California’s Per Partner Penalty: A Proposal for Reform to Encourage Compliance but Not Unfairly Punish¹

By Brian W. Toman & Shirley J. Wei²

EXECUTIVE SUMMARY

When a partnership fails to timely file its partnership return including all of the required information, California imposes a "per partner" penalty on the partnership in the amount of $18 multiplied by the number of partners in the partnership for each month (or fraction thereof) during which the failure continues (not to exceed 12 months) unless there is reasonable cause for the failure. The stated intent for the per partner penalty is to encourage compliance with California’s tax filing requirements. However, for partnerships with multiple tiers and/or thousands of partners, the penalty could be a hundred times or more greater than the underlying tax liability. We do not believe that the California Legislature could have intended this inequitable result.

Modeled after the federal per partner penalty, the California penalty fails to account for the inherent differences between the two taxing systems, which justify a more severe penalty at the federal level, but not at the state level. Unlike the federal tax system, it is not always clear when a partnership or its partners are subject to California’s taxing jurisdiction such that they must file a California tax return. Specifically, an upper-tier partnership may not be aware that it must file a California tax return because a lower-tier partnership is "doing business" in California. As a result, the penalty could be imposed at each level, and when partnerships have thousands of partners, the penalty becomes significantly more severe where such a financial sanction is disproportionate to the inadvertent offense of not filing a California tax return. The penalty should be adjusted to account for situations where large, complex partnerships are caught off guard by this California tax filing requirement.