Rev. Proc. 84-35: Small Partnership Relief From the Late Form 1065 Penalty

You run a small partnership. Maybe it is you and your spouse, or you and two friends who bought a rental property together. The Form 1065 went in late, and now the IRS wants thousands of dollars for a return that showed no tax due.

There may be a way out that most people never hear about. It is called Rev. Proc. 84-35, and for the right partnership it can make that penalty go away. The catch is that "the right partnership" is defined narrowly, and the IRS checks.

The Problem Rev. Proc. 84-35 Solves

IRC Section 6698 penalizes a partnership that files Form 1065 late or files it without required information. The penalty is a base amount times the number of partners, for each month or part of a month the failure continues, for up to 12 months. For returns required to be filed in 2026, Rev. Proc. 2024-40 sets that base amount at $255 per partner, per month.

The statute excuses the penalty if the failure was due to reasonable cause. Normally, you have to prove reasonable cause with facts. Rev. Proc. 84-35 is different. For qualifying small partnerships, reasonable cause is presumed. That is a big advantage. You are not arguing about illness or lost records. You are showing that the partnership fits a profile.

For the mechanics of the underlying penalty, see our guide to the Form 1065 late filing penalty.

The Four Criteria

IRM 20.1.2.4.3.1 sets out how the IRS applies Rev. Proc. 84-35. Reasonable cause for filing a late or incomplete return is presumed for a small partnership that meets all of these conditions:

1. 10 or fewer partners. A husband and wife (or their estate) filing a joint return count as one partner for this test.
2. Every partner is an individual or a deceased partner's estate. Nonresident aliens are excluded, so a nonresident alien partner disqualifies the partnership.
3. Same-proportion allocations. Each partner's share of income, deductions, and credits must be allocated in the same proportion as all other items.
4. Every partner reported on a timely filed return. Each partner must have reported his or her share of partnership income on a timely filed income tax return.

All four. Not three out of four.

Where Partnerships Fail the Test

An Entity Partner

The list of qualifying partners is individuals (other than nonresident aliens) and estates of deceased partners. A corporation, another LLC or partnership, or a trust is not on that list. Many modern ownership structures put a holding company or a family trust in the cap table. If your partnership has one, Rev. Proc. 84-35 is likely off the table.

Special Allocations

If the operating agreement gives one partner 70 percent of the depreciation and 50 percent of the income, the allocations are not in the same proportion. That is common in real estate deals and service partnerships. It is also disqualifying under the third criterion.

A Partner Who Filed Late

This is the one that catches people. The partnership's relief depends on every partner's individual return being timely. If one partner filed late, or never reported his or her share of partnership income, the presumption fails for everyone.

And the IRS does not forget. IRM 20.1.2.4.3.1 instructs employees, when abating under Rev. Proc. 84-35, to tell the taxpayer the penalty will be reassessed if the IRS later finds that any partner was not a qualifying partner, filed late, or failed to report his or her share of partnership income. Relief granted on a bad representation is relief on loan.

What Rev. Proc. 84-35 Does Not Cover

• S corporations. IRM 20.1.2.6.3 states plainly that relief under Rev. Proc. 84-35 does not apply to S corporations. The Form 1120-S late filing penalty has its own relief rules.
• The BBA tracking report penalty. IRM 20.1.2.3.12.2.1 says Rev. Proc. 84-35 relief does not apply to the IRC 6698 penalty for a pass-through partner's late Form 8985 tracking report in a centralized partnership audit. Reasonable cause can still be considered there.
• Audit procedure exemptions. IRM 20.1.2.4.3.1 also makes a point worth repeating: being exempt from special partnership audit procedures is not the same thing as being exempt from filing a timely, complete partnership return. Small partnerships still have to file.

Late and Incomplete: A Helpful Rule

Sometimes a return is both late and incomplete. Under IRM 20.1.2.4.3, when the IRS abates an incomplete return penalty, it normally assesses the late filing penalty in its place unless the partnership had reasonable cause for filing late. But there is an exception: if the incomplete return penalty is being abated under Rev. Proc. 84-35, the IRS is told not to assess the late filing penalty. Rev. Proc. 84-35 covers both late and incomplete returns.

How to Request Relief

IRM 21.7.4.4.2.8.2 describes Rev. Proc. 84-35 as allowing reasonable cause abatement of the penalty for filing a late or incomplete return for certain small partnerships. In practice, your request should make the IRS's job easy.

1. File the return. If the Form 1065 is still outstanding, file it. Our guide to catching up unfiled 1065 and 1120-S returns covers multi-year situations.
2. Identify the penalty and tax year. Reference the notice and the specific period.
3. Walk through each criterion. State the number of partners, confirm each is an individual or a deceased partner's estate (and not a nonresident alien), confirm allocations are in the same proportion, and confirm each partner reported his or her share on a timely filed return.
4. Support it. Copies of the Schedules K-1 and the partnership agreement's allocation provisions help. So does confirmation of each partner's filing date.
5. Submit it. The IRS website says written penalty relief requests can be made on Form 843, Claim for Refund and Request for Abatement.

If You Do Not Qualify

Failing Rev. Proc. 84-35 is not the end of the road. IRM 20.1.2.4.3.1 says partnerships that do not qualify may still qualify for abatement under normal reasonable cause criteria. See our guide to reasonable cause for late entity returns.

And there is another option that is often faster. The same IRM section tells IRS employees not to reject an abatement request to get additional information if the partnership qualifies for First Time Abate. FTA covers the IRC 6698(a)(1) late filing penalty for partnerships with a clean three-year history. Our First Time Abate guide for entity returns explains the criteria.

Which should you lead with? That depends. If FTA is available and Rev. Proc. 84-35 is a clean fit, think about the future. Under IRM 20.1.1.3.3.2.1, a penalty removed under FTA in the three-year look-back period keeps FTA from applying to a later year. Rev. Proc. 84-35 is based on who your partners are, not on your history. Spending FTA when you did not need to can cost you later.

A Note on Husband and Wife Partnerships

Spouses who co-own an LLC often file Form 1065 without thinking twice. For Rev. Proc. 84-35, a husband and wife filing a joint return count as one partner. That helps with the 10-partner count. But the other three criteria still apply, including timely filing of the joint return. For more on how spousal LLCs are treated, see our firm's article on husband and wife LLCs and partnership returns.

The Bottom Line

Rev. Proc. 84-35 is one of the cleanest penalty relief tools in the partnership world. For a small partnership of individuals with straight-up allocations and partners who file on time, it can make a painful penalty disappear.

But it is a checklist, not a feeling. Miss one box and it does not apply. If you are not sure your partnership fits, call the Law Offices of Darrin T. Mish, P.A. in Tampa, Florida at 813-229-7100. Small partnerships get a break. They just have to earn it on paper.