Which states penalize an undisclosed reportable transaction on a partnership return, and who files the disclosure?

The federal rule decides who discloses

Every state rule read here starts from the federal duty. Treas. Reg. section 1.6011-4 requires every taxpayer that "has participated" in a reportable transaction to file a disclosure statement, and participation is tested one return at a time (Treas. Reg. section 1.6011-4(a), (c)(3)(i)). That produces three patterns for a partnership and its partners.

• Listed transactions and transactions of interest. The partnership participates when its return reflects the listed consequences. A partner participates when its own return reflects them or it knows or has reason to know that its tax benefits derive from them. Both can be disclosers for the same transaction: penalties "can apply at both the entity and the individual levels," and "Each entity must be separately analyzed" (IRM 20.1.13.3.4).
• Confidential and contractual protection transactions. Where the confidentiality limit or the fee refund right runs to the partnership, the regulation places participation in the partnership "and not the partner" (Treas. Reg. section 1.6011-4(c)(3)(i)).
• Loss transactions. A loss transaction is a section 165 loss that meets a threshold, tested first against the published exceptions. Under section 1.6011-4(b)(8)(i) the Commissioner can except transactions by published guidance, and Rev. Proc. 2013-11 does so for a loss on an asset with a qualifying basis, ordinarily basis "determined solely by reference to" cash paid for the asset and its improvements, and for eleven further losses (Rev. Proc. 2013-11, sections 4.01 to 4.03). One of the five conditions fails for a tiered structure's most common loss: the asset must not be "an interest in a passthrough entity" within the meaning of IRC section 1260(c)(2) (section 4.02(1)(b)). A loss on the sale of a lower-tier partnership interest therefore counts whatever was paid for it, and it is a section 165 loss because that term "includes, for example, a loss resulting from a sale or exchange of a partnership interest under section 741" (Treas. Reg. section 1.6011-4(b)(5)(iii)(B)). A loss on cash-bought equipment, real property or stock is ordinarily excepted.

After the exceptions come the thresholds. The partnership tests its own section 165 loss against its threshold "whether or not any losses flow through" to partners, without offsetting gains: $10 million in a single year or $20 million in combination where every partner, looking through partnerships, is a corporation, and $2 million or $4 million otherwise. Each partner tests the loss allocated to it against its own threshold: $10 million or $20 million for a corporation, and $2 million or $4 million for an individual, S corporation or trust (Treas. Reg. section 1.6011-4(b)(5)(i), (b)(5)(iii)(A), (c)(3)(i)).

Treas. Reg. section 1.6011-18 identifies certain partnership related-party basis adjustment transactions as transactions of interest, effective January 14, 2025, and it remained in the Code of Federal Regulations as of October 19, 2026. Notice 2025-23 (April 17, 2025) announced the intent to remove it and a waiver of IRC section 6707A(a) penalties for any failure to file Form 8886 required because of it, and REG-108921-25 (March 6, 2026) proposes the removal, with participants able to treat it as occurring on January 14, 2025. The states that require a duplicate key their duty to the federal duty as it stands when the return is filed. No state source read addresses a transaction the IRS has stopped penalizing.

The partnership attaches Form 8886 to its return for each year it participates and sends a copy to the Office of Tax Shelter Analysis the first time, and a loss transaction is disclosed for the first year the threshold is reached (Treas. Reg. section 1.6011-4(d), (e)(1), (e)(2)(ii)). A partner whose timely Schedule K-1 arrives less than 10 calendar days before its return is due has 60 calendar days after the due date to file with that office. If a transaction becomes listed, or a transaction of interest, after the return is filed, the taxpayer files with that office within 90 calendar days for every participating year still open to assessment ((e)(2)(i)). A taxpayer uncertain whether it must disclose may file on a protective basis ((f)(2)), and a form stating that information will be provided on request is not a complete disclosure.

