently provided such an answer in PMTA 2020-01, posted to the IRS website on January 15. In this memo, the Office of Chief Counsel answered an important lingering question we’ve had since 2018:
Is the penalty relief granted to small partnerships by Revenue Procedure 84-35, 1984-1 C.B. 509,[i] for failure to file a partnership return obsolete since the Bipartisan Budget Act of 2015 (BBA) replaced TEFRA with new unified partnership audit procedures beginning in 2018? (see this post for more detailed analysis of this question)
In its recent memo, the IRS states that Revenue Procedure 84-35 is not obsolete and continues to apply. The memo goes on to say:
The repeal of the small partnership exception in IRC § 6231(a)(1)(B) does not affect the scope of the penalty under IRC § 6698 for failure to file a partnership return. Revenue Procedure 84-35 allows the IRS to implement procedures requiring partnerships claiming relief under Revenue Procedure 84-35 to demonstrate that they are entitled to this relief.
What does this mean?
First, remember that Rev. Proc. 84-35 does not exempt small partnerships from the requirement of filing a Form 1065, U.S. Return of Partnership Income. Rather, it provides a method to establish “reasonable cause” to get out from under the onerous failure to file penalty if certain conditions are met. The most recent inflation adjustment set the penalty at $210/month/per partner for failure to file a partnership return in 2021 (for the 2020 tax year).[ii]
Chief counsel advice issued in 2017 (CCA 201733013) stated that good cause could be established under Rev. Proc. 84-35 if the partnership met the requirements and the examiners followed the procedures set forth in IRM 18.104.22.168.3.1(2):
- The partnership must consist of 10 or fewer partners. For the purpose of this requirement, a husband and wife (or their estate) filing a joint return is considered one partner.
- Each partner is either an individual (excluding nonresident aliens), or the estate of a deceased partner.
- Each partner's items of income, deductions, and credits are allocated in the same proportion as all other items of income, deductions, and credits.
- The partnership has not elected to be subject to the consolidated audit procedures under I.R.C. §§ 6221 through I.R.C. § 6233 (subchapter C).
- Each partner reported his or her share of partnership income on his or her timely filed income tax return.
The CCA concluded by stating that Rev. Proc. 84-35 “does not provide an automatic exemption to partnerships from the requirement of filing a Form 1065.” Rather, the “penalty may be avoided if it is shown that the failure to file a complete or timely return was due to reasonable cause.”
The recent program manager technical advice clarifies that Rev. Proc. 84-35 is still available to establish this reasonable cause.
And that's good news!
[i] A domestic partnership composed of 10 or fewer partners and coming within the exception outlined in section 6231(a)(1)(B) of the Code will be considered to have met the reasonable cause test and will not be subject to the penalty imposed by section 6698 for the failure to file a complete or timely partnership return, provided that the partnership, or any of the partners, establishes, if so required by the Internal Revenue Service, that all partners have fully reported their shares of the income, deductions, and credits of the partnership on their timely filed income tax returns.
[ii] Rev. Proc. 2019-44.
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