The Internal Revenue Service (IRS) is the federal agency responsible for administering the United States tax laws. The agency is tasked with ensuring taxpayers comply with the tax laws and accurately report their income and deductions. However, in some cases, taxpayers may make errors or omissions on their tax returns that can trigger IRS penalties. One such penalty is the accuracy-related penalty, which is levied on taxpayers who fail to accurately report their income, deductions, or credits. This post will provide an overview of the IRS accuracy-related penalty, including what it is, how it works, and what taxpayers can do to avoid it.
What Is the Accuracy-Related Penalty?
The accuracy-related penalty is a penalty that the IRS imposes on taxpayers who fail to accurately report their income, deductions, or credits. It is imposed under Section 6662 of the Internal Revenue Code (IRC) and is intended to encourage taxpayers to take reasonable steps to ensure their tax returns are accurate. The penalty is calculated as a percentage of the underpayment of tax that is attributable to inaccurate reporting. Specifically, the penalty is equal to 20% of the underpayment of tax that is attributable to one or more of the following:
Negligence or Disregard of Rules or Regulations
Due to carelessness or willful disregard of the tax laws, taxpayers are frequently subject to the accuracy-related penalty. Disregarding rules or regulations is a deliberate or intentional failure to comply with tax laws, whereas negligence is defined as a failure to exercise reasonable care in the preparation of a tax return. For example, a taxpayer who fails to report all of their income on their tax return may be subject to the accuracy-related penalty for negligence.
Substantial Understatement of Income Tax
Another reason taxpayers may be hit with the accuracy-related penalty is due to a substantial understatement of income tax. This occurs when the amount of tax reported on the tax return is substantially less than the amount of tax that should have been reported. Specifically, a substantial understatement of income tax occurs if the understatement of tax exceeds more than 10% of the correct tax liability or $5,000.
Substantial Valuation Misstatement
When the value or adjusted basis of any property claimed on a tax return is materially overstated, it constitutes a substantial valuation misstatement. When the value or adjusted basis reported on the tax return is 200% or higher than the true value or adjusted basis, it constitutes a significant valuation error.
Substantial Overstatement of Pension Liabilities
The accuracy-related penalty can also be imposed on taxpayers who substantially overstate their pension liabilities. This occurs when a taxpayer overstates the amount of their pension liabilities by more than 10% of the correct amount.
How Does the Accuracy-Related Penalty Work?
The accuracy-related penalty is calculated as a percentage of the underpayment of tax that is attributable to inaccurate reporting. The penalty rate is 20%, which means that the penalty will be equal to 20% of the underpayment of tax that is attributable to inaccurate reporting. However, the penalty can be reduced or eliminated if the taxpayer can show that they had reasonable cause for the inaccurate reporting and that they acted in good faith.
What Are the Penalties for Failing to Pay the Accuracy-Related Penalty?
If a taxpayer fails to pay the accuracy-related penalty, the IRS may take enforcement actions, including placing a lien on the taxpayer’s property or seizing their assets. In addition, the IRS may also assess interest on the unpaid penalty at a rate that is generally equal to the federal short-term rate plus 3%.
What Can Taxpayers Do to Avoid the Accuracy-Related Penalty?
To avoid the accuracy-related penalty, taxpayers should take reasonable steps to ensure the accuracy of their tax returns. Here are some tips to help taxpayers avoid the accuracy-related penalty:
- Keep Accurate Records
One of the best ways to ensure the accuracy of your tax return is to keep accurate records of all your income, expenses, and deductions. This includes keeping receipts, invoices, bank statements, and other relevant documents that support the amounts reported on your tax return. By keeping accurate records, you can easily verify the information reported on your tax return and avoid making mistakes or omissions.
- Hire a Tax Professional
Another way to avoid the accuracy-related penalty is to hire a tax professional to prepare your tax return. Tax professionals have the knowledge and expertise to accurately prepare your tax return and ensure that all applicable deductions and credits are claimed. They can also help you identify potential tax issues and provide guidance on how to avoid penalties.
- Use Tax Preparation Software
If you prefer to prepare your tax return yourself, consider using tax preparation software. Tax preparation software can help you accurately calculate your taxes and identify potential errors or omissions. Most tax preparation software programs also have built-in error checks and audit protection features that can help you avoid penalties.
- Review Your Tax Return before Filing
Before filing your tax return, review it carefully to ensure that all the information is accurate and complete. Double-check all calculations, ensure that all income and deductions are reported correctly, and make sure you have signed and dated the return. Taking the time to review your tax return can help you catch errors or omissions before they result in penalties.
- Seek Professional Advice
If you have any doubts or questions about how to accurately report your income, deductions, or credits, seek professional advice. A tax professional can help you understand the tax laws and regulations and provide guidance on how to comply with them. Seeking professional advice can help you avoid mistakes or omissions that could result in an accuracy-related penalty.
The accuracy-related penalty is a serious penalty that can result in significant financial consequences for taxpayers who fail to accurately report their income, deductions, or credits. To avoid this penalty, taxpayers should take reasonable steps to ensure the accuracy of their tax returns, including keeping accurate records, hiring a tax professional, using tax preparation software, reviewing their tax returns before filing, and seeking professional advice when necessary. By taking these steps, taxpayers can reduce their risk of penalties and ensure compliance with tax laws.