IRS's Waiver of Penalties in Two Years Does Not Require Agency to Abate Penalties in Two Other Years With Similar Facts

The fact that the IRS waives a penalty in one year does not require that the IRS must waive the penalty in a later year was the holding of the United States District Court of the District of South Dakota in the case of Battle Flat, LLC v. United States, Docket No. 5:13-cv-05070 (2015 TNT 184-15).

The issue in this case involved a partnership that filed its returns late for a number of years. 

The partnership in question had fewer than 10 partners, all of whom were natural persons or estates.  Such small partnerships can qualify for automatic relief from late filing penalties pursuant to Revenue Procedure 84-35.

To qualify for relief under Revenue Procedure 84-35, the partnership must meet the following criteria:

A domestic partnership composed of 10 or fewer partners and coming within the exceptions 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 requested 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. 

The partnership in question met the size criteria, but it turned out the partnership was not the only late filer involved here.  Some of the partners had also not timely filed their return.

Despite that fact, the IRS had granted reasonable cause relief for the late filing for two years.  But the IRS denied relief for another pair of years and the partnership protested.

The partnership complained about this inconsistent treatment but the Court found the partnership had no cause to complain.  As the opinion notes:

Battle Flat...asserts the IRS "has not consistently or even-handedly" applied Revenue Procedure 84-35. (Docket 20 at p. 3). The IRS' decision not to enforce Revenue Ruling 84-35 benefitted Battle Flat. Battle Flat's contention the IRS has not "even-handedly" enforced Revenue Ruling 84-35 based in part on the IRS removal of the 2006 penalties is without merit. The IRS expressly noted the penalty was removed "based solely on [Battle Flat's] compliance history" and explained "this type of penalty removal is a one-time consideration available only for a first-time penalty charge." (Docket 23-1 at p. 1). The IRS has not inconsistently applied Revenue Procedure 84-35 or unfairly enforced the procedure by removing Battle Flat's 2006 late-filing penalty.

Battle Flat asserts the IRS inconsistently enforced Revenue Procedure 84-35 because the 2009 late-filing penalty was removed and refunded.6 (Docket 20 at p. 1). The court is unable to discern if Battle Flat's partners failed to timely file their 2009 personal income tax returns. Compare Docket 20 at p. 1 ("[N]ot all partners timely filed their income tax returns in those years [2006, 2007, 2008, and 2009]."), with (Docket 19 at p. 3) (referencing only "2006, 2007, and 2008" when stating that "not all partners timely filed their income tax returns.").7

The IRS informed Battle Flat that it removed the late-filing penalty:

[B]ased on [Battle Flat's] statement that [it] qualif[ied] for penalty relief under Rev. Proc. 84-35 . . . The penalty will be reassessed if [the IRS] later find[s] that [Battle Flat] does not qualify for relief because . . . [a]ny partner filed late or failed to report their distributive share of partnership items on their income tax return.

(Docket 23-2 at p. 1).

Even if a partner of Battle Flat failed to timely file his or her 2009 personal income tax return, any error by the IRS in failing to verify that Battle Flat and its partners actually complied with Revenue Procedure 84-35 does not preclude the IRS from enforcing the procedure for the 2007 and 2008 tax years. See Tigrett v. United States, 213 F. App'x 440, 450 (6th Cir. 2007) ("[T]he IRS'[ ] erroneous treatment of an issue one year does not preclude its subsequent correction of its error in other tax years.") (citing Knights of Columbus Council No. 3660 v. United States, 783 F.2d 69, 73 (7th Cir. 1986)); see also Hawkins v. C.I.R., 713 F.2d347, 351-52 (8th Cir. 1983) ("[I]t is settled that even if the Commissioner erroneously may have accepted the tax treatment of certain items in previous years, he is not precluded from correcting that error in a subsequent year.") (citing Harrah's Club v. United States, 661 F.2d 203, 205 (Ct. Cl. 1981)). Finally, the court is reminded that "[e]ach tax year stands on its own." Kliethermes v. United States, 27 Fed. Cl. 111, 114 (1992). The IRS did not inconsistently apply Revenue Procedure 84-35 or unfairly enforce the procedure by removing and refunding portions of Battle Flat's 2009 late-filing penalty.

The Court also refused to ignore the Revenue Ruling, finding that it is entitled to deference as a reasonable application of the underlying law.  The partnership noted that the law itself imposed no “timely filing” requirements on the partners, but the Court held:

The IRS' position is persuasive. Although § 6698 does not expressly impose a timeliness requirement by which partners in a "small" partnership must file their personal income tax return in lieu of filing a partnership tax return, this is exactly the type of interpretative question left to the discretion of the IRS in implementing our nation's tax laws. See Mead Corp., 533 U.S. at 227-28. The IRS' interpretation that partners in a "small" partnership timely file their personal income tax returns is reasonable and is a highly practical aid in its assessment of the tax consequences of a partnership for a given year and on a year-over-year basis. IRS' interpretation is consistent with the legislative history of § 9968 in that it strains credulity to characterize a personal income tax return filed years after the reporting deadline as an adequate, full reporting of each partner's share of the partnership's income and deductions. See H.R. REP. 95-1445, 75.