Interest and Penalties

Interest

Interest is charged on taxes not paid by the due date, even if an extension of time to file is granted. Interest is also charged from the due date (including extensions) to the date of payment on the failure to file penalty, the accuracy-related penalty, and the fraud penalty. The interest charged is figured at a rate determined under section 6621.

Late Filing of Return

A penalty is assessed against the partnership if it is required to file a partnership return and it (a) fails to file the return by the due date, including extensions, or (b) files a return that fails to show all the information required, unless such failure is due to reasonable cause. If the failure is due to reasonable cause, attach an explanation to the partnership return. If no tax is due, the penalty is $50 for each month or part of a month (for a maximum of 5 months) the failure continues, multiplied by the total number of persons who were partners in the partnership during any part of the partnership's tax year for which the return is due. If tax is due, the penalty is the amount stated above plus 5% of the unpaid tax for each month or part of a month the return is late, up to a maximum of 25% of the unpaid tax. If the return is more than 60 days late, the minimum penalty is $100 or the balance of the tax due on the return, whichever is smaller.

Late Payment of Tax

A partnership that does not pay the tax when due generally may have to pay a penalty of ½ of 1% a month or part of a month for each month the tax is not paid, up to a maximum of 25%. The penalty is imposed on the net amount due. The penalty will not be imposed if the partnership can show that failure to pay on time was due to reasonable cause.

Failure To Furnish Information Timely

For each failure to furnish Schedule K-1 to a partner when due and each failure to include on Schedule K-1 all the information required to be shown (or the inclusion of incorrect information), a $50 penalty may be imposed with respect to each Schedule K-1 for which a failure occurs. The maximum penalty is $100,000 for all such failures during a calendar year. If the requirement to report correct information is intentionally disregarded, each $50 penalty is increased to $100 or, if greater, 10% of the aggregate amount of items required to be reported, and the $100,000 maximum does not apply.

Trust Fund Recovery Penalty

This penalty may apply if certain excise, income, social security, and Medicare taxes that must be collected or withheld are not collected or withheld, or these taxes are not paid. These taxes are generally reported on:

• Form 720, Quarterly Federal Excise Tax Return;
• Form 941, Employer's Quarterly Federal Tax Return;
• Form 943, Employer's Annual Tax Return for Agricultural Employees; or
• Form 945, Annual Return of Withheld Federal Income Tax.

The trust fund recovery penalty may be imposed on all persons who are determined by the IRS to have been responsible for collecting, accounting for, and paying over these taxes, and who acted willfully in not doing so. The penalty is equal to the unpaid trust fund tax. See the instructions for Form 720; Pub. 15, Circular E, Employer's Tax Guide; or Pub. 51, Circular A, Agricultural Employer's Tax Guide, for more details, including the definition of a responsible person.

Accounting Methods

Figure ordinary income using the method of accounting regularly used in keeping the partnership's books and records. Generally, permissible methods include:

• Cash,
• Accrual, or
• Any other method authorized by the Internal Revenue Code.

In all cases, the method used must clearly reflect income. Generally, if inventories are required, the accrual method must be used for sales and purchases of merchandise. However, qualifying taxpayers and eligible businesses of qualifying small business taxpayers are excepted from using the accrual method and may account for inventoriable items as materials and supplies that are not incidental. For more details, see Schedule A - Cost of Goods Sold, on page 18.

Generally, a partnership may not use the cash method of accounting if (a) it has at least one corporate partner, average annual gross receipts of more than $5 million, and it is not a farming business or (b) it is a tax shelter (as defined in section 448(d)(3)). See section 448 for details.

Under the accrual method, an amount is includible in income when:

• All the events have occurred that fix the right to receive the income which is the earliest of the date: (a) the required performance takes place, (b) payment is due, or (c) payment is received, and
• The amount can be determined with reasonable accuracy.

See Regulations section 1.451-1(a) for details.

Generally, an accrual basis taxpayer can deduct accrued expenses in the tax year in which:

• All events that determine liability have occurred,
• The amount of the liability can be figured with reasonable accuracy, and
• Economic performance takes place with respect to the expense.

There are exceptions to the economic performance rule for certain items, including recurring expenses. See section 461(h) and the related regulations for the rules for determining when economic performance takes place.

Long-term contracts (except for certain real property construction contracts) must generally be accounted for using the percentage of completion method described in section 460. See section 460 for general rules on long-term contracts.

Change in accounting method. Generally, the partnership must get IRS consent to change its method of accounting used to report income (for income as a whole or for any material item). To do so, it must file Form 3115, Application for Change in Accounting Method. It may also have to make an adjustment to prevent amounts of income or expense from being duplicated or omitted. This is called a section 481(a) adjustment, which is taken into account over a period not to exceed 4 years.