The federal penalty for omission is 75 percent of the decrease in tax, capped at $200,000 ($100,000 for a natural person) for a listed transaction and $50,000 ($10,000) for any other, with a $10,000 minimum ($5,000), and a listed transaction penalty cannot be rescinded (IRC section 6707A(a) to (d)). The IRM treats partnerships as non-taxable entities for this penalty, so the $10,000 minimum applies to a partnership return (IRM 20.1.13.3.4). The 20 percent reportable transaction understatement penalty rises to 30 percent on undisclosed amounts, and the reasonable cause exception is unavailable without adequate disclosure (IRC sections 6662A, 6664(d)). The assessment period for an undisclosed listed transaction stays open until one year after the information is furnished (IRC section 6501(c)(10)).

How the states borrow the rule, and where they add to it

The four states verified (New York, Illinois, Minnesota and California) all trigger the state duty from the federal disclosure duty, and they differ on state-only transactions and look-back.

• The federal duplicate. New York, Illinois and Minnesota each require a copy of whatever was filed federally, and the trigger is the federal duty under section 1.6011-4, not a separate state test (N.Y. Tax Law section 25(a); 35 ILCS 5/501(b); Minn. Stat. section 289A.121, subd. 5). California adopts IRC section 6011 into its own code, so the federal participation tests apply through the state statute, and the form booklets say what a partnership or LLC attaches (Rev. and Tax. Code section 18407(a)). In all four, a partnership with a federal duty carries it to every state return it files within the statute's scope.
• State-only transactions. New York and California add transactions that have no federal Form 8886 behind them (below); Illinois and Minnesota add none in the texts read.
• Look-back. Illinois requires disclosure of a transaction entered into after February 28, 2000 "that becomes a listed transaction at any time," and Minnesota of one entered into after December 31, 2001 that the IRS "determines is a listed transaction at any time" (35 ILCS 5/501(b); Minn. Stat. section 289A.121, subd. 5(c)). New York requires, with the first Form DTF-686 a filer submits, every prior federal disclosure for a listed transaction in a year the filer also had a New York return, and every prior disclosure for another reportable transaction in a year still open to assessment.

A member of a unitary group that includes a federal discloser must also disclose in Illinois and Minnesota (35 ILCS 5/501(b); Minn. Stat. section 289A.121, subd. 5(b)). The texts read do not extend that rule to partnerships.

California

Rev. and Tax. Code section 18407 applies IRC section 6011 to "any person liable for any tax" under the California income and franchise tax parts and directs the FTB to identify and publish listed transactions, federal or California-only, by notice. A partnership or LLC involved in a reportable transaction attaches Form 8886 to Form 565 or Form 568 and, the first time the transaction is disclosed on the return, sends a duplicate to the FTB's Tax Shelter Filing address (2025 Partnership Tax Booklet; 2025 LLC Tax Booklet). The booklets, not the statute, are the source of that instruction. FTB Notice 2011-01 is a California-only listing aimed at partnerships: abusive sales factor manipulation by apportioning corporate taxpayers that use one or more partnerships to inflate the denominator of the California sales factor, with reporting requirements under section 18407 and penalties under sections 19772, 19164(a), 19774, 19777 and 19164(c). The FTB's shelter pages carry no consolidated list, and the article does not claim that Notice 2011-01 is the only one.

The omission penalty is IRC section 6707A as modified by Rev. and Tax. Code section 19772. The decrease in tax is measured as if the transaction "were respected for state tax purposes," the caps become $30,000 ($15,000) for listed transactions and $15,000 ($5,000) for others, and the floor becomes $2,500 ($1,250). The section "only applies to taxpayers with taxable income greater than two hundred thousand dollars ($200,000)," and neither the section nor the FTB's investor penalties page gives an entity rule. The FTB's likely position: its booklets say the FTB may impose penalties if the partnership fails to file Form 8886, so the FTB treats the partnership as a person subject to section 19772 and would measure the $200,000 test by the partnership's own taxable income under IRC section 703(a) as California applies Subchapter K. That is reasoning from the booklets, with sections 703(a) and 17851 unread, and the floor figure is contingent on it.

