You open the mailbox, and there it is. A thin envelope from the Department of the Treasury. Your heart sinks. You’ve been audited, or maybe just "adjusted," and now the IRS says you owe more tax. But then you see it—the IRS accuracy related penalty. It’s not just the back taxes. It’s not just the interest. It’s a massive 20% surcharge tacked onto the underpayment. Suddenly, a $5,000 mistake is a $6,000 nightmare.
It happens.
Most people think the IRS only penalizes criminals or tax evaders. That’s just not true. The IRS accuracy related penalty is basically the "you should have known better" tax. It covers everything from honest-but-sloppy math to aggressive tax positions that didn't quite hold up under scrutiny.
What Exactly Is This 20% Hit?
Section 6662 of the Internal Revenue Code is where the magic (or the misery) happens. This isn't a "one size fits all" thing, though it often feels like it. The IRS bundles several different types of mistakes under this one umbrella. If you underpay your tax because of negligence or a "substantial understatement" of income tax, they hit the 20% button.
Think about that for a second. If you’re a small business owner and you accidentally claim a personal vacation as a business trip, and that deduction saved you $10,000 in taxes, the penalty alone is $2,000. Plus interest. It adds up. Fast.
There are two main triggers you need to care about.
First, there’s negligence. The IRS defines this as any failure to make a reasonable attempt to comply with the law. Basically, if you were lazy with your record-keeping or ignored clear rules, you’re negligent.
Second, there’s the substantial understatement. For individuals, this usually kicks in if the amount of tax you missed is more than 10% of what you actually owed, or $5,000, whichever is greater. You don't even have to be "negligent" to hit this one; you just have to be wrong by a large enough margin.
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The Negligence Trap
What does "reasonable attempt" even mean? It’s subjective. Kinda. If you’ve got a shoebox full of faded receipts and you just guessed the totals, that’s negligence. If you didn't check your 1099s against your return, that’s negligence. The IRS expects you to act like a "prudent person." If a prudent person would have caught the mistake, and you didn't, you're paying the 20%.
Honestly, most of these penalties come from simple carelessness. People get busy. They use tax software and just click "next" without looking at the fine print. But the software is only as good as the data you give it.
When the Penalty Jumps to 40%
Wait, 40%? Yeah.
While the standard IRS accuracy related penalty is 20%, it can double. This usually happens in cases involving "gross valuation misstatements."
Let’s say you donate a piece of art to a museum. You claim it’s worth $100,000 to get a massive deduction. The IRS later determines it’s actually worth $20,000. Because your valuation was 400% or more of the correct amount, they don't just take the 20% penalty. They go for the 40% "gross" penalty. It’s a hammer meant to stop people from inflating the value of assets to skirt taxes.
It’s not just art, either. This happens with land conservation easements, closely held business stock, and even complex international transfer pricing. If you’re playing in those leagues, you better have a rock-solid appraisal from someone who knows what they're doing.
Substantial Understatement for Businesses
Corporations have it a bit tougher. For them, a substantial understatement is the lesser of 10% of the tax required (or, if greater, $10,000) or simply $10 million. If you’re running a mid-sized company, $10,000 is a rounding error. This makes it incredibly easy for the IRS to trigger the penalty during a routine corporate audit.
How to Fight Back: The Reasonable Cause Defense
You aren't necessarily stuck with the bill. There is a way out, but it’s a steep hill to climb.
The most common way to get an IRS accuracy related penalty waived is by proving "Reasonable Cause and Good Faith." This is found in Section 6664(c).
You basically have to prove that, despite the error, you were trying your best to be honest and accurate. Maybe you relied on a tax professional who gave you bad advice. Maybe there was a death in the family or a natural disaster that made record-keeping impossible.
But here’s the kicker: simply saying "my accountant did it" isn't a get-out-of-jail-free card.
The IRS looks at:
- Your education and experience level.
- Whether the tax issue was complex or simple.
