48.6 Tax Penalties for Inaccurate Returns
A 20% “accuracy-related” penalty generally applies to the portion of any tax underpayment attributable to any of the following: (1) negligence or disregard of IRS rules and regulations; (2) substantial understatement of tax liability; (3) overvaluation of property; or (4) undervaluation of property on a gift tax or estate tax return. There is no stacking of penalties. Only one 20% penalty can be imposed on a portion of an underpayment, even if that portion is attributable to more than one of the above types of prohibited conduct. These penalties may be avoided by showing that you acted in good faith and with reasonable cause in underpaying the tax. Reliance on a tax preparer may constitute reasonable cause and good faith, but the reliance on the preparer must be reasonable. The Tax Court has held that reliance on a preparer is not reasonable if the taxpayer does not provide the preparer with the documents necessary to make a professional conclusion, or if the preparer lacks sufficient expertise to justify reliance. A stricter reasonable cause exception applies to the penalty for overvaluing charitable donations, discussed below.
There is a 40% penalty for an underpayment of tax that is attributable to an undisclosed foreign financial asset.
Penalties apply to taxpayers who fail to disclose participation in “reportable” transactions and to taxpayers who understate tax liability on “listed” transactions or on other reportable transactions with a significant tax avoidance purpose.
Penalties also may be imposed for filing an erroneous refund claim or a frivolous return.
Negligence or disregard of IRS rules or regulations.
The 20% penalty applies to the portion of the underpayment attributable to negligence. Negligence is defined as failing to make a reasonable attempt to comply with the law. Failure to report income shown on an information return, such as interest or dividends, is considered strong evidence of negligence.
The 20% penalty may also apply if you take a position on a return which is contrary to IRS revenue rulings, notices, or regulations. This penalty for disregarding IRS rules or regulations may be avoided if you have a reasonable basis for your position and you disclose that position on Form 8275 or on Form 8275-R in the case of a good faith position contrary to a regulation. Thus, disclosure will not avoid a penalty for a position that does not have a reasonable basis.
Substantial understatement of tax.
If you understate tax liability on a return by the greater of $5,000 or 10% of the proper tax, you may be subject to a penalty equal to 20% of the underpayment attributable to the understatement.
The penalty may be avoided if you have a reasonable basis for your position and you disclose the position to the IRS on Form 8275, or on Form 8275-R in the case of a position that is contrary to an IRS regulation.
The penalty also may be avoided if you can show that your position was supported by “substantial authority” such as statutes, court decisions, final, temporary, or proposed IRS regulations, IRS revenue rulings and procedures, and press releases or notices published by the IRS in the weekly Internal Revenue Bulletin. You may also rely on IRS private letter rulings and technical advice memoranda, as well as IRS actions on decisions and general counsel memoranda. However, according to the IRS, such rulings and internal IRS memoranda that are more than 10 years old should be accorded very little weight. Congressional committee reports and the tax law explanations prepared by Congress’s Joint Committee on Taxation, known as the “Blue Book,” may be relied on as authority for your position.
Caution
However, the exceptions for disclosed positions (with a reasonable basis) and substantial authority do not apply to items attributable to a tax shelter, which for this purpose means any arrangement that has tax avoidance or evasion as a significant purpose. An understatement of tax due to tax shelter positions may be subject to the understatement penalty for “reportable” transactions discussed below.
Overvaluing property value or basis.
If the claimed value of property donated to charity is 150% or more of the correct value, resulting in a tax underpayment exceeding $5,000, a penalty equal to 20% of the underpayment applies, and the penalty is doubled to 40% if the overvaluation is 200% or more. A reasonable cause exception to the 20% penalty is available if you relied on a qualified appraisal and you investigated the value of the property in good faith (14.16). The same penalty thresholds and rates apply where the basis of depreciable property has been inflated.
Undervaluation on gift or estate tax return.
If the value of property reported on a gift tax or estate tax return is 65% or less of the correct value, and the resulting tax underpayment from the undervaluation exceeds $5,000, the penalty is 20% of the underpayment. The penalty doubles to 40% of the underpayment if the claimed value of the property is 40% or less of the correct value.
Penalties relating to reportable transactions.
A penalty may be imposed on individuals and business entities who fail to adequately disclose a “reportable” transaction on Form 8886. This penalty is in addition to any other penalty that may be imposed. Some reportable transactions may fall into the category of “listed” transactions. The Form 8886 instructions explain the difference between listed transactions and other types of reportable transactions. The amount of the penalty for failure to disclose is generally 75% of the tax reduction claimed on the return as a result of the transaction, but there is a minimum penalty of $5,000 per reportable transaction (whether or not listed) for individuals ($10,000 for non-individual returns). There is also a maximum penalty. If the failure to disclose involves a reportable transaction that is not a listed transaction, the maximum penalty is $10,000 ($50,000 for non-individual returns). If the transaction is a listed transaction, the maximum penalty is $100,000 for individuals ($200,000 for non-individual returns).
There is a separate “accuracy-related” penalty for understating tax liability attributable to a listed transaction or to any reportable transaction (other than a listed transaction) with a significant tax avoidance purpose. The penalty is generally 20% of the understatement if the transaction was adequately disclosed on Form 8886. There is an exception for reasonable cause, but to qualify, stringent requirements must be met; see Code Section 6664(d). If the transaction was not adequately disclosed, the penalty increases to 30% of the understatement and there is no reasonable cause exception.
Understatement due to undisclosed foreign financial asset.
A 40% accuracy-related penalty applies to the portion of a tax underpayment that is attributable to an undisclosed specified foreign financial asset. These are assets required to be reported on Form 8938, as discussed in 48.7.
Fraud penalty.
A 75% penalty applies to the portion of any tax underpayment due to fraud. If the IRS establishes that any part of an underpayment is due to fraud, the entire underpayment will be attributed to fraud, unless you prove otherwise.
Interest on penalties.
A higher interest cost is imposed on individuals subject to the following penalties: failure to file a timely return, negligence or fraud, overvaluation of property, undervaluation of gift or estate tax property, substantial understatement of tax liability, or understatements attributable to reportable transactions or undisclosed foreign financial assets. Interest starts to run on these penalties from the due date of the return (including extensions) until the date the penalty is paid. For other penalties, interest is imposed only if the penalty is not paid within 21 calendar days of an IRS demand for payment if the penalty is less than $100,000. The interest-free period is 10 business days after the IRS demand for payment if the penalty is $100,000 or more.
Penalty for filing excessive refund claim.
A 20% penalty can apply to an excessive claim for refund or credit on any original (46.4) or amended return (47.8). The penalty is 20% of the “excessive” amount, the excess of the refund or credit claimed over the amount allowed, unless there is a reasonable basis for the amount claimed. The penalty does not apply to claims relating to the Earned Income Credit (25.10). It also does not apply to any portion of the excess that is subject to the accuracy-related penalties (including the penalty for understatements due to reportable or listed transactions), or the fraud penalty.
Penalty for frivolous tax return or submission.
In addition to any other penalty, there is a $5,000 penalty for filing a frivolous tax return. A $5,000 penalty also applies to frivolous submissions, including requests for a collection due process hearing or an application for an installment agreement, offer-in-compromise, or Taxpayer Assistance Order based on a frivolous position. In Notice 2010-33, the IRS lists positions it considers frivolous. The IRS will periodically revise the list.
Acting on wrong IRS advice.
A penalty will not be imposed if you reasonably rely on erroneous advice provided in writing by IRS officials in response to your specific written request. It is necessary for you to show that you provided accurate information when asking for advice.