California: Two conflicting decisions on small partnership penalty relief, conformity

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Detailed California Development

The California Office of Tax Appeals recently released conflicting decisions in two cases involving partnerships seeking relief from the per-partner late filing penalties. The first case, Too Fun Designs, involved a taxpayer that had formed a two-person partnership to sell items she made as part of her crocheting hobby. The taxpayer was unaware that the partnership had a tax filing obligation until two years later, when she attended a small business association meeting on taxation. After she filed the past-due returns, the California Franchise Tax Board assessed a per-partner late-filing penalty of $432. The taxpayer argued that California should abate the penalty because the IRS had abated the late-filing penalties. The federal relief was permitted for the first year under the IRS First-Time Abatement program, to which California does not conform; for the second year, the IRC provided relief under the “small partnership” penalty relief provision in Revenue Procedure 84-35 that applies to partnerships with 10 or fewer partners, as long as the partners timely filed returns reporting their shares of the partnership's income deductions and credits. The ALJs, agreeing with the taxpayer, determined in a non-precedential decision that California conforms to the relief available under Revenue Procedure 84-35 and abated the penalty for both years.

In the second case issued just one day after Too Fun Designs, the OTA determined that California does not conform to Revenue Procedure 84-35. In Auburn Old Town Gallery, a 60-member LLC timely paid its LLC fee and tax, but because of an oversight by the taxpayer’s accountant, its return was filed a year late. The late filing resulted in the Franchise Tax Board assessing a per-partner late-filing penalty of $12,960. The ALJs, this time in a precedential decision, sided with the Franchise Tax Board, finding that the oversight did not establish reasonable cause. The ALJs also noted that small partnership penalty relief was not available to the taxpayer, stating “California does not conform to Revenue Procedure 84-35. No analysis of the conformity issue was provided so it’s not clear why the ALJs flipped their determination, but the taxpayer clearly exceeded the 10-partner limit imposed by Revenue Procedure 84-35.  

Although the two decisions conflict as to whether California conforms to Revenue Procedure 84-35, the non-precedential Too Fun Designs decision provides an analysis why it does apply in California. Therefore, partnerships with 10 or fewer partners facing late filing penalties may be able to use the reasoning in Too Fun Designs to get relief using the using the same arguments used by the ALJs in that decision.  Please contact Gina Rodriquez at 916-551-3132 with questions on these two decisions.

This Week's Developments

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Sarah McGahan

Sarah McGahan

Managing Director, State & Local Tax, KPMG US