Accuracy-Related Penalty (IRC 6662) and Reasonable Cause

Accuracy-Related Penalty (IRC 6662) and Reasonable Cause

Accuracy-Related Penalty (IRC 6662) and Reasonable Cause

While there are many different types of civil tax violations under the Internal Revenue Code, one of the most common types of penalties involves the underpayment of income tax. It should be noted that not every inaccurate tax return results in accuracy-related penalties — it depends on the amount of underpayment relative to the total amount of payments that are due. These penalties can vary, especially if the IRS determines there are ‘Gross Value Misstatements,’ or issues with ‘Foreign Financial Asset Understatements’ — which can result in a significantly higher penalty. Underpayment of tax cases are litigated often. When the matter turns from an IRS administrative scenario to a litigation case, the Taxpayer’s best position to abate penalties is usually for them to show there was reasonable cause sufficient to avoid a penalty in the first place. Let’s look at the basics of the 26 USC 6662 accuracy-related penalty and the 26 USC 6664 Reasonable Cause exception: 

Reasonable Cause Avoids Penalties

The most important factor in avoiding penalties resulting from the underpayment of tax under Internal Revenue Code 6662 is being able to prove reasonable cause. Reasonable cause does not just reduce penalties, it eliminates them — because no penalty can be issued with respect to any portion of an underpayment when there was reasonable cause with respect to that portion of the underpayment.

The 26 CFR 1.664-4 Regulation is Very Important

The regulation involving reasonable cause and good faith exception is very important, because it specifically lays out what is required to prove reasonable cause and — even provides some examples. The specific regulation is 26 CFR section 1.6664–4. The regulation specifically provides that each taxpayer’s situation should be evaluated on a case-by-case basis, taking into account all the pertinent facts and circumstances. This is referred to as the ‘totality of the circumstance’ test — and it is based on the general overall presentation of facts by the Taxpayer as to why there was an underpayment.

Totality of the Circumstance (Facts and Circumstances)

When it comes to the totality of the circumstances, the most important aspect is the amount of effort the taxpayer took to determine their own IRS tax liability. In other words, when the taxpayer submitted their original tax return and calculated the tax amount due, did the taxpayer sufficiently show give it their best shot to provide the IRS with an accurate presentation of their tax situation. This is important, because if it turns out that the taxpayer was fraudulent and not negligence, the penalties can be significantly higher under 26 USC 6663.

Important Facts & Circumstances to Consider

Some of the more important aspects of proving reasonable cause include:

      • What is the taxpayer’s experience knowledge and education?

      • What is the information they relied on in the W-2 or 1099 accurate?

      • If the tax information they received (W-2, 1099, etc.) was inaccurate, was the taxpayer aware of the inaccuracy at that time?

      • Did the taxpayer rely on a professional tax preparer/advisor – and if so, what is the reliance.

Section 6751 Penalties

There has been a recent surge in IRS disputes (Audits, Appeals, CDP and Litigation) focused specifically on the Internal Revenue Code section 6751 and the procedural requirements that must be followed when the IRS issues penalties. According to statute, before penalties can be assessed they must be personally approved by the immediate supervisor of the individual making the assessment – noting, there are exceptions to this rule such as the automatically calculated through electronic means exceptions. But in some circumstances, the Taxpayer may want to make the 6751 argument – although it may be more difficult in the Ninth Circuit and the case of Laidlaw.

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