Example. The partnership changes to the cash method of accounting. It accrued sales in 2000 for which it received payment in 2001. It must report those sales in both years as a result of changing its accounting method and must make a section 481(a) adjustment to prevent duplication of income.

See Rev. Proc. 99-49, 1999-2 C.B. 725, to figure the amount of a section 481(a) adjustment. Include any positive section 481(a) adjustment on page 1, line 10. If the section 481(a) adjustment is negative, report it on Form 1065-B, line 23. For more information, see Pub. 538, Accounting Periods and Methods.

Mark-to-Market Accounting Method for Dealers in Securities

Generally, dealers in securities must use the mark-to-market accounting method described in section 475. Under this method, any security that is inventory to the dealer must be included in inventory at its fair market value (FMV). Any security that is not inventory and that is held at the close of the tax year is treated as sold at its FMV on the last business day of the tax year, and any gain or loss must be taken into account in determining gross income. The gain or loss taken into account is generally treated as ordinary gain or loss. For details, including exceptions, see section 475 and the related regulations.

Dealers in commodities and traders in securities and commodities may elect to use the mark-to-market accounting method. To make the election, the partnership must file a statement describing the election, the first tax year the election is to be effective, and, in the case of an election for traders in securities or commodities, the trade or business for which the election is made. The statement must be filed by the due date (not including extensions) of the partnership return for the tax year immediately preceding the election year and attached to that return, or if applicable, to a request for an extension of time to file that return. For more details, see Rev. Proc. 99-17, 1999-1 C.B. 503, and sections 475(e) and (f).

Accounting Periods

A partnership is generally required to have one of the following tax years:

1. The tax year of a majority of its partners (majority tax year).
2. If there is no majority tax year, then the tax year common to all of the partnership's principal partners (partners with an interest of 5% or more in the partnership profits or capital).
3. If there is neither a majority tax year nor a tax year common to all principal partners, then the tax year that results in the least aggregate deferral of income.
4. Some other tax year, if:
   • The partnership can establish that there is a business purpose for the tax year (see Rev. Proc. 87-32, 1987-2 C.B. 396); or
   • The tax year is a grandfathered year (see Rev. Proc. 87-32); or
   • The partnership elects under section 444 to have a tax year other than a required tax year by filing Form 8716, Election to Have a Tax Year Other Than a Required Tax Year. For a partnership to have this election in effect, it must make the payments required by section 7519 and file Form 8752, Required Payment or Refund Under Section 7519.

A section 444 election ends if a partnership changes its accounting period to its required tax year or some other permitted year or it is penalized for willfully failing to comply with the requirements of section 7519. If the termination results in a short tax year, type or legibly print at the top of the first page of Form 1065-B for the short tax year, SECTION 444 ELECTION TERMINATED.

To change an accounting period, see Pub. 538 and Form 1128, Application To Adopt, Change, or Retain a Tax Year (unless the partnership is making an election under section 444).

Note: The tax year of a common trust fund must be the calendar year.

Rounding Off to Whole Dollars

You may round off cents to whole dollars on your return and accompanying schedules. To do so, drop amounts under 50 cents and increase amounts from 50 to 99 cents to the next higher dollar.

Recordkeeping

The partnership must keep its records as long as they may be needed for the administration of any provision of the Internal Revenue Code. The partnership usually must keep records that support an item of income, deduction, or credit on the partnership return for 3 years from the date the return is due or is filed, whichever is later. It also must keep records that verify its basis in property for as long as they are needed to figure the basis of the original or replacement property.

The partnership should also keep copies of all returns it has filed. They help in preparing future returns and in making computations when filing an amended return.

Administrative Adjustment Requests

To correct an error on a Form 1065-B already filed, file Form 8082, Notice of Inconsistent Treatment or Administrative Adjustment Request (AAR). Generally, an adjustment to a partnership item requested on Form 8082 will flow through to the partners and be taken into account in determining the amount of the same item for the partnership tax year in which the IRS allows the adjustment. If the income, deductions, credits, or other information provided to any partner on Schedule K-1 are incorrect under section 704 in the partner's distributive share of any partnership item shown on Form 1065-B, file an amended Schedule K-1 (Form 1065-B) for that partner with the Form 8082. Also give a copy of the amended Schedule K-1 to that partner.

See the Form 8082 instructions for details on how to file the amended Form 1065-B.

A change to the partnership's Federal return may affect its state return. This includes changes made as a result of an examination of the partnership return by the IRS. For more information, contact the state tax agency for the state in which the partnership return is filed.

Other Forms, Returns, and Statements That May Be Required

• Forms W-2 and W-3, Wage and Tax Statement; and Transmittal of Wage and Tax Statements. Use these forms to report wages, tips, other compensation, and withheld income, social security and Medicare taxes for employees.
• Form 720, Quarterly Federal Excise Tax Return. Use Form 720 to report environmental excise taxes, communications and air transportation taxes, fuel taxes, luxury tax on passenger vehicles, manufacturers' taxes, ship passenger tax, and certain other excise taxes.