Rescission belongs to the Chief Counsel alone, is unavailable for a listed transaction, requires among other conditions an unintentional mistake of fact and a compliance history, and cannot be reviewed in any administrative or judicial proceeding (section 19772(f)). The deficiency assessment procedures do not apply to the penalty (section 19772(g)), so there is no deficiency protest. The FTB's likely position is that whether the penalty applied at all, meaning whether the transaction was reportable or the threshold met, can be raised only by paying and claiming a refund under the ordinary refund provisions; sections 19306 and 19322 were not read.

Disclosure works three times in California: it avoids the section 19772 penalty, it holds the reportable transaction understatement penalty of section 19164.5 at the federal 20 percent rate rather than 30 percent, and it halves the noneconomic substance penalty of section 19774 from 40 percent to 20 percent. A fourth consequence follows once the FTB has contacted a taxpayer about an abusive tax avoidance transaction, a term that includes an undisclosed reportable transaction and any listed transaction: section 19777 adds 100 percent of the interest on the resulting deficiency, reduced to 50 percent where the taxpayer files an amended return reporting the transaction before the notice of proposed assessment.

New York

Tax Law section 25(a) reaches every taxpayer or person required to disclose federally and requires a duplicate with the return under Article 9, 9-A, 22 or 33. Partnerships file under Article 22, and the instructions for Form DTF-686 list partnerships, LLCs treated as partnerships, partners and members among the filers. Form DTF-686, with a duplicate of Form 8886 attached, goes with the return for the year. New York then adds its own layer. A New York reportable transaction, "a transaction that has the potential to be a tax avoidance transaction," is disclosed with the return by every taxpayer that participated, in one of three categories designated by 20 NYCRR Part 2500 (New York listed, confidential and contractual protection transactions), on Form DTF-686-ATT (20 NYCRR sections 2500.2, 2500.3(a), 2500.5(a)). The Part copies the federal partnership rule for confidential and contractual protection transactions and provides for protective disclosures and determinations (sections 2500.4(b), 2500.6). A nonresident individual partner included in the partnership's group return under Article 22 does not file Form DTF-686 individually.

The penalty for a failure under section 25(a) is fixed and depends on the filer's article. An Article 22 filer, a partnership or an individual partner, pays $10,000, or $25,000 for a listed transaction, with no reduction for a natural person (Tax Law section 685(x)(2)). A corporation pays $20,000, or $50,000 for a listed transaction, under section 1085(p). Each is rescindable only for a non-listed transaction where rescission would promote compliance and effective tax administration, and neither statute says the determination is reviewable. The amount does not depend on the tax effect, and section 685(x) reaches an omitted Form DTF-686-ATT as well as an omitted federal duplicate (section 685(x)(3)). New York's reportable transaction understatement penalty is 20 percent, or 30 percent where the disclosure requirement is not met (sections 685(p-1), 1085(k-1)). For Article 22, the assessment period for an undisclosed listed transaction does not expire until one year after the commissioner is furnished the information or a section 25(c) request is met, and a deficiency attributable to an abusive tax avoidance transaction may be assessed within six years (section 683(c)(11)). Each of these provisions carries the note that it is repealed July 1, 2029; they are stated as in force through that date.

Illinois

A taxpayer required to disclose under section 1.6011-4 that participated in a year "for which a return is required under Section 502" files a copy of the disclosure with the Department (35 ILCS 5/501(b)). The rule calls for two copies, one attached to the Illinois return for the same year and a second sent to the address the Department designates (86 Ill. Adm. Code 100.5060(b)(2)(B)). Illinois is the one state read that speaks to the partner and the partnership together. A partner's obligation "shall be met" if the partnership discloses on a timely composite return that includes the partner or, for years ending after December 31, 2014, on the partnership's replacement tax return (100.5060(c)(4)). The Department's page adds that the obligation remains the partner's. A taxpayer that believes it has no Illinois return to file may disclose on a protective basis (100.5060(e)).

