How to Handle IRS Accuracy-Related Penalties

You probably know the IRS imposes tax penalties when taxpayers don’t comply with tax laws. That means not filing their tax returns, not paying taxes, or not providing accurate information. If you disregard tax regulations or understate your income tax, you could get hit with IRS accuracy-related penalties.

This type of penalty is typically equal to 20% of how much you underpaid, and situations that trigger the penalty are negligence or disregard in following tax rules and understating your taxes by a significant amount. Depending on whether you agree or disagree with the penalty, you have steps you can take to resolve the issue as soon as possible.

Find out more about the accuracy-related tax penalty and what to do when you get a CP2000 or CP3219A notice in the mail.

Key takeaways:

• What is an accuracy-related penalty? The penalty is 20% of the taxes you underpaid because of negligence, disregard, or substantial understatement.
• What triggers the accuracy-related penalty? Common reasons include underreporting your income by claiming deductions you don’t qualify for or overstating the value of business assets or charitable deductions. 
• What to do if you agree? Pay the penalty, address the mistake, and set up a payment plan if needed.
• What to do if you disagree? Dispute the penalty by sending supporting documentation or show reasonable cause for the error you made.
• How do you prevent accuracy-related penalties? Maintain accurate records, review your tax returns carefully, and consult a tax professional.

What Is an Accuracy-Related Penalty?

The accuracy-related penalty is a penalty that applies if you don’t pay the amount you owe, whether you haven’t reported all the income you earned for the year or you claim tax credits or deductions that you actually don’t qualify for. In either case, you’re understating what you actually owe.

The standard accuracy-related penalty rate is 20% of the underpaid tax that was caused by either disregard or negligence. So, if you should have owed $10,000 but your return only shows that you owe $4,000, you would owe 20% of the difference, $6,000. So, the penalty would be $1,200. Taxpayers with higher tax bills can see how quickly this penalty adds up and tacks on a significant amount to the overall tax balance.

How Do You Get an Accuracy-Related Penalty?

Let’s dig deeper into how you would get the accuracy-related penalty. As mentioned, the IRS imposes this penalty when you neglect or disregard tax laws:

• Negligence: The IRS considers whether you made a “reasonable attempt” to follow tax regulations in filing your tax return. If you didn’t, this is negligence. For example, if you claim a tax credit but have no documentation to show that you qualify, that could be negligence.
• Disregard: This is when you “carelessly, recklessly, or intentionally” disregarded tax laws that apply to you. This could happen if you carelessly apply a tax credit to your return that seems really high, but you don’t check to ensure you actually qualify or that it’s accurate.

If these reasons led to an underpayment of tax, you may get an accuracy-related penalty. Contact a tax attorney at Seattle Legal Services to figure out your next steps when you receive a penalty notice.

What Is Substantial Understatement of Tax?

The IRS considers your understated income tax “substantial” if you underreport your tax liability by either 10% of what was required or $5,000, whichever is more. This leads to the accuracy-related penalty.

So what would cause this kind of understatement? It may not always be on purpose, but you will still be penalized. Common causes of underreporting may be:

• You didn’t report all your income, leaving off self-employment or freelance work that should have been reported.
• You failed to include investment income or capital gains for the year.
• You claimed deductions or credits that were too high.
• You claimed deductions or credits you didn’t qualify for.

The IRS considers these situations as failing to follow tax laws. If you can show you had a reasonable cause for your mistake, the IRS may agree to an exception.

Accuracy-Related Penalty Notices

You’ll always be notified about a penalty via a notice sent through the regular mail. The most common is the CP2000 notice, which is used when the details the IRS receives from other parties, like a bank or an employer, don’t align with the information you provided on your tax return. 

The CP2000 notice will include the correct amount that you owe and the penalties that have accrued because of your discrepancy. Notice CP3219A essentially provides the same information, and you may receive this version. Both notices outline what to do if you agree or disagree with the proposed updates to your tax bill and the penalty.

Anytime you receive an IRS notice, the best thing to do is act fast — otherwise, your bill could continue to build with penalties and interest. Talk to a tax professional about your options and the best way forward for your situation.

What If You Agree with the IRS Penalty?

Do what you can to quickly take care of the issue if you agree with the understatement of tax and the penalty. Take these steps:

• Pay the penalty: This helps you avoid interest and additional penalties from building up on your balance.
• Pay off your updated tax balance: If you now owe more money to the IRS because of your understated tax liability, pay it off in full if you’re able to.
• Set up a payment plan: If you can’t pay everything right now, set up an installment agreement online to pay off what you owe over time via monthly payments.
• Address the problem that led to the inaccuracy: Figure out what mistake led to the underreporting. Did you leave off 1099 income? Is it your record-keeping practices? Address the cause so it doesn’t happen again.