• Form 940 or Form 940-EZ, Employer's Annual Federal Unemployment (FUTA) Tax Return. The partnership may be liable for FUTA tax and may have to file Form 940 or Form 940-EZ if it paid wages of $1,500 or more in any calendar quarter during the calendar year (or the preceding calendar year) or one or more employees worked for the partnership for some part of a day in any 20 different weeks during the calendar year (or the preceding calendar year).
• Form 941, Employer's Quarterly Federal Tax Return. Employers must file this form quarterly to report income tax withheld on wages and employer and employee social security and Medicare taxes. Agricultural employers must file Form 943, Employer's Annual Tax Return for Agricultural Employees, instead of Form 941, to report income tax withheld and employer and employee social security and Medicare taxes on farmworkers.
• Form 945, Annual Return of Withheld Federal Income Tax. Use this form to report income tax withheld from nonpayroll payments, including pensions, annuities, IRAs, gambling winnings, and backup withholding. See Trust Fund Recovery Penalty on page 4.
• Forms 1042 and 1042-S, Annual Withholding Tax Return for U.S. Source Income of Foreign Persons; and Foreign Person's U.S. Source Income Subject to Withholding. Use these forms to report and send withheld tax on payments or distributions made to nonresident alien individuals, foreign partnerships, or foreign corporations to the extent these payments or distributions constitute gross income from sources within the United States that is not effectively connected with a U.S. trade or business. A domestic partnership must also withhold tax on a foreign partner's distributive share of such income, including amounts that are not actually distributed. Withholding on amounts not previously distributed to a foreign partner must be made and paid over by the earlier of (a) the date on which Schedule K-1 is sent to that partner or (b) the 15th day of the 3rd month after the end of the partnership's tax year. For more information, see sections 1441 and 1442 and Pub. 515, Withholding of Tax on Nonresident Aliens and Foreign Corporations.
• Form 1096, Annual Summary and Transmittal of U.S. Information Returns.
• Form 1098, Mortgage Interest Statement. Use this form to report the receipt from any individual of $600 or more of mortgage interest (including points) in the course of the partnership's trade or business and reimbursements of overpaid interest.
• Forms 1099-A, B, INT, LTC, MSA, MISC, OID, R, and S. You may have to file these information returns to report acquisitions or abandonments of secured property; proceeds from broker and barter exchange transactions; interest payments; payments of long-term care and accelerated death benefits; miscellaneous income payments; distributions from an Archer MSA; original issue discount; distributions from pensions, annuities, retirement or profit-sharing plans, IRAs, insurance contracts, etc.; and proceeds from real estate transactions. Also, use certain of these returns to report amounts that were received as a nominee on behalf of another person.

For more information, see the General Instructions for Forms 1099, 1098, 5498, and W-2G, and the separate specific instructions for each type of information return you file (for example, Instructions for Forms 1099-MISC).

Note: Every partnership must file Forms 1099-MISC if, in the course of its trade or business, it makes payments of rents, commissions, or other fixed or determinable income (see section 6041) totaling $600 or more to any one person during the calendar year.