The penalty is $15,000 "for each failure," or $30,000 for a listed transaction, deemed assessed on the filing date of the return (35 ILCS 5/1001(b)(1), (2)). It is capped: the total penalty for a taxable year "shall not exceed 10%" of the increase in net income, or reduction in Illinois net loss, that would result had the taxpayer not participated in any reportable transaction affecting its net income for the year (35 ILCS 5/1001(c)). For a loss transaction the cap is 10 percent of the loss's effect on net income, and the fixed amount usually stands; for a transaction with no effect on net income, such as a confidential transaction, a transaction of interest or a disclosure-only item, the cap is zero. Rescission is available only for a non-listed transaction on the compliance ground, and, alone among the four states and the federal rule, the determination "may be reviewed in any administrative or judicial proceeding" (35 ILCS 5/1001(b)(3)). The Department's penalty page also states a reportable transaction understatement penalty without citing a statute, and the article does not state it.

Minnesota

A taxpayer that must disclose under section 1.6011-4 and participated "in a taxable year for which a return is required under chapter 290" files a copy with the commissioner, and a transaction that the IRS "determines is a listed transaction at any time" after December 31, 2001 must be disclosed (Minn. Stat. section 289A.121, subd. 5). The penalty for failing to include the information is $10,000 for an individual and $50,000 otherwise, or $100,000 and $200,000 for a listed transaction, with an added per-member amount for a unitary business. Abatement is available only for a non-listed transaction, only to promote compliance, and the determination is not reviewable (section 289A.60, subd. 26(d), (g), (h)). The 20 and 30 percent understatement penalty has a reasonable cause exception only where the facts are adequately disclosed under section 289A.121 (section 289A.60, subd. 27). The 2025 partnership return instructions say nothing about Form 8886.

Whether a partnership's own Minnesota return is a return "required under chapter 290" for this purpose was not resolved from the sources read. The commissioner's likely position: subdivision 1 scopes the section to a tax shelter that "is doing business in this state" or "has one or more investors that are Minnesota taxpayers under chapter 290," and the partnership files its own chapter 290 return, so the duty attaches at the partnership level and the $50,000 ($200,000 listed) figure is the partnership's exposure. The minimum fee statute was not read. The text does reach a partner that files a chapter 290 return.

What the four states share

A partner answers on its own federal participation, not on the partnership's filing, and a lower-tier partnership's Form 8886 does not by itself make the upper tier a discloser. None of the four statutes gives a general reasonable cause defense to the failure-to-disclose penalty. Other states have their own disclosure statutes and penalties; only these four were verified, and the article states no others.

A worked example

Facts. A Delaware LLC taxed as a partnership ("Holdings") owns an equipment rental business directly and, for several years, a 40 percent interest in a lower-tier crane leasing partnership, for which it paid $9 million in cash. Its partners are a C corporation holding 70 percent and an individual holding 30 percent. It files returns in California (Form 568), New York (IT-204), Illinois (IL-1065) and Minnesota (M3). In the current year Holdings sells the entire lower-tier interest to an unrelated buyer for $4 million and recognizes a section 165 loss of $5 million ($9,000,000 adjusted basis, assumed unchanged, less $4,000,000 proceeds). Its rental operations produce $3 million of ordinary business income the same year. Nothing about the transaction is listed, confidential or contractually protected, and no partner has any other section 165 loss.

