IRC 6662 Penalties: Calculations, Defenses, and Relief

The IRC 6662 accuracy-related penalty adds 20% to the portion of a federal tax underpayment caused by negligence, a substantial understatement of income tax, a valuation misstatement, a transaction lacking economic substance, or an undisclosed foreign financial asset understatement.¹ The rate doubles to 40% for the worst categories. A separate statute, IRC 6664, lets the IRS waive the penalty if you show reasonable cause and good faith, but the standard is stricter than most taxpayers expect.²

How the Penalty Is Calculated

The base penalty equals 20% of the underpayment traceable to qualifying misconduct.¹ An underpayment is the gap between the tax you actually owe and the tax shown on your return, after rebates. The penalty attaches only to the dollars tied to a listed type of misconduct, not to your entire liability.

If the same dollars fall into more than one category (say, both negligence and a substantial understatement), the rate on that portion is still 20%. The IRS cannot stack accuracy-related categories to exceed the rate. The penalty can, however, be assessed alongside the separate failure-to-file penalty for a late return.³ If the IRS proves civil fraud under IRC 6663, the fraud penalty replaces the accuracy-related penalty on that portion of the underpayment.

The rate rises to 40% in three situations: gross valuation misstatements, undisclosed transactions lacking economic substance, and undisclosed foreign financial asset understatements.¹

Negligence and Disregard of Rules

Negligence is the most common trigger. The statute defines it broadly as any failure to make a reasonable attempt to comply with the tax code.¹ In practice, it covers the errors that follow from careless work: poor records, deductions with no legal basis, or leaving income off a return when a Form 1099 or W-2 reported it to the IRS. The IRS does not have to show intent. Sloppy is enough.

Disregard covers any careless, reckless, or intentional failure to follow Treasury regulations, revenue rulings, or other published IRS guidance.¹ The distinction matters because disclosure on Form 8275 can defeat a disregard penalty but cannot cure negligence. Negligence is a reasonable cause fight.

Substantial Understatement of Income Tax

The penalty also applies when the size of the error crosses a threshold, whether or not you were careless.

Individuals

An understatement is substantial if it exceeds the greater of 10% of the tax that should have been shown on the return, or $5,000.¹ The $5,000 floor is fixed by statute and does not adjust for inflation. If your correct tax was $40,000 and your return showed $30,000, the $10,000 gap clears both the floor and the 10% test.

A stricter version applies when you claim the qualified business income deduction under Section 199A. The 10% figure drops to 5%, which makes the threshold much easier to cross.¹

C Corporations

For C corporations other than S corporations and personal holding companies, the threshold is the lesser of $10 million or 10% of the tax required to be shown, with a $10,000 floor.¹ At higher income levels the corporate rule is actually harder to avoid than the individual rule.

Shrinking the Understatement

The understatement figure can be reduced two ways, and this is where most disputes happen. Items backed by substantial authority drop out of the calculation. So do items you adequately disclosed on the return, if the position had at least a reasonable basis. Both terms are explained below.

Valuation Misstatements

Reporting the wrong value or basis for property triggers the penalty when the error is large enough. A substantial valuation misstatement exists when the value or adjusted basis you claimed is 150% or more of the correct figure.¹ Claiming a $150,000 charitable donation of property actually worth $100,000 hits that mark.

The penalty only applies if the resulting underpayment exceeds $5,000, or $10,000 for corporations other than S corporations and personal holding companies.¹

The rate rises to 40% for a gross valuation misstatement, meaning a claimed value of 200% or more of the correct amount.¹ These cases usually involve overvalued charitable contributions.

For charitable deduction property, the general reasonable cause defense is unavailable when the overstatement is substantial or gross, unless you obtained a qualified appraisal from a qualified appraiser and independently investigated the property’s value in good faith.² The appraisal by itself is not enough.

Transactions Lacking Economic Substance

The penalty applies to any underpayment from a transaction entered into primarily for tax benefits, without a meaningful change in your economic position apart from the tax savings. The rate is 20% if the relevant facts were adequately disclosed on the return, and 40% if they were not.¹

This is one of the harshest categories. Disclosure on Form 8275 cannot eliminate the penalty for these transactions; it can only pull the rate down from 40% to 20%.⁴ The reasonable cause defense is also statutorily unavailable here.

Undisclosed Foreign Financial Assets

If you were required to report foreign financial assets, through FBAR (FinCEN 114), Form 8938, or similar provisions, and did not, any resulting underpayment is penalized at 40%.¹ There is no 20% tier; the failure to report is built into the offense. This penalty runs on top of the standalone penalties for failing to file the foreign disclosure forms themselves.

Cutting the Understatement Before It Sticks

Two doctrines shrink the understatement used to test the substantial understatement threshold. Both are worth understanding before a dispute starts.

Substantial Authority

An item backed by substantial authority is excluded from the understatement calculation. Substantial authority is an objective legal standard sitting between reasonable basis (the lowest useful standard) and more likely than not (better than 50-50).⁵ No regulation fixes a percentage.

Authorities that count include the Internal Revenue Code, Treasury regulations, revenue rulings and procedures, tax treaties, court decisions, and congressional committee reports.⁵ Textbooks, articles, and opinions from tax professionals do not, though the underlying authorities they cite might. The odds that you will never be audited are also irrelevant.

