Case — Accuracy Related Penalty

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TL Case Summ

THE QUESTION

What is the “amount shown as tax on the return” for purposes of calculating an accuracy-related penalty?

THE DISPUTE

Taxpayer Says: The amount shown as tax on the return is calculated without regard to refundable credits or, alternatively, the amount shown as tax on the return is reduced by the refundable credits but not below zero.

Internal Revenue Service Says: The amount shown as tax on the return is reduced by the refundable credits claimed on the return.

THE LAW

From Internal Revenue Code Section 6662(a): Provides the rules for the application of an accuracy-related penalty, including a penalty that is predicated on negligence or a substantial understatement of income tax.

From Internal Revenue Code Section 6664(a): Underpayment.–For purposes of this part, the term “underpayment” means the amount by which any tax imposed by this title exceeds the excess of–(1) the sum of–(A) the amount shown as the tax by the taxpayer on his return, plus (B) amounts not so shown previously assessed (or collected without assessment),
over (2) the amount of rebates made.

THE CAUSE OF THE DISPUTE

When you file an inaccurate federal income tax return and underpay the tax you actually owe, the IRS can assess an accuracy-related penalty. If your underpayment is not related to fraud, the penalty is generally 20% of the amount you underpaid. Here’s the formula for calculating your underpayment: underpayment equals (the amount you should have reported) less (the amount you did report minus any rebates).

In this case, the taxpayer and the IRS agree there was an underpayment of tax and that the correct tax due was $144. The dispute arose over what amount is considered “tax shown on the return,” one of the four components on which the penalty is based.

On his 2008 individual federal income tax return, the taxpayer reported

• $0 of income tax due after applying the standard deduction and personal exemptions,
• $144 of self-employment tax,
• $1,447 of additional child tax credit,
• $4,824 of earned income credit, and
• $1,200 of recovery rebate credit, resulting in
• $7,327 of overpayment, claimed as a refund.

The IRS refunded the $7,327, then determined the taxpayer was not eligible to receive any of the credits. On the notice sent to the taxpayer, the IRS assessed a 20% penalty based on $7,327 (the $144 of tax due less the refundable credits claimed of $7,471).

The taxpayer disagreed with the assessment, arguing that the penalty should be calculated only on the tax that would have been due before the credits were applied ($144). Alternatively, the taxpayer says the penalty should be assessed on the tax of $144 less an equal offsetting amount of credits (in other words zero tax shown on the return).

WHAT WOULD YOU DECIDE?

Make your selection, then see “The Court’s Decision” below for a full explanation

For the or for the

THE COURT’S DECISION

For a full explanation, hover your mouse over the link

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HL Carpenter, an experienced investor and a CPA, specializes in reader friendly articles on taxes and investing for individuals and small businesses, and publishes two newsletters: Taxing Lessons and Top Drawer Ink. Visit TaxingLessons.com and HLCarpenter.com.

This information should not be considered legal, investment or tax advice. Taxing Lessons and Top Drawer Ink Corp. do not provide legal, investment or tax advice. Always consult your legal, investment and/or tax advisor regarding your personal situation.

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For the Taxpayer. In the case of an underpayment due to negligence or a substantial understatement of income tax, among other things, section 6662 imposes an accuracy-related penalty on the underpayment. Section 6664(a) defines the term “underpayment” in part by reference to the amount shown as the tax by the taxpayer on his return. The earned income credit, additional child tax credit, and recovery rebate credit all reduce the amount shown as the tax by the taxpayer on his return, but not below zero. We hold that the amount of tax shown on the return is zero. The result of this conclusion is that, for penalty computation purposes, petitioners have an underpayment of $144.
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