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Substantial Underreporting Penalty

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    Substantial Underreporting Penalty

    When a photo-finish shows a horse wins a race because his nose crosses the finish line first, I do not regard the losing horse as losing by a "substantial" amount.

    A few years ago, government officials losing sleep because of not having enough revenue, dreamed up this idea of creating a penalty for those who under-report their revenue by a "substantial" amount.

    Last year I fought a "substantial" penalty with an auditor over $30,000 worth of bank deposits when the taxpayer reported $1.5MM in revenue. The bank showed this $30,000 that the customer didn't know was borrowed or whatever, and IRS didn't know either until further queries from the bank itself. This understatement of 2% was deemed to be "substantial" underreporting. I had to give in to this $5000 ding in compromise to win $27K on another issue.

    Another client was assessed (on a nasty letter) a "substantial" penalty over a $600 K-1 not reported in the midst of $150,000 of mainstream income.

    Am I misunderstanding because I believe in Webster definitions? Or is the govt straining at the furthest imagination to ring up the cash register?

    #2
    Are you referring to Accuracy Related Penalty for "Substantial Understatement of Income Tax"?

    That is specifically defined in the Code to be the greater of 10% of the tax on the return or $5000.
    https://www.law.cornell.edu/uscode/text/26/6662#d

    Note that it is based on the amount of "tax", not the amount of any other number on the tax return. Expense amounts ("valuation") are subject to the penalty if they are 150%-200% off.


    However, it seems that your examples don't fit that. If they assessed a penalty (other than a late penalty), I would inquire exactly what the name of the penalty is, and under what Code section that penalty is.

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