One Man's Opinion

IRS Rules Discriminate against Small Business

May 1, 2016: The small business owner probably doesn’t know or realize it but several years ago Congress passed general authorization for and the Internal Revenue Service implemented tax penalty rules that discriminate against the Limited Liability Corporation, Partnership or other revenue pass through companies.  Faced with a history of certain businesses taking advantage of the ineffectiveness of the then  in-place rules for penalties when unethical managements of Partnerships filed their (1065) tax return late, the Congress opened the door and authorized what by any means is an extraordinarily high (and certainly unfair) penalty to be charged those companies for late filing of their Partnership return.  Justification was made by the authors stating that it was Congress’ intent to place in effect a punishment so egregious that the strategy then in use would no longer be a justifiable excuse for delaying the reporting and the payment of taxes due.  Given the wording of the Bill passed by Congress, the IRS moved immediately to put in place a rule that applied solely  to the “pass though” class company like the Partnership or LLC and LLP company that has caused any owner or manager of such a company to be extra careful that they file their partnership return in such a way as to have absolute proof that it was timely.

But what about those very small businesses formed as a Limited Liability Company usually for safeguard against company liability extending to their partner’s personal responsibility.  Well these rule changes have added to the cost of doing business at least by a small amount paid to assure that no extension (available but adds to cost of preparation) or late filing occurs (modest cost of registration and signature for receipt required).  These costs are not much for each company but become significant when taking into account the millions and millions of tax returns filed.

It is the purpose of this article to provide some facts that the Congress and the Internal Revenue Service have not nor do they want to talk about or defend their rules as being equitable across all equities.  The specific provision changed in the current rules for a company filing their 1065 late is a penalty of $195 for each partner for each month up to 12 months plus interest with possible abatement for the first year’s offense.  For a large family running a business, in which multiple generations hold an interest, and it is organized as an LLC a partnership or any income pass though company,, the IRS rules for penalties relating to late filing of their 1065 return is not only inequitable, it is discriminatory when compared with individual, non-profit or with the taxable corporation.

In a sample case, notices began to be received on June 21, 2015 by an LLC company advising that company of a penalty assessment totaling $26,080.00 for non-filing their 2010 1065 partnership information return(five years after the alleged failure to file).  Additional letters or notices were received advising that two other sister companies were also being assessed $26,080  and that such assessment penalties also would apply to the years 2011 and 2012 for each of the three companies.  This notwithstanding the fact that the K1s for each partner were mailed to them and their share of partnerships income  included in their personal tax returns which were filed on time and the taxes due paid on time.  The original family LLC company had split into three separate LLC companies in 2010, so the total of assessed penalties for the Group of three companies was $257,133. Since it is the practice to forgive the first offense at the IRS, it is presumed that the penalties for 2010 will be abated.  Management used its normal method of mailing its return and K1s and given that the K1s were received by partners and taxes paid, the company was under the impression that like in every year for 16 years filing their returns, the filing had been received by the IRS. The copies of the mail records showing date and time of mailing were unfortunately in the files of the CFO’s former employer.  It was normal procedure to use their facility to hold in personal but separate files of the business as a convenience. And this had been approved by the employer.  This became a factor when following a merger of her former company, she has been forbidden access to the successor company’s files for a search for the presumed registration receipts.

Upon receipt of the penalty notices, the company began an appeal stating that it was unaware that the Service had not received them and had no knowledge of its alleged failure to file since the return was prepared and Member K1s sent to all partners who then included the amounts of income in their personal returns.  No timely notice of a failure to file had been received prior to that time and although the Financial Officer who prepared these returns believes she followed the same procedure as she had in prior years, due to a merger due diligence procedure she was managing, it is possible that even though all the information was completed and stored on the “Cloud”, failing to have access to her former company’s files has prevented the opportunity to verify, if she could, the receipt of registered mailing notices from the USPS.  So at worst the violation had no bearing or effect upon the timely payment of appropriate tax liabilities by the partners for each of the three years in question.

It seemed to fall into the category of “no harm, no foul” (or at least not a $26,080 foul)  So shouldn’t be a problem since all the partners had paid their taxes on time, a simple call to the IRS Collection Division should get a reversal based on that fact and subsequent filing of the missing 1065 returns, right?  Wrong!! The agent said the policy of the IRS is to forgive a tax filing omission once and apply all assessed penalties thereafter.  The Agent said this company is liable for the full amount of penalty inequity  notwithstanding.  No consideration was given for the 5 year delay in filing a notice of alleged non-filing of the 2010 return or any of the others for that matter.  After multiple conversation and submission of additional information refuting the contention that the 1065 was not filed, or lost after being filed, the Service has sent the company numerous notices of it’s intent to seize each company’s assets in amounts to settle this inequitable penalty.  In one of the three companies, the penalty amount $86,711.00 is equal to 45% of its assets.

The IRS publishes an information document regarding its organization’s purpose or mandate in which the first paragraph makes the statement that the “The Primary objective of the Internal Revenue Service is to collect revenue and administer the U.S. Tax code in a fair and just way.”  I can’t help but think the Congressmen that voted for the law that gave the IRS the right to create such a rule that punishes small businesses like this one should recognize that they made a mistake and correct the open ended amount of penalty that could be charged the LLC, LLP and other income pass through companies for any violation of an administrative nature like failing to file the 1065 partner information return.

The Government’s discrimination is clearly visible in the Lois Lerner case which the Department of Justice dismissed last Fall.  This two year old referral by the House of Representatives Ways and Means Committee stated that Lois Lerner as head of an IRS division overseeing exempt organizations took an “aggressive and improper” interest in Crossroads GPS, the group co-founded by Karl Rove that spent tens of millions of dollars in the 2010 and 2012 election cycles.  This dismissal, notwithstanding the fact that Lois Lerner allegedly was in Contempt of Congress when she read a written statement before taking the “Fifth Amendment” rather than testify before that Committee.  The Referral , however was based on Lerner’s history of  violating administrative rules by destroying her Emails relating to her management of the division.  In their investigation of the charge, the Department of Justice probe found “substantial evidence of mismanagement, poor judgment and institutional inertia leading to the belief by many tax-exempt applicants that the IRS targeted them based on their political viewpoints. “But poor management is not a crime,” Assistant Attorney General Peter Kadzik said in the letter.  Maybe it is and maybe it isn’t but if it isn’t, how then can the IRS conclude that a simple oversight in filing an LLC Partnership 1065 information return should be judged a crime punishable in the amount of 45% of their assets or $85,711.00.  Fairness?  Not to me!!

One Man’s Opinion—Bud Brewer

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