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Tom Talks Taxes - March 21, 2022
Mitigating problems from a missed pass-through entity extension
March 15, 2022 — just last week — was the federal deadline for calendar year 2021 partnership and S corporation returns. By that date, a taxpayer had to either file a return or request a deadline extension using Form 7004, Application for Automatic Extension of Time To File Certain Business Income Tax, Information, and Other Returns. The extended deadline is September 15, 2022.
What if neither a return nor an extension was filed? The entity is subject to a penalty of $210 for each month or part of a month the return is late (up to a maximum of 12 months) multiplied by the total number of partners in the partnership during any part of the partnership's tax year or the total number of shareholders in the S corporation during any part of the S corporation's tax year. The partnership late-filing penalty is found in §6698, and the S corporation late-filing penalty is found in §6699.
First things first — the taxpayer should attempt to minimize the late-filing penalty by filing the return on or before April 15, 2022. Filing the return on April 16, 2022 or later will lead to an additional monthly penalty since the penalty applies for each month or part of a month that it is late. All subsequent months will end on the 15th of each month; therefore, going beyond each additional 15th of the month will lead to increased monthly penalties. This definition of a month is found in Treas. Reg. §301.6651-1(b), which the Internal Revenue Manual (IRM) says applies to these penalties as well.
If the lRS assesses a late-filing penalty, then there are three ways to attempt to get it abated:
First Time Abate (FTA). This provision applies to the partnership and S corporation late filing penalties. The IRS will remove the penalty if no penalties were assessed in the prior three years. FTA can apply even if the entity did not exist in all of the prior three years. The entity must be in filing and payment compliance to qualify for FTA. The IRS generally applies FTA before considering reasonable cause. See IRM 22.214.171.124.3.2.1 (10-19-2020), First Time Abate (FTA).
Rev. Proc. 84-35. Under this provision, reasonable cause for filing a late or incomplete return will be presumed for certain small partnerships if four criteria are met: (1) The partnership must consist of 10 or fewer partners. For the purpose of this requirement, two spouses (or their estate) filing a joint return is considered one partner; (2) Each partner is either an individual (excluding nonresident aliens), or the estate of a deceased partner; (3) Each partner's items of income, deductions, and credits are allocated in the same proportion as all other items of income, deductions, and credits; (4) Each partner reported the partner’s share of partnership income on the partner’s timely filed income tax return. This relief does not apply to S corporations. See IRM 126.96.36.199.3.1 (03-09-2022), Revenue Procedure 84−35.
Reasonable Cause. The taxpayer must show it exercised ordinary business care and prudence, but nevertheless was unable to timely file the return. The IRS considers four factors: (1) taxpayer’s reason; (2) compliance history; (3) length of time; (4) circumstances beyond the taxpayer’s control. A reasonable cause narrative should have specific details, including dates and actions taken to get into compliance as soon as possible. See IRM 188.8.131.52.2.2 (02-22-2008), Ordinary Business Care and Prudence.
In addition, certain elections may now be unavailable to the entity because of the late-filed return. Most statutory or regulatory elections must be made by the due date of the return, either including or excluding extensions. Some examples of common elections that must be made by the due date of the return including extensions are:
Election out of the centralized partnership audit regime (CPAR),
De minimis safe harbor (DMSH) election for amounts paid to acquire or produce tangible property,
Safe harbor election for small taxpayers for costs of work performed on owned or leased buildings, and
Election out of §168(k) bonus depreciation.
One major exception is that the §179 expensing election can be made on a late-filed tax return per Treas. Reg. §1.179-5(a).
Treasury regulations do provide for automatic late election relief in two circumstances:
Certain uncommon elections can be made on an amended or late-filed return within 12 months of the original or extended due date under Treas. Reg. §301.9100-2(a). Examples include the §472 last-in, first-out (LIFO) inventory method, the §444 taxable year election, and the §754 election to adjust basis on partnership transfers and distributions.
Any elections required to be made by the due date of the return including extensions can be made on an amended return filed within six months of the original due date under Treas. Reg. §301.9100-2(b); however, the return has to be timely filed by the original due date for this relief to be available.
If a taxpayer does not qualify for automatic late election relief, then the taxpayer can request an extension of time to make the election via private letter ruling if the taxpayer meets the requirements in Treas. Reg. §301.9100-3. A private letter ruling is costly; however, the benefit may outweigh the cost in some circumstances.
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