- If you provided all the necessary info to your tax preparer.
- Whether you actually followed the professional advice you were given.
If you’re a CPA yourself, the IRS isn't going to buy the "I didn't know" excuse. If you’re a 22-year-old filing your first complex return, they might be a bit more lenient.
The "Substantial Authority" Escape Hatch
There is another way to avoid the penalty for a substantial understatement: Substantial Authority.
This is some high-level legal maneuvering. It means that even if the IRS disagreed with your position, there was enough legal precedent (court cases, revenue rulings, etc.) to support what you did. It’s basically saying, "Hey, I wasn't just guessing; here are three court cases that say I'm right."
If you have substantial authority for your position, the penalty can disappear. But—and this is a big but—this doesn't apply to "tax shelters." If the IRS thinks you entered a deal specifically to avoid taxes, the bar for avoiding penalties is much, much higher.
Real World Example: The 1099-B Mess
Let’s look at a scenario that hits regular investors.
Imagine you sold a bunch of crypto or stocks in 2024. You get your 1099-B, but you realize the "basis" (what you paid) is missing for some old coins. You estimate it at $50,000. Later, the IRS audits you and finds the basis was actually $10,000. You owe tax on that $40,000 difference.
Because you guessed—and guessed wrong—the IRS will likely slap on the IRS accuracy related penalty. Why? Because you didn't have receipts. You didn't make a "reasonable attempt" to find the cost basis. You just picked a number that lowered your tax bill.
In this case, arguing "reasonable cause" is tough. You’d need to show you tried to get the records from a defunct exchange or that the data was lost in a way you couldn't control.
Practical Steps to Protect Yourself
Nobody wants to hand over an extra 20% of their hard-earned money to the government. Preventing this penalty is mostly about being boring and meticulous.
1. Documentation is King
If you take a deduction, have a paper trail. If you claim a business expense, keep the receipt. If you take a weird tax position, write a memo explaining why you think it’s legal at the time you file. Don't wait for the audit to start scrambling for justification.
2. Disclosure is Your Shield
If you’re worried about a specific position you’re taking, you can actually tell the IRS about it. By filing Form 8275 (Disclosure Statement), you’re saying, "Hey, I’m doing this, and it might be controversial." If you disclose the position and it has a "reasonable basis," the IRS usually cannot hit you with the accuracy-related penalty even if they eventually decide you were wrong. It’s like a "no-penalty" insurance policy, though it does draw a giant red circle around that item for the auditor.
3. Hire a Real Pro
Don't just use a "tax preparer" who works out of a pop-up shop in February. If your taxes are complex, you need an Enrolled Agent (EA) or a CPA. Ask them specifically about "Section 6662 protection." A good pro will tell you if a deduction is risky.
4. Review the "Small" Stuff
Check your names, Social Security numbers, and math. Simple clerical errors that lead to an underpayment can still trigger negligence penalties.
The Bottom Line on IRS Accuracy Related Penalties
The IRS isn't your friend, but they aren't always the villain either. They use the IRS accuracy related penalty as a tool to keep the system running. If there were no penalties for being wrong, everyone would "accidentally" underpay and just wait to see if they got caught.
If you get hit with one, don't panic. Look at the reason code. If you truly had a good reason for the mistake, fight it. Write a clear, concise letter during the audit process. Provide your evidence.
But the best defense is a clean return. Tax law is dense. It’s confusing. It’s often contradictory. But the IRS expects you to navigate it—or pay someone who can.
Immediate Next Steps:
- Check your last three years of tax returns for any "estimated" figures that lack receipts.
- If you find a major error before the IRS does, consider filing an amended return (Form 1040-X). Voluntarily correcting a mistake before an audit starts is one of the best ways to show "good faith" and avoid penalties.
- Gather all 1099s and W-2s and ensure they match your filed returns exactly; the IRS computers flag these discrepancies automatically.