Reasonable Cause for Late Partnership and S Corporation Returns

"We had a good reason" is what every business owner says after a late return. The IRS hears it all day. Most of those reasons do not work, not because they are untrue, but because they do not fit the legal standard.

If your partnership or S corporation filed late and does not qualify for First Time Abate or small partnership relief, reasonable cause is the main road left. Here is what the IRS actually looks for, and how to give it to them.

Where Reasonable Cause Comes From

Both entity late filing penalties have a reasonable cause exception written into the statute. IRC 6698(a) imposes the partnership return penalty "unless it is shown that such failure is due to reasonable cause." IRC 6699(a) uses the same language for S corporation returns. For how the penalties are computed, see our guides to the Form 1065 late filing penalty and the Form 1120-S late filing penalty.

The statute does not define reasonable cause. The IRS's working definition is in IRM 20.1.1.3.2: relief is generally granted when the taxpayer exercised ordinary business care and prudence in determining its tax obligations but was nevertheless unable to comply. IRM 20.1.1.3.2.1 also points to Treas. Reg. 301.6651-1(c), the failure to file regulation, as containing examples that may help in determining whether reasonable cause exists.

Before You Argue Reasonable Cause

Check the easier doors first. IRM 20.1.1.3.3.2.1 says administrative waivers like First Time Abate are considered before reasonable cause. Small partnerships may qualify for presumed reasonable cause under Rev. Proc. 84-35. See our guides to First Time Abate for entity returns and Rev. Proc. 84-35 relief.

And file the return. IRM 20.1.2.4.3 states that reasonable cause is not demonstrated, and cannot be presumed, as long as the failure continues. A relief request for a return that still has not been filed is a request the IRS can deny on its face.

The Questions the IRS Asks

IRM 20.1.1.3.2 lists the questions IRS employees consider when weighing reasonable cause:

1. What happened, and when did it happen?
2. During the period of noncompliance, what facts and circumstances prevented the taxpayer from filing?
3. How did those facts and circumstances result in the failure?
4. How did the taxpayer handle the rest of its affairs during that time?
5. Once the circumstances changed, what did the taxpayer do to comply?

Your request should answer every one of those questions. Directly. With dates.

The IRM also states that reasonable cause does not exist if, after the circumstances that explain the noncompliance end, the taxpayer fails to comply within a reasonable period of time. A crisis in January does not excuse a return filed in December.

What Ordinary Business Care Looks Like

IRM 20.1.1.3.2.2 says ordinary business care and prudence includes making provisions for business obligations to be met when reasonably foreseeable events occur. The IRS reviews four things:

• Your reason. The dates and explanation must line up with the penalty period.
• Compliance history. The IRS checks at least three prior years. A first-time failure helps but does not by itself establish reasonable cause.
• Length of time. How long between the event and when you finally complied.
• Circumstances beyond your control. Whether the event could have been anticipated.

IRM 20.1.1.3.5 adds that the burden of proving entitlement to relief is generally on the taxpayer.

Reasons That Can Work

Death, Serious Illness, or Unavoidable Absence

This is often the strongest category, but entities face a twist. Under IRM 20.1.1.3.2.2.1, for a corporation or other entity, the illness or absence of the responsible person can establish reasonable cause if that person had sole authority to execute the return.

If someone else was authorized to file, the IRS will ask why that person did not. And if only one person was authorized, the IRS will ask whether that arrangement was itself consistent with ordinary business care. A small LLC run by one managing member should expect that question.

The IRM lists what to provide: the relationship of the parties, the date of death, the dates and severity of the illness, how the event prevented compliance, whether other business obligations were impaired, and whether tax duties were handled promptly once the situation passed.

Fire, Casualty, or Natural Disaster

IRM 20.1.1.3.2.2.2 first asks whether the entity was an "affected taxpayer" covered by official disaster relief. If not, a fire or disaster can still support reasonable cause, but the event alone is not enough. The IRS looks at timing, the effect on the business, steps taken to comply, and whether the entity filed once it became possible.

Unable to Obtain Records

Pass-through entities depend on records from others: bank statements, brokerage reports, and sometimes K-1s from lower-tier partnerships. IRM 20.1.1.3.2.2.3 says inability to obtain records may establish reasonable cause in some cases but not others. The IRS will want to know why the records were needed, what steps were taken to get them, whether other means were explored, why the entity did not estimate the information, and whether it filed promptly once the records arrived.

That estimate question is the one most requests skip. Have an answer for it.

System Problems

The IRS's reasonable cause web page lists system issues that delayed a timely electronic filing as an example of a reason that may qualify. Keep rejection notices and screenshots.

Reasons That Usually Fail

"Our CPA Didn't File It"

This is the most common excuse and one of the weakest. IRM 20.1.1.3.2.2.5 says reliance on another party to comply generally is not reasonable cause, particularly for filing obligations, because the taxpayer's responsibility cannot be delegated. IRM 20.1.1.3.3.4.3 adds that reliance on a tax advisor's advice may help only in very limited instances involving technical or complicated substantive issues, and the duty to file generally cannot be excused by reliance on an advisor.

There is a narrow difference between "my accountant forgot" and "my accountant advised me, on a genuinely technical question, that no return was required." The second can sometimes be argued. The first almost never.

Mistakes and Forgetfulness

IRM 20.1.1.3.2.2.4 says a mistake generally does not meet the ordinary business care standard, though the reason for it may support other facts. IRM 20.1.1.3.2.2.7 says the same about forgetfulness. "We lost track of the deadline" is not a reason. It is a confession.

Ignorance of the Law

Under IRM 20.1.1.3.2.2.6, not knowing about a filing requirement can support reasonable cause only together with other facts. The IRS considers education, whether the taxpayer was previously subject to the requirement, prior penalties, recent changes in forms or law, and the complexity of the issue. Reasonable cause is never presumed just because ignorance is claimed.

That can matter for LLC owners who did not realize their entity was classified as a partnership, or for owners of a newly formed entity. It rarely helps an entity that has filed the same return for years.

Building the Request

1. File every delinquent return first. Our guide to catching up unfiled 1065 and 1120-S returns covers the process.
2. Identify the penalty and period. IRM 20.1.1.3.5 says the request should identify the penalty and address reasons that apply to it.
3. Tell a dated story. Match each event to the filing deadline and to the date the return was actually filed.
4. Explain the rest of the business. If the business kept operating normally while the return sat, address why.
5. Attach proof. The IRS web page mentions items like hospital or court records or a doctor's letter with start and end dates, documentation of disasters, and copies of letters and responses.
6. Submit it properly. The IRS says some penalties can be reduced by phone, and written requests can be made on Form 843, Claim for Refund and Request for Abatement.

For a broader look at how the IRS treats small business compliance problems, see our firm's guide to IRS problems for small businesses.

The Bottom Line

Reasonable cause is not about whether you had a bad year. It is about whether a careful business, facing what you faced, still could not have filed on time. The facts have to carry that argument, and the dates have to match.

If your partnership or S corporation needs to make that case, call the Law Offices of Darrin T. Mish, P.A. in Tampa, Florida at 813-229-7100. A good reason helps. A documented one wins arguments.