Accuracy-Related Penalty

The accuracy-related penalty is the IRS charge for a tax return that understates the tax because of carelessness, disregard of the rules, or certain larger errors. It is the penalty most often attached to an audit or to a notice that says your return does not match reports from employers and banks. This page explains what triggers it, how it is calculated, when it grows to 40%, and how to respond.

What triggers it

Section 6662 lists several grounds. The two you see most often are:

• Negligence or disregard of rules. Negligence means not making a reasonable attempt to follow the tax law when preparing the return. Disregard means carelessly, recklessly or intentionally ignoring the rules. The IRS gives examples such as leaving out income that was reported on a Form 1099, or not checking a credit or deduction that looks too good to be true.
• Substantial understatement of income tax. The understatement is large enough compared with the correct tax. The thresholds are on our page about the substantial understatement penalty.

The same section also covers valuation misstatements, estate and gift valuation understatements and certain transactions without economic substance. The valuation rules are on the valuation misstatement penalties page. An adjustment made at audit is what creates the underpayment, so the penalty usually arrives with an audit report, a CP2000 notice or a notice of deficiency.

How the penalty is calculated

Take the underpayment, which is the extra tax that results from the correction, and apply 20% to the part that qualifies. The penalty is added to the tax, and interest runs on both.

Example (hypothetical). You forgot a $40,000 payment reported to the IRS on a Form 1099-NEC. The correction adds $10,000 of tax. If the IRS finds the omission was negligence and asserts the penalty, the penalty is 20% of $10,000, which is $2,000. You would owe the $10,000 tax, the $2,000 penalty and interest on both from the due date of the return (including extensions) until it is paid.

When two accuracy grounds overlap, the IRS applies the penalty only once to the same dollars. The rate does not stack up to 40% because two grounds apply.

When the rate is 40%

The rate doubles to 40% in these situations, as written in section 6662:

• gross valuation misstatements, such as claiming property is worth 200% or more of its true value
• an understatement tied to a transaction involving an undisclosed foreign financial asset
• a transaction lacking economic substance that was not adequately disclosed on the return

Foreign reporting is an area where the 40% rate can matter for people with accounts or companies abroad. See our foreign reporting penalties overview for how the 40% rule fits with Forms 8938, 5471 and 3520.

Accuracy-related versus fraud

Fraud is a different and much more serious penalty. The fraud penalty is 75% and requires the IRS to prove intent. An honest mistake, a careless error or reliance on bad advice is not fraud. The two penalties cannot be applied to the same part of an underpayment, although both can appear on one return if they cover different pieces. See the civil fraud penalty.

How to avoid it

• Match every Form W-2, 1099 and 1098 you receive to your return before you file.
• Keep records for each deduction and credit, and do not claim anything you could not support.
• Claim positions that have substantial support in the law, or disclose the position properly on the return.
• If you find an error after filing, ask a professional whether an amended return before the IRS contacts you could help. See amended returns.

Disputing or getting relief

First, check the adjustment itself. If the underlying change is wrong, the penalty falls with it. Respond to the notice by its deadline, with a signed explanation and documents. If you receive a notice of deficiency, the notice gives a date by which you must file a petition with the U.S. Tax Court, and the Court cannot consider a late petition. See the CP3219A notice page.

Second, ask for reasonable cause. For accuracy-related penalties the IRS looks at your effort to report the correct tax, how complex the issue was, your education and experience, and the steps you took to understand your obligation or get advice. If you relied on an advisor, the IRS may look at whether you gave the advisor complete information and whether the advisor was competent for your situation. Our page on reasonable cause penalty relief walks through the evidence. Accuracy-related penalties are not eligible for first-time abatement, which covers different penalties.

If the IRS and you still disagree, IRS Appeals is the usual next stage before court.

How we can help

We can review the audit report or notice, test whether each adjustment and the penalty on it holds up, gather the reasonable-cause evidence and prepare the response. For clients with foreign accounts or businesses, we check whether the 40% rate is in play. We do not promise removal, but the facts about how you prepared the return often matter a great deal.

Our IRS audit representation page explains how an engagement works. You can also contact us.

Frequently asked questions

General information only, not tax, legal or accounting advice for your situation. Rules, limits and deadlines change; confirm the current rules with the official source or a qualified professional before you act. Reading this page does not create a professional relationship with CPA Tax Payroll and Accounting Corp.