• Step 1, the exception test. The loss results from the sale of a partnership interest under section 741, so it is a section 165 loss for the test (Treas. Reg. section 1.6011-4(b)(5)(iii)(B)). Rev. Proc. 2013-11 excepts a loss on an asset with a qualifying basis only if the asset is not an interest in a passthrough entity (section 4.02(1)(b)). A partnership interest is such an interest, so the cash Holdings paid does not help, and none of the eleven section 4.03 losses describes the sale. The $5,000,000 loss counts in full, without regard to the $3,000,000 of ordinary income.
• Step 2, the partnership's federal test. Not every partner of Holdings is a corporation, so its threshold is $2 million in a single year. $5,000,000 is at least $2,000,000, so Holdings has participated in a loss transaction and attaches Form 8886 to Form 1065 for that year, with a copy to the Office of Tax Shelter Analysis because it is the first year.
• Step 3, each partner's federal test. The corporate partner's share is $5,000,000 times 70% = $3,500,000, below its $10,000,000 threshold. The individual's share is $5,000,000 times 30% = $1,500,000, below the $2,000,000 threshold. Check: $3,500,000 + $1,500,000 = $5,000,000. Neither partner discloses federally.
• Step 4, the states. California: Form 8886 goes with Form 568, and a duplicate goes to Tax Shelter Filing because this is the first year. New York: Form DTF-686 with a duplicate Form 8886 attached to the IT-204, and no Form DTF-686-ATT because nothing here is a New York reportable transaction. Illinois: a copy attached to the IL-1065 and a second copy to the Department's address. Minnesota: the partnership-level duty is the open question, and the commissioner's likely reading attaches it. No partner files anything in any of the four, because no partner has a federal duty.
• Step 5, the cost of omission if Holdings forgets. New York: $10,000 under section 685(x), Holdings being an Article 22 filer. Illinois: $15,000 under section 1001(b)(1); had Holdings not participated, its net income for the year would be higher by the $5,000,000 loss, so the section 1001(c) cap is 10% times $5,000,000 = $500,000, and $15,000 stands. Federal: 75 percent of a zero decrease in tax on a partnership return is $0, so the $10,000 minimum governs. California: $2,500, but only if the FTB applies section 19772 to Holdings and the $200,000 test of section 19772(d) is met on Holdings' own taxable income, which the example does not compute; if it is met, 75 percent of a zero decrease is $0, so the section 19772(b)(4) floor governs. Minnesota: $50,000 under section 289A.60, subd. 26(d), "in any other case," if the duty attaches at the partnership level. The stated amounts total $10,000 + $15,000 + $10,000 = $35,000. With the two contingent amounts the total is $10,000 + $15,000 + $10,000 + $50,000 + $2,500 = $87,500, and the largest single number is the contingent one.
• Variant. The sale price is $0 and the loss is $9 million. Holdings still discloses. The corporate partner's share is $9,000,000 times 70% = $6,300,000, below $10,000,000, but the individual's share is $9,000,000 times 30% = $2,700,000, at least $2,000,000. Check: $6,300,000 + $2,700,000 = $9,000,000. The individual now discloses federally, so it discloses with its own return in California, in Minnesota if it files under chapter 290, and in New York, unless it is a nonresident included in Holdings' group return, in which case no individual Form DTF-686 is due. In Illinois, Holdings may discharge the individual's duty on its IL-1065 replacement tax return. If the individual omits the disclosure, its own penalties are $10,000 in New York under section 685(x)(2), the same figure as for any Article 22 filer; $15,000 in Illinois (cap 10% times $2,700,000 = $270,000); and $10,000 in Minnesota. The federal and California penalties are 75 percent of the decrease in tax on the individual's own return, with natural person floors of $5,000 and $1,250, which the example does not compute.

What the example shows: the exception test comes before the thresholds, the partnership and partner tests run separately, and the partnership's penalty is a fixed sum unrelated to tax, with the two open-point states carrying the largest contingent exposure. What it leaves out: listed transactions and transactions of interest, New York and California state-only transactions, section 988 losses, unitary group members and the understatement penalties.

Practice notes

Test every section 165 loss against Rev. Proc. 2013-11 before the thresholds, and run the federal participation test twice for every Form 8886 the partnership files, once for the partnership and once for each partner's allocated share against that partner's own threshold.

Keep a state disclosure register keyed to each federal Form 8886 and each state-only transaction: state, filer (partnership or partner), form, first-year duplicate sent, prior-year statements submitted with the first DTF-686, and date. Send the California duplicate to Tax Shelter Filing and the Illinois second copy to the Department's address in the first year, separately from the return, and check the New York and California state-only lists.

Where a partner's share crosses its threshold, tell the partner in writing with the Schedule K-1; for Illinois, decide whether the partnership will disclose for the partner on the replacement tax return; for New York, note whether the partner is on the group return. Calendar the 90-day federal window and the Illinois and Minnesota "at any time" rules when a transaction becomes listed after the return is filed, and check the state position before relying on a federal penalty waiver such as Notice 2025-23. Treat listed transactions as unrescindable in every state read, and in Illinois test the 10 percent cap. G&G State Tax Group provides reportable transaction disclosure review for multistate partnership filings alongside its state and local tax practice.