“Taxpayers who are hit with the 20 percent penalty for negligence or disregard of rules may try to establish reasonable cause for underpayment and show that you acted in good faith.”
AS OUR tax laws become more complex, we find it more difficult to comply. As we fail to comply in filing or paying required taxes, the IRS hits us with certain penalties. Let’s gain a little understanding on the subject of penalties.
The source of these penalties is The Internal Revenue Code, which imposes various civil penalties when requirements of tax laws are disobeyed without reasonable cause, or as the result of negligence, intentional disregard, willful disobedience or fraudulent intent.
Numerous penalties have been consolidated into two penalty groups: A uniform accuracy-related penalty and a fraud penalty.
1. Accuracy-related penalties are computed at 20 percent of underpayments attributable to any of the following:
A. Negligence or disregard of rules or regulations,
B. Substantial understatement of income tax,
C. Substantial valuation overstatement,
D. Substantial overstatement of pension liabilities.
2. Taxpayers who are hit with the 20 percent penalty for negligence or disregard of rules may try to establish reasonable cause for underpayment and show that you acted in good faith. (TIP: there is no longer a presumption that failure to include amounts from W-2, 1099 or K-1 is negligent).
3. The IRS may impose the 20 percent penalty where there is substantial understatement of tax. This exists when the understatement exceeds the greater of 10 percent of the tax required or $5,000 ($10,000 for regular “C” corporations). You may avoid this penalty by showing good faith or reasonable cause. (TIP: Avoid this penalty by providing substantial authority and disclosing relevant facts. Use and attach Form 8275 to your return. Feel free to call our office for a blank Form 8275).
4. The IRS may also assess the 20 percent penalty for substantial valuation overstatement of basis if the value of any property claimed is 200 percent or more of the correct basis (Beware: the penalty rate increases to 40 percent if you claim 400 percent or more of the correct amount).
5. The 20 percent accuracy-related penalty also applies to substantial overstatement of pension liabilities if the actuarial determination is 200 percent or more of the correct amount. (The penalty is also doubled to 40 percent if the gross valuation is misstated by 400 percent or more).
6. The second group of accuracy-related penalty is for fraud. The fraud penalty is imposed at the whopping rate of 75 percent of any underpayment. If any portion is attributable to fraud, it is presumed that the entire underpayment is attributable to fraud. Of course, burden of proof lies with the IRS.
7. There are also distinct and separate penalties for the underpayment of estimated tax. The penalty is equal to the interest that would accrue on the underpayment. There are very few instances when this type of penalty can be waived (forgiven) such as casualty, disaster, or if you are retired after the age of 62 or become disabled during the tax year. (Fill in and attach Form 8210 to see if you meet various exceptions and thereby avoid this penalty).
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Victor Santos Sy, CPA, MBA, provides professional services in accounting and tax controversy including IRS audit defense and offers in compromise. He also advises clients on choices of entity including corporations for small businesses and LLCs for rentals. Vic worked with SyCip, Gorres, Velayo (SGV – Andersen Consulting) and Ernst & Young before establishing Sy Accountancy Corporation at 704 Mira Monte Place, Pasadena, CA 91101. The firm celebrates its 35th anniversary this year. You may email tax questions to Vic at [email protected]. You are welcome to visit our website for more than 300 tax tips at www.victorsycpa.com.