Adequate Disclosure on Form 8275

Disclose a questionable position on your return, and if the position has at least a reasonable basis the item drops out of the understatement calculation. Adequate disclosure means filing Form 8275, which identifies the item, its dollar amount, and the legal issue.⁴ An attached letter is not a substitute.

Reasonable basis is stricter than it sounds. It is significantly more than “not frivolous” and is not satisfied by a position that is merely arguable.⁴

If your position contradicts a Treasury regulation, you file Form 8275-R instead and explain why you believe the regulation is invalid. For intentional or reckless disregard of a regulation, disclosure only avoids the penalty if the position is a good-faith challenge to the regulation’s validity.⁶

Disclosure has limits. It cannot prevent the penalty for negligence, valuation misstatements, transactions lacking economic substance, or undisclosed foreign financial assets.⁴

Qualified Amended Returns

Filing an amended return before the IRS contacts you can shrink or eliminate the underpayment that triggers the penalty. A qualified amended return increases the tax shown, narrowing the gap between what you reported and what you owed.⁷

To qualify, the amended return must be filed after the original due date (including extensions) and before the earliest of these events:

The date the IRS first contacts you about any examination of the return, including a criminal investigation.
The date the IRS contacts anyone about an examination related to abusive tax shelter promotion tied to benefits you claimed.
The date the IRS announces a settlement initiative to compromise penalties for a listed transaction you participated in.

First IRS contact is the deadline that matters in most cases. Once the exam letter or call comes, the window closes. The protection does not apply to fraudulent positions on the original return.

The Reasonable Cause Defense

The strongest defense once a penalty is on the table is showing that you had reasonable cause and acted in good faith. If both prongs are met, the penalty is waived on that portion of the underpayment.² The analysis is case-by-case, with no bright line.

The IRS weighs the effort you made to report the correct tax, the complexity of the issue, your education and experience, and the steps you took to understand your obligations or get help.⁸

Reliance on a Tax Professional

The most successful reasonable cause argument is good-faith reliance on a competent tax professional. Four conditions have to line up:

The advisor had the expertise for the specific issue involved.
You gave the advisor all relevant facts and did not withhold or misrepresent anything.
You actually relied on the advisor’s conclusions rather than reaching your own and seeking confirmation.
The advice itself did not rest on unreasonable assumptions or read as too good to be true.

Reliance fails if you knew or should have known the advisor lacked the relevant expertise, or if the advice was obviously implausible. The test is whether a reasonable person in your position would have questioned it.⁸

Software Errors

Reliance on tax preparation software is a grayer area. The IRS has accepted system issues as reasonable cause in the context of late-filed or late-paid returns, but its guidance does not list software errors as reasonable cause for accuracy-related penalties.⁸ Even if a glitch caused your error, you still have to show you entered accurate information and that a reasonable person would not have caught the mistake on the finished return.

Interest on the Penalty

The accuracy-related penalty is not a fixed charge that sits still until you pay. Interest runs on the penalty from the due date of the return (including extensions) until the payment date.⁹ The rate is the federal short-term rate plus three percentage points, reset quarterly and compounded daily. For the first half of 2026, the rate was 7% for Q1 and 6% for Q2.¹⁰

Because interest starts from the return due date rather than the penalty assessment date, a penalty assessed three years after you filed already carries three years of accumulated interest. On a large understatement, the interest can approach the penalty itself.

Requesting Penalty Relief

You have options at several stages once the IRS proposes the penalty.

During the Audit

The best moment to raise reasonable cause is during the exam. Give the auditor the supporting record: the advisor’s engagement letter, correspondence showing the facts you disclosed, notes on the research done, and any written advice you received. The examiner can recommend removing the penalty before the case moves forward.

Administrative Relief

Once the penalty is assessed, you can request abatement by calling the number on your IRS notice or filing Form 843 (Claim for Refund and Request for Abatement). If you ask for reasonable cause relief but the IRS finds you qualify for first-time abatement instead, the IRS applies that relief automatically and notifies you.¹¹ First-time abatement is a separate administrative waiver for taxpayers with a clean compliance history over the prior three years, and is more commonly seen with filing and payment penalties than with accuracy-related penalties.

Appeals and Tax Court

If the examiner or the initial administrative review denies relief, you can request a conference with the IRS Independent Office of Appeals. Appeals officers weigh the likelihood that the IRS would prevail in court, and they often have more room to move on penalty issues than on the underlying tax. If Appeals does not resolve it, you can petition the U.S. Tax Court before paying, or pay the penalty and file a refund claim in federal district court.

1
Office of the Law Revision Counsel. 26 USC 6662 – Imposition of Accuracy-Related Penalty on Underpayments
2
Office of the Law Revision Counsel. 26 USC 6664 – Definitions and Special Rules
3
eCFR. 26 CFR 1.6662-2 – Accuracy-Related Penalty
4
Internal Revenue Service. Instructions for Form 8275 Disclosure Statement
5
GovInfo. 26 CFR 1.6662-4 – Substantial Understatement of Income Tax
6
Internal Revenue Service. Instructions for Form 8275-R Regulation Disclosure Statement
7
eCFR. 26 CFR 1.6664-2 – Underpayment
8
Internal Revenue Service. Penalty Relief for Reasonable Cause
9
Office of the Law Revision Counsel. 26 USC 6601 – Interest on Underpayment, Nonpayment, or Extensions of Time for Payment of Tax
10
Internal Revenue Service. Quarterly Interest Rates
11
Internal Revenue Service. Administrative Penalty Relief