An IRS accuracy-related penalty is a charge of 20% of a taxpayer’s underpayment of federal taxes due to negligence, substantial understatement of income tax, or other errors found on their tax return. In some cases, the IRS can impose a penalty charge higher than 20%.
How can you avoid an accuracy-related penalty, or remove IRC 6662 if you’ve already received notice of penalization? In this post, we’ll discuss the ins and outs of IRS Code Section 6662, also known as IRS accuracy-related penalties, explain how you can avoid this scenario, and share what to do if you find yourself in trouble with the IRS.
Use the links below to navigate to the section that best describes your query, or read through for a complete overview on the topic.
- IRS Code Section 6662 — What Does it Mean?
- Reasonable cause exception
- How Accuracy-Related Penalties Are Calculated
- Types of Accuracy-Related Penalties
- Substantial Understatement
- Valuation Triggers
- How Can I Remove an IRS Accuracy-Related Penalty?
IRS Code Section 6662 — What Does it Mean?
IRS Code Section 6662 allows the IRS to levy a penalty charge if a taxpayer has underpaid on their taxes as a result of their negligence, disregard of regulations, or due to substantial understatement of their income tax liabilities. Accuracy-related penalties are employed to help the IRS enforce accurate payment and filing of annual tax returns. Unlike a randomized IRS audit, taxpayer records must meet certain conditions for Code 6662 to be applied; but it’s important to note that accuracy errors are commonly associated with audit penalties.
In order for the IRS to apply an accuracy-related penalty via IRC 6662, the taxpayer must have underpaid on their taxes and the underpayment must be related to one of the following triggers:
- Negligence or disregard of rules or regulations
- Substantial understatement of income tax
- Any substantial valuation misstatement under chapter 1
- Any substantial overstatement of pension liabilities
- Any substantial estate or gift tax valuation understatement
- While these guidelines may sound relatively straightforward at first, accuracy-related penalty cases are among the most litigated issues between taxpayers and the Internal Revenue Service. This is due in part, to the fact that some taxpayers may establish reasonable cause for underpayment.
Reasonable cause exception
If a taxpayer can attribute their underpayment due to a reasonable cause, an accuracy-related penalty cannot be applied. But what exactly constitutes a “reasonable cause”? Typically, reasonable cause claims are assessed on a case-by-case basis where all circumstances are taken into account, including the taxpayer’s experience, knowledge, and education, specifically in the context of taxes. If a taxpayer seems to have acted in good faith but made an error due to a misunderstanding or simple miscomputation, they may fit the reasonable cause definition and be considered an exception to the rule.
Note: If a tax professional helped file your taxes but gave you incorrect information unbeknownst to you, the tax court may or may not classify the underpayment error as a reasonable cause.
How Accuracy-Related Penalties Are Calculated
Accuracy-related penalties are imposed when a taxpayer underpays on their taxes as a result of one of the aforementioned “triggers.” Substantial understatement, negligence, and disregard of regulation penalties are generally calculated as 20% of the understatement of the tax. In some circumstances, like if a taxpayer made a gross valuation misstatement, they may face a more aggressive 40% penalty.
Keep in mind, you should think of this penalty as an addition to your taxes owed, meaning that you can accrue interest on this amount in addition to the accrued interest on your outstanding tax balance.
Types of Accuracy-Related Penalties
As we mentioned, there are several circumstances where an accuracy-related penalty may be levied — if a taxpayer displayed negligence, disregard for tax rules, or substantially understated their income tax liabilities — but what exactly do these classifications mean? Let’s take a look at each trigger to get a better understanding of how IRC 6662 works and how these categories translate to accuracy-related penalties.
The negligence penalty trigger is just what it sounds like — the failure to follow tax regulations that any ordinary taxpayer would. Examples of negligent actions that may result in an accuracy-related penalty include:
- Not keeping accurate or adequate books and tax records
- Failing to accurately substantiate items on tax return
The disregard penalty trigger is used when the IRS believes that a taxpayer has overlooked tax rules and regulations put forth by the IRS. Disregard is further defined within the following three categories:
- Careless Disregard: Taxpayer disregard is classified as careless when courts assess that the taxpayer did not do their reasonable diligence to ensure the correctness of their return.
- Reckless Disregard: Reckless disregard is a step up from careless disregard and is typically used when a taxpayer makes little to no effort to find out if a tax regulation exists.
- Intentional Disregard: When a taxpayer is aware of the tax rule or regulation that they have disregarded.
The IRS uses the substantial understatement trigger when a taxpayer files a frivolous tax return with substantial inaccuracies. For individual taxpayers, the IRS classifies an understatement as substantial if it is the greater of 10% of the tax required to be shown on the return for the tax year, or $5,000.65.
In addition to negligence, disregard, and substantial understatements, the IRS may elect an accuracy-related penalty for:
- Substantial valuation misstatement
- Substantial overstatement of pension liabilities
- Substantial estate or gift tax valuation