Accuracy Related Penalty for IRS or Federal Taxes
If you are audited, and the IRS finds that you have understated income, took improper tax deductions or credits, or had an inaccurate tax return you will face a tax bill. This tax bill contains typically tax penalties and interest. If these mistakes were not deliberate or fraudulent but rather careless, you will be served with an accuracy-related penalty. This penalty can also be included in a correction notice.
IRS Code Section 6662 includes the Accuracy Related Penalty which consolidates penalties related to the accuracy of returns. The penalty is normally 20% of the total understatement of tax. In certain cases, with gross valuation misstatements (discussed below) it may be 40%. It applies to the portion of underpayment caused by one or more of the penalties below (but not attributed to fraud). These penalties cannot be stacked. In other words, if there was a substantial understatement of tax and negligence attributed to one item, then the total accuracy-related penalty is still 20% (or 40% if there was negligence and a gross valuation).
IRS Negligence Penalty
Negligence can be defined as the failure or lack of any reasonable effort to comply with IRS rules and regulations and use proper care in preparing a return. Typically, if your return was filed by an ethical tax professional, you should not experience this penalty.
Some examples of negligence could be:
- A failure to keep records to support credits or deductions claimed
- If you fail to reasonably check the accuracy of a deduction or credit that seems “too good to be true”
- You fail to include income on your tax return that was clearly shown in an information return (like a 1099)
- You continue yearly to make the same careless mistakes with certain items even though you were notified
Intentional Disregard Penalty
Intentional disregard would be the “careless, reckless, or intentional disregard” of the tax code when you prepared your tax return. Your actions would be considered careless if you did not illustrate “reasonable diligence” to determine whether an item on your return was correct. A disregard that is characterized as reckless means that you put in little or no effort to figure out the existence of a regulation. Lastly, an intentional disregard means that you knew of the rule or regulation being disregarded. Form 8275 can be utilized to disclose a certain position on your tax return that was contrary to IRS rules and regulations.
Substantial Understatement Penalty
If you understate your tax liabilities by more than $5,000 (or at least by 10%), then you have substantially understated your income. You may be able to cancel this penalty if you can adequately disclose details (on Form 8275 or 8275-R) as to why you handled an item in question, that was characterized with reason, or if you relied on substantial authority (statues, recent court rulings, press releases, notices, and so on). Realize, substantial authority will not resolve tax shelter issues alone.
Substantial Valuation Misstatement Penalty
If you substantially misstate the value of any property by 150% or more on your tax return (based on a valuation or adjusted basis) or that you incorrectly claim the price of a property or service related to a transaction with another person(s) (that you donated for example) by 200% or more (or 50% or less) than the actual true amount, you could be facing a substantial valuation misstatement penalty. If you misstate the valuation of the property by 400% or more than this penalty increases to 40% from the normal 20%. However, if the misstatement does not cause a tax understatement exceeding $5,000, then no penalty shall be assessed. You may be able to negate this penalty if you can prove that the pricing method used was reasonable, was documented, and was in accordance with tax code pricing methods.
Substantial Overstatement of Pension Liabilities Penalty
If a company substantially overstates pension liabilities by 200% or more of the amount determined to be correct, then this penalty will be assessed. If the overstatement is by 400% or more, then the normal 20% penalty becomes 40%. No penalty will be imposed if the overstatement resulted in a tax understatement of $1k or less.
Substantial Gift or Estate Tax Valuation Understatement Penalty
The IRS will hand you this penalty if the value of the any property reported on an estate or gift tax return is 65% or less of the correct valuation amount. If the tax understatement is due to a “gross valuation” misstatement of 40% or less of the correct amount, the penalty is 40%. This penalty is voided if the underpayment tax amount attributed to the property valuation misstatement is not greater than $5,000.
Understatements Related to Listed or Reportable Transactions Penalty
There is an accuracy related penalty for tax understatements resulting from “listed” and “reportable transactions” (with a tax shelter intention). The penalty is 20% of the understatement of tax if the taxpayer disclosed the transaction and 30% if it was not disclosed. Reportable transactions are broadly defined so reach out to a tax professional if you have questions.
How Can an Accuracy-Related Penalty Be Removed or Abated?
If you believe you acted in good faith utilizing some fact, legal foundation, or have reasonable cause (a valid excuse) or a reasonable basis as to why you did not follow IRS rules and regulations, you may be able to abate or reduce these penalties (aka Penalty Abatement – see our penalty abatement page). Moreover, if you can show that you incurred a penalty due to incorrect advice from an IRS employee, or if you fit a statutory exception, you may be able to abate these penalties. If you have been already assessed an accuracy related penalty, then you can either request an audit reconsideration to challenge the penalty, or you can pay it and then ask for a refund with Form 843.