Before the enactment of the Improved Penalty Administration and Compliance Tax Act (IMPACT), there were different penalties for the following prohibited acts. Instead of these penalties, IMPACT provides a single accuracy-related penalty for the following forms of misconduct:
- IRC § 6653(a) – Negligent underpayment of tax
- IRC § 6661 – substantial understatements of income tax
- IRC § 6659 – Valuation overstatement
- IRC § 6660 – Valuation understatements for estate or gift tax purposes
- IRC § 6659A – Pension liability overstatement
Accuracy-Related Penalty
The IRS imposes an accuracy-related penalty equal to twenty percent (20%) of any underpayment of federal tax resulting from certain specified taxpayer behaviors (IRC § 6662). The penalty is applicable when:
- A taxpayer has an underpayment of tax.
- The underpayment is attributable to one of the specific conditions or behaviors provided under IRC § 6662.
What Triggers The Accuracy-Related Penalty?
To reiterate, for an accuracy-related penalty of twenty percent (20%) to apply, the taxpayer must have a tax underpayment attributable to one of the following conditions or behaviors, referred to as triggers:
- Negligence or disregard of rules or regulations
- Any substantial understatement of income tax
- A substantial valuation overstatement
- Any substantial pension liabilities overstatements
- Any substantial understatement of estate or gift tax valuation
- Any disallowance of claimed tax benefits because of a transaction lacking economic substance
- Any undisclosed foreign financial asset understatement
Exceptions
The accuracy-related penalty is not applicable to disallowed tax benefits resulting from transactions that lack economic substance. Also, the twenty-percent (20%) penalty does not apply to valuation overstatements related to charitable deduction property. However, for these exceptions to apply, the taxpayer must have reasonable cause and good faith.
Increase to 40%
Generally, the accuracy-related penalty is twenty percent (20%). However, the IRS may impose an accuracy-related penalty at a rate of forty percent (40%) when there is a gross valuation misstatement involving the following:
- A substantial valuation overstatement
- A substantial overstatement of pension liabilities
- A substantial understatement of valuation of an estate or gift tax valuation
In addition, a forty percent (40%) penalty is imposed in the case of improper disclosure of a transaction lacking economic substance.
Fraud Penalty
If the taxpayer’s conduct amounts to fraud, IRC § 6663 imposes a fraud penalty (a separate and higher penalty) of seventy-five percent (75%).
Imposition of the Penalty
Different types of misconduct or triggers can be attributed to different portions of the total underpayment. Hence, the IRS can impose a penalty on the various portions of the understatement for a single tax year, allowing it to impose the fraud penalty of seventy-five percent (75%) to understated portions where the accuracy penalty was not imposed. However, the IRS cannot impose the accuracy-related penalty (IRC § 6662) and the fraud penalty (IRC § 6663) on the same portion of an understatement.