Unfortunately, first-time penalty abatement doesn’t apply to these types of penalties. Even if you agree with the IRS penalty and notice, it’s helpful to discuss the situation with a tax expert. They can explain tax law and what went wrong and advise you on how to set up more effective tax preparation practices.

What If You Disagree with the IRS Penalty?

The process can be more complex if you disagree with the IRS notice. Follow these steps if you know that something is wrong:

• Read the notice thoroughly: Make sure you fully understand the numbers and information on the notice. Review your own records and anything you received from third parties, such as an employer or client, to verify that you are correct.
• Act quickly: It’s important to start your dispute before the IRS actually assesses the penalty, so respond to the notice as soon as you receive it.
• Review the dispute options: Your notice will include instructions for what to do if you disagree with the penalty. Follow these instructions carefully to move forward with the dispute.
• Provide all relevant documentation to initiate a dispute: The IRS will need to see any evidence that supports your claims, including copies of tax documents or bank statements.
• File an appeal: If you responded to the notice with information about why you’re disputing the penalty, and the IRS rejected this response, you could then appeal that decision. Always work with a tax attorney if you’re going this route.

If you believe the IRS made a mistake, talk to a tax expert. A tax attorney or CPA can review all your records and the IRS’s claims to ensure you submit the best response that will lead to your desired outcome.

Showing Reasonable Cause

Another way to dispute your accuracy-related penalty is to show the IRS you had reasonable cause for the error. This involves proving that you made reasonable efforts to comply with tax law but couldn’t because of circumstances beyond your control. Reasonable cause factors vary, but examples include that you took the advice of a tax professional or the IRS that was incorrect or you used inaccurate information from a tax form, such as a Form 1099, to prepare your tax return.

The IRS may agree that your situation occurred due to reasonable cause if you generally acted in good faith and didn’t show willful neglect.

How to Prevent Accuracy-Related Penalties

Whether or not you agree with the accuracy-related penalty and information on your notice, you want to do everything you can to avoid these penalties in the future. Here are a few ways to do it:

Maintain Organized, Accurate Records

Take a look at how you currently manage and store your tax records. Are you updating throughout the year, or throwing things together last minute? Make sure you have a system in place for storing important tax documents securely and keeping your information up to date. You may want to incorporate a calendar and automated notifications so you don’t miss any important deadlines.

Review Your Tax Return for Mistakes

Double and triple-check your tax return to ensure accuracy. Make sure all deductions you take are accurate, and review the income you reported against each of your tax documents. Look at all income you received throughout the year to ensure you’re not leaving anything out when reporting. It’s easy to forget a project you worked on at the beginning of the year, for example.

Check Your Credits and Deductions

Many accuracy-related penalties come from trying to take deductions and credits you don’t actually qualify for — or trying to claim too much. Review eligibility guidelines for each tax credit and deduction. Working with a tax professional or using an online platform can help you avoid missing something important when it comes to deductions and credits.

File Your Tax Return Properly

Fully comply with tax laws when filing your tax return. Only include accurate information, and make sure you file by the applicable deadline. Remember that you’ll need to file quarterly tax returns if you have self-employment income, so this requires even more planning and diligence with your tax records.

Pay Your Full Tax Liability

It’s never wise to understate your income since you will eventually be left with an even higher tax bill that includes penalties and interest. Commit to being responsible for your full tax liability each year to stay in good standing with the IRS. Pay off your bill in full as quickly as possible.

Contact the IRS If You Can’t Pay

Never try to deceive the IRS or neglect tax laws if you’re unable to pay your taxes. You have options to get relief, including applying for a payment plan, asking for an offer in compromise if your financial situation won’t allow you to pay in full, or requesting currently not collectible status if going through a financial hardship. If you need more time to file your return, you can easily apply for an extension to get an extra six months — though you’ll still have to pay your taxes by the original tax deadline.

Work with a Tax Attorney

Whatever your tax issue, it’s always wise to talk to a tax professional about what’s going on. A tax attorney can help you understand your rights as a taxpayer, tax relief options, tax laws that apply to you, tax credit eligibility requirements, and tax return dates and deadlines.

It’s especially important to hire a professional if you’re dealing with a very large sum owed, your issues span multiple years, or you have a complex tax situation, such as business taxes.

Get Expert Help from Seattle Legal Services

Dealing with tax penalties is common but never fun. The IRS will impose a penalty if you understate your tax liability, whether through negligence or disregard for tax laws. You’ll then get a notice in the mail about the penalty and your new balance.

Never ignore IRS notices, however daunting they may be. Instead, talk to a tax expert for help. The team at Seattle Legal Services is ready to assist you in understanding tax laws and breaking down your responsibilities. We’ll help you dispute a penalty or IRS decision and negotiate on your behalf. 

Contact Seattle Legal Services to get started with a tax attorney.