What Is the IRS Accuracy-Related Penalty?
Understand the key distinctions that can lead to an IRS accuracy-related penalty and the standard of care required to avoid or contest it with the IRS.
The Internal Revenue Service (IRS) can assess a range of civil penalties against taxpayers who fail to meet their tax obligations. Among these is the accuracy-related penalty, which applies when a taxpayer does not report their tax liability correctly on a filed return. This penalty is not intended for simple mathematical errors but is reserved for specific types of inaccuracies that suggest a higher degree of fault, such as negligence or a significant understatement of the taxes owed.
Actions That Trigger the Penalty
Negligence or Disregard of Rules
One reason for an accuracy-related penalty is negligence or a disregard of tax rules. The IRS defines negligence as any failure to make a reasonable attempt to comply with the Internal Revenue Code. This can include failing to keep adequate books and records or not substantiating items properly. For example, a taxpayer who claims a large amount of business meal expenses without keeping any receipts could be found negligent.
Disregard implies a higher level of fault and is defined as any careless, reckless, or intentional ignoring of tax rules. A taxpayer who knowingly claims deductions for personal expenses as business costs is an example of disregarding the rules. Negligence is about failing to exercise due care, while disregard involves a more conscious choice to ignore known duties.
Substantial Understatement of Income Tax
A taxpayer can also trigger the penalty by substantially understating their income tax liability. An understatement is the difference between the tax that should have been shown on the return and the amount that was actually reported. The IRS considers this understatement “substantial” if it exceeds certain thresholds.
For individual taxpayers, an understatement is substantial if the amount is more than the greater of 10% of the correct tax or $5,000. A stricter rule applies to taxpayers who claim the qualified business income deduction. For these individuals, the threshold is lower; an understatement is considered substantial if it exceeds the greater of 5% of the correct tax or $5,000.
Valuation Misstatements
The penalty also applies to certain valuation misstatements. This occurs when a taxpayer incorrectly states the value of property, which in turn leads to an underpayment of tax. A common example is a substantial overstatement of the value of property donated to a charity. It can also happen in the context of estate and gift taxes, where understating the value of an asset reduces the tax owed.
A valuation misstatement is considered substantial if the value claimed on the return is 150% or more of the correct amount. If the valuation is 200% or more of the correct amount, it is classified as a “gross valuation misstatement,” which increases the penalty to 40%. The penalty is calculated on the portion of the tax underpayment attributable to this incorrect valuation.
Calculating the Penalty Amount
The standard accuracy-related penalty is 20% of the portion of the tax underpayment that resulted from the specific error. It is not applied to the entire tax bill but only to the underpayment caused by the negligence, substantial understatement, or other trigger. For example, if an audit determines a taxpayer underpaid their taxes by $10,000 due to a substantial understatement, the penalty would be $2,000, which is 20% of that specific underpayment.
Information Needed for an Abatement Request
Understanding Reasonable Cause
A taxpayer can request that the IRS remove, or abate, an accuracy-related penalty if they can show they had “reasonable cause” for the error and acted in good faith. The IRS determines reasonable cause based on all the facts and circumstances of a specific case. The question is whether the taxpayer exercised ordinary business care and prudence in determining their tax obligations but was nevertheless unable to comply.
Factors the IRS considers include the taxpayer’s experience, knowledge, and education. Other circumstances that can support a reasonable cause claim include an honest misunderstanding of fact or law, or reliance on the advice of a competent tax professional.
Required Documentation and Evidence
To argue for reasonable cause, a taxpayer must provide credible and verifiable evidence to support their claim. The type of documentation needed will depend on the specific reason for the error. For instance, if the mistake was due to a major life event, such as a serious illness or a death in the immediate family, hospital records or a death certificate would be important evidence.
If the taxpayer’s argument is based on reliance on a tax advisor, they must show that the advisor was competent and that the taxpayer provided the advisor with all necessary and accurate information. Evidence could include a copy of the advice, proof of the advisor’s qualifications, and records of the information shared with them. For errors caused by unavoidable circumstances like a natural disaster, documentation such as insurance claims or news reports can be used to substantiate the claim.
Completing Form 843
The formal way to request a penalty abatement is by filing Form 843, Claim for Refund and Request for Abatement. The taxpayer must provide basic information, such as their name, address, and Social Security number, and specify the tax period and the penalty amount they are asking to have abated.
The most important part of the form is Line 7, which asks for an explanation of why the request should be granted. Here, the taxpayer must present their detailed reasonable cause argument, referencing the supporting documents they have gathered. The explanation should be clear and factual, outlining the events and circumstances that led to the error.
The Process for Requesting Abatement
Once Form 843 and all supporting documentation have been prepared, the entire package should be mailed to the IRS service center where the original tax return was filed. The address for the correct service center can be found in the instructions for Form 843. It is advisable to send the request via certified mail with a return receipt.
After the request is submitted, the IRS will review the Form 843 and the accompanying evidence. This process can take several months. The agency will then issue a letter of determination. If the request is denied, the taxpayer will receive a letter explaining the decision and has the right to appeal the decision within 60 days.