No Obligation to File Inaccurate Return to Avoid Failure to File Penalty

A partnership was a partner in a Cayman Islands partnership – that investment made up most of its assets. The Cayman Islands partnership did not file a Form 1065 income tax return and did not give a Form K-1 to the taxpayer partnership, because it was determined that the partnership accounting records were such a mess that it would cost several million dollars to put them in good shape and meanwhile the Cayman Islands partnership was liquidating.

Thus, the taxpayer partnership did not have the information it needed to file its own Form 1065, and did not file one. The IRS sought to impose a failure to file penalty under Section 6698. This penalty is only $195 multiplied by the number of partners – but this partnership had about 1600 partners. That would put the penalty at $312,000! And this went on for 3 years.

The taxpayer partnership claimed reasonable cause. The partnership tried, but failed…