For many years, the penalty for failure to file a partnership return was $50 per partner per month for a maximum of 5 months. At $250 per partner, some small partnerships opted not to file the return; the cost of preparing the return would be more than the maximum penalty exposure. Especially if the owners were already reporting their shares of entity-level income, filing the return was more a formality than anything else.
Over the last couple of years, similar penalties have been extended to S corporations, and the penalty rates have been creeping up. The current penalty rate is $89 per partner/shareholder per month for a maximum of 12 months. That works out to $1,068 per partner/shareholder for an unfiled return. This is more significant, but still invites the cost/benefit question.
The new legislation extending unemployment benefits and the homebuyer credit (it became law in November) includes a little noticed provision that increases these penalties again. The new penalty rate will be $195 per partner/shareholder per month for a maximum of 12 months. Now the maximum penalty will work out to $2,340 per partner/shareholder for an unfiled return. The budget estimates accompanying the legislation anticipate collecting over $1.2 billion of additional penalties over the next 10 years as a result of the change.
The increased penalty applies to returns for 2010 and future years. This means that the additional penalty won't start to apply until 2011. The new penalty rates change the landscape, and flow-through entities that have previously made their filing decision based on a cost/benefit analysis might want to revisit that decision.
The new penalty regimen will primarily affect small partnerships. Most S corporations understand they need to file a tax return, even if the S corporation has only one shareholder. Partnerships are different. The dividing line for tax purposes between partnerships and other co-ownership arrangements is often very vague. Some taxpayers erroneously assume that if they only have a "joint venture," they need not file a partnership tax return. Disregarding penalty issues, if the co-owners are reporting their share of joint venture income, the failure to treat the joint venture as a partnership and file a partnership tax return on its behalf is largely a "no harm, no foul" issue. At the new penalty rate, however, participants in these co-ownership arrangements might want to reconsider whether their joint activity rises to the level of something that is technically characterized as a partnership for tax purposes and whether it would be prudent to begin filing partnership tax returns to limit the penalty exposure.
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