• Form 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations. A partnership may have to file Form 5471 if it (a) controls a foreign corporation; or (b) acquires, disposes of, or owns 10% or more in value or vote of the outstanding stock of a foreign corporation; or (c) owns stock in a corporation that is a controlled foreign corporation for an uninterrupted period of 30 days or more during any tax year of the foreign corporation, and it owned that stock on the last day of that year.
• Form 5713, International Boycott Report, is used by persons having operations in, or related to, a boycotting country, company, or national of a country, to report those operations and figure the loss of certain tax benefits. The partnership must give each partner a copy of the Form 5713 filed by the partnership if there has been participation in, or cooperation with, an international boycott.
• Form 8264, Application for Registration of a Tax Shelter. Tax shelter organizers must file Form 8264 to get a tax shelter registration number from the IRS.
• Form 8271, Investor Reporting of Tax Shelter Registration Number. Partnerships that have acquired an interest in a tax shelter that is required to be registered use Form 8271 to report the tax shelter's registration number. Attach Form 8271 to any return on which a deduction, credit, loss, or other tax benefit attributable to a tax shelter is taken or any income attributable to a tax shelter is reported.
• Form 8275, Disclosure Statement. File Form 8275 to disclose items or positions, except those contrary to a regulation, that are not otherwise adequately disclosed on a tax return. The disclosure is made to avoid the parts of the accuracy-related penalty imposed for disregard of rules or substantial understatement of tax. Form 8275 is also used for disclosures relating to preparer penalties for understatements due to unrealistic positions or disregard of rules.
• Form 8275-R, Regulation Disclosure Statement, is used to disclose any item on a tax return for which a position has been taken that is contrary to Treasury regulations.
• Forms 8288 and 8288-A, U.S. Withholding Tax Return for Dispositions by Foreign Persons of U.S. Real Property Interests; and Statement of Withholding on Dispositions by Foreign Persons of U.S. Real Property Interests. Use these forms to report and send withheld tax on the sale of U.S. real property by a foreign person. See section 1445 and the related regulations for additional information.
• Form 8300, Report of Cash Payments Over $10,000 Received in a Trade or Business. File this form to report the receipt of more than $10,000 in cash or foreign currency in one transaction or a series of related transactions.
• Form 8308, Report of a Sale or Exchange of Certain Partnership Interests, is used by a partnership to report the sale or exchange by a partner of all or part of a partnership interest where any money or other property received in exchange for the interest is attributable to unrealized receivables or inventory items.
• Form 8594, Asset Allocation Statement Under Sections 338 and 1060. Both the seller and buyer of a group of assets that makes up a trade or business must use this form to report such a sale if goodwill or going concern value attaches, or could attach, to such assets and if the buyer's basis in the assets is determined only by the amount paid for the assets.
• Form 8697, Interest Computation Under the Look-Back Method for Completed Long-Term Contracts. Partnerships that are not closely held use this form to figure the interest due or to be refunded under the look-back method of section 460(b)(2) on certain long-term contracts that are accounted for under either the percentage of completion-capitalized cost method or the percentage of completion method.
• Forms 8804, 8805, and 8813, Annual Return for Partnership Withholding Tax (Section 1446); Foreign Partner's Information Statement of Section 1446 Withholding Tax; and Partnership Withholding Tax Payment (Section 1446). File Forms 8804 and 8805 if the partnership had effectively connected gross income and foreign partners for the tax year. Use Form 8813 to send installment payments of withheld tax based on effectively connected taxable income allocable to foreign partners.

  Exception: Publicly traded partnerships that do not elect to pay tax based on effectively connected taxable income do not file these forms. They must instead withhold tax on distributions to foreign partners and report and send payments using Forms 1042 and 1042-S. See section 1446 for more information.

• Form 8832, Entity Classification Election. Except for a business entity automatically classified as a corporation, a business entity with at least two members may choose to be classified either as a partnership or an association taxable as a corporation. A domestic eligible entity with at least two members that does not file Form 8832 is classified under the default rules as a partnership. However, a foreign eligible entity with at least two members is classified under the default rules as a partnership only if at least one member does not have limited liability. File Form 8832 only if the entity does not want to be classified under these default rules or if it wants to change its classification.
• Form 8865, Return of U.S. Persons With Respect To Certain Foreign Partnerships. A domestic partnership may have to file Form 8865 if it:
  1. Controlled a foreign partnership (i.e., it owned more than a 50% direct or indirect interest in the partnership).
  2. Owned at least a 10% direct or indirect interest in a foreign partnership while U.S. persons controlled that partnership.
  3. Had an acquisition, disposition, or change in proportional interest of a foreign partnership that:
     1. Increased its direct interest to at least 10% or reduced its direct interest of at least 10% to less than 10%.
     2. Changed its direct interest by at least a 10% interest.
  4. Contributed property to a foreign partnership in exchange for a partnership interest if:
     1. Immediately after the contribution, the partnership owned, directly or indirectly, at least a 10% interest in the foreign partnership; or
     2. The fair market value of the property the partnership contributed to the foreign partnership in exchange for a partnership interest, when added to other contributions of property made to the foreign partnership during the preceding 12-month period, exceeds $100,000.

     Also, the domestic partnership may have to file Form 8865 to report certain dispositions by a foreign partnership of property it previously contributed to that foreign partnership if it was a partner at the time of the disposition.

  For more details, including penalties for failing to file Form 8865, see Form 8865 and its separate instructions.

• Form 8866, Interest Computation Under the Look-Back Method for Property Depreciated Under the Income Forecast Method. Partnerships that are not closely held use this form to figure the interest due or to be refunded under the look-back method of section 167(g)(2) for certain property placed in service after September 13, 1995, depreciated under the income forecast method.
• Statement of section 743(b) basis adjustments. If the partnership is required to adjust the bases of partnership properties (under section 743(b) because of a section 754 election) on the sale or exchange of a partnership interest or on the death of a partner, the partnership must attach a statement to its return for the year of the transfer. The statement must list:
  1. The name and identifying number of the transferee partner,
  2. The computation of the adjustment, and
  3. The partnership properties to which the adjustment has been allocated.

  See Regulations section 1.743-1(k) for more information.

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