Mandatory large partnership e-filing for 2000.

Partnerships with more than 100 partners (i.e., large partnerships) must file their Federal partnership returns electronically (e-file) for tax years ending on or after Dec. 31, 2000. The Taxpayer Relief Act of 1997 amended Sec. 6011(e) to require large partnerships to file their Forms 1065, U.S. Partnership Return of Income, and Schedules K-1 on magnetic media. Regs. Sec. 301.6011-3(f) provides for large partnerships to e-file partnership returns for tax years ending on or after Dec. 31, 2000. A partnership has more than 100 partners if, during the tax year, the partnership had over 100 partners, regardless of whether the partnership had over 100 partners on any particular day in the year (Regs. Sec. 301.6011-3(d)(5)).

Under Regs. Sec. 301.6011-3(f), electing large partnerships are not required to e-file their returns for tax years ending before Jan. 1, 2001. Sec. 775(a)(1) defines an "electing large partnership" as any nonservice large partnership that elects to apply the simplified reporting provisions under Secs. 771-777. The e-filing requirement also does not apply to (1) fiscal-year filers, (2) final-year returns, (3) short-year returns, (4) foreign address partnerships and (5) delinquent and amended returns; see Pub. 1524 (9/15/00) and Draft Announcement of Form 1065, Electronic Filing Waiver Request Procedure (12/13/00).

Partnership E-Filing

The IRS conducted a voluntary e-filing program for partnership returns for the 1999 tax year. For that year, the IRS approved four companies to e-file partnership returns. Of the four companies approved, one was a software vendor; the other companies consisted of two taxpayers and a small practitioner. In total, for 1999, the Service electronically processed 143 partnership returns and 179,553 Schedules K-1.

For the 2000 tax year, the IRS published draft specifications (Draft Pub. 1524) and expected to begin testing vendors and others on or about Dec. 18, 2000. Although testing and approval took several months last year, the Service represented that it expects the testing and approval process to take much less time this year. The IRS had expected to begin accepting electronic partnership returns for 2000 on or after Feb. 26, 2001.

Waivers and Penalties

Waiver of electronic filing. The Service may grant a hardship waiver from the e-filing requirement. Regs. Sec. 301.6011-3(b) allows a waiver based on facts and circumstances. One factor in determining hardship is the reasonableness of the incremental cost to the partnership of complying with e-filing requirements. Another factor is a breakdown of the equipment used to e-file. Informally, the IRS has indicated that a waiver will not be granted if there is an approved vendor capable of e-filing the partnership return at a reasonable cost. The Service recently published Ann. 2000-101, setting forth the procedure for requesting a hardship waiver. The waiver request must be made by the tax matters partner to the IRS's Memphis Submission Processing Center. The Service has established three separate filing periods, as follows:

1. For returns due April 16, 2001: Jan. 2, 2001-Feb. 2, 2001;

2. For returns due July 16, 2001: Feb. 3, 2001-May 1, 2001; and

3. For returns due Oct. 15, 2001: May 2, 2001-Aug. 1, 2001.

The IRS will respond within 30 days of receiving a request. Caution: Once the IRS issues its decision, there is no appeal of a rejection.

Penalty. Regs. Sec. 301.6011-3(c) applies to Sec. 6721 if a partnership fails to e-file a partnership return; the penalty under Sec. 6721(a) is $50 per return. Sec. 6724(e) treats each Schedule K-1 as a separate return. Thus, the penalty for failing to e-file a partnership return for the 2000 tax year is $50 per Schedule K-1.

Waiver of penalty. A penalty under Regs. Sec. 301.6011-3(c) can be waived under the undue economic hardship waiver provisions of Regs. Sec. 301.6724-1(c)(3). A partnership may be entitled to a penalty waiver for undue economic hardship if it establishes that (1) it attempted on a timely basis to contract out the e-filing, (2) the cost of e-filing was prohibitive, as determined at least 45 days before the due date of the return (without extensions), (3) the cost was supported by a minimum of two cost estimates from unrelated parties and (4) it filed the return on paper. Under Regs. Sec. 301.6724-1(c)(3), an economic hardship waiver is available only once. Simply put, the partnership will not receive an economic hardship waiver if it previously received one.

It appears that the Service has adopted a less stringent standard for obtaining a hardship waiver from e-filing than for obtaining a reasonable cause waiver from a penalty for failing to e-file. It may make sense for a taxpayer to satisfy the more stringent waiver test of Regs. Sec. 301.6724-1(c)(3). Consequently, if the IRS denies the initial waiver request and the client is unable to e-file, a reasonable cause waiver could be available. In addition, a taxpayer should file any waiver request as soon as possible after Jan. 2, 2001 and on or before 75 days before the return's due date, without extensions.

FROM PETER O'BYRNE, BBA, AND DRITA TONUZI, J.D., LL.M., NEW YORK, NY