IRS TAX PROBLEMS – Defenses to “Accuracy-Related” Penalty






Internal Revenue Code (IRC) Section 6662(b)(2) authorizes the Internal Revenue Service (IRS) to impose a penalty if an underpayment exceeds a computational threshold called a “substantial understatement”.



Pursuant to IRC Section 6662(d)(1)(A), for Individuals, the “understatement” of tax is “substantial” if it exceeds the greater of $5,000 or Ten percent (10%) of the tax that must be shown on the return.


Pursuant to IRC Section 6662(d)(1)B), for Corporations (other than S corporations or personal holding companies), an “understatement” is “substantial” if it exceeds the lesser of Ten percent (10%) of the tax required to be shown on the return (or, if greater, $10,000), or $10,000,000.


INTERNAL REVENUE MANUAL Section  (01-24-2012)

Examination Penalty Assertion

In proposing the penalty to the taxpayer or taxpayer’s representative, the examiner will:

  1. Fully explain the proposed penalty.
  2. Document the reasons why the penalty assertion is appropriate.
  3. Consider and document any possible exceptions to the penalty provided by the taxpayer or the taxpayer’s representative whether or not they are accepted.


The level of taxpayer cooperation is not grounds for asserting or not asserting a penalty.


BURDEN OF PROOF – Pursuant to IRC Section 7491(c), in court proceedings, the IRS bears the initial burden of production regarding the accuracy-related penalty. The IRS must first present sufficient evidence to establish that the penalty is warranted. The burden of proof then shifts to the taxpayer to establish any exception to the penalty, such as reasonable cause.






Pursuant to IRC Section 6662(a), the amount of an accuracy-related penalty equals Twenty percent (20%) of the portion of the underpayment attributable to a substantial “understatement”. An “understatement” is the difference between (1) the correct amount of tax and (2) the tax reported on the return, reduced by any rebate.


Pursuant to IRC Section 6662(d)(2)B) and Treasury Regulation Section 1.6662-4, understatements are reduced by the portion attributable to an item for which the taxpayer had “substantial authority” for the tax treatment of the item.


TREASURY REGULATION Section 1.6662-4(d)Substantial authority


(1) Effect of having substantial authority. If there is substantial authority for the tax treatment of an item, the item is treated as if it were shown properly on the return for the taxable year in computing the amount of the tax shown on the return. Thus, for purposes of section 6662(d), the tax attributable to the item is not included in the understatement for that year.

(2) Substantial authority standard. The substantial authority standard is an objective standard involving an analysis of the law and application of the law to relevant facts. The substantial authority standard is less stringent than the more likely than not standard (the standard that is met when there is a greater than 50-percent likelihood of the position being upheld), but more stringent than the reasonable basis standard as defined in § 1.6662-3(b)(3). The possibility that a return will not be audited or, if audited, that an item will not be raised on audit, is not relevant in determining whether the substantial authority standard (or the reasonable basis standard) is satisfied.



(3) Determination of whether substantial authority is present


(i) Evaluation of authorities. There is substantial authority for the tax treatment of an item only if the weight of the authorities supporting the treatment is substantial in relation to the weight of authorities supporting contrary treatment. All authorities relevant to the tax treatment of an item, including the authorities contrary to the treatment, are taken into account in determining whether substantial authority exists. The weight of authorities is determined in light of the pertinent facts and circumstances in the manner prescribed by paragraph (d)(3)(ii) of this section. There may be substantial authority for more than one position with respect to the same item. Because the substantial authority standard is an objective standard, the taxpayer’s belief that there is substantial authority for the tax treatment of an item is not relevant in determining whether there is substantial authority for that treatment.


(ii) Nature of analysis. The weight accorded an authority depends on its relevance and persuasiveness, and the type of document providing the authority. For example, a case or revenue ruling having some facts in common with the tax treatment at issue is not particularly relevant if the authority is materially distinguishable on its facts, or is otherwise inapplicable to the tax treatment at issue. An authority that merely states a conclusion ordinarily is less persuasive than one that reaches its conclusion by cogently relating the applicable law to pertinent facts. The weight of an authority from which information has been deleted, such as a private letter ruling, is diminished to the extent that the deleted information may have affected the authority’s conclusions. The type of document also must be considered. For example, a revenue ruling is accorded greater weight than a private letter ruling addressing the same issue. An older private letter ruling, technical advice memorandum, general counsel memorandum or action on decision generally must be accorded less weight than a more recent one. Any document described in the preceding sentence that is more than 10 years old generally is accorded very little weight. However, the persuasiveness and relevance of a document, viewed in light of subsequent developments, should be taken into account along with the age of the document. There may be substantial authority for the tax treatment of an item despite the absence of certain types of authority. Thus, a taxpayer may have substantial authority for a position that is supported only by a well-reasoned construction of the applicable statutory provision.


(iii) Types of authority. Except in cases described in paragraph (d)(3)(iv) of this section concerning written determinations, only the following are authority for purposes of determining whether there is substantial authority for the tax treatment of an item: Applicable provisions of the Internal Revenue Code and other statutory provisions; proposed, temporary and final regulations construing such statutes; revenue rulings and revenue procedures; tax treaties and regulations thereunder, and Treasury Department and other official explanations of such treaties; court cases; congressional intent as reflected in committee reports, joint explanatory statements of managers included in conference committee reports, and floor statements made prior to enactment by one of a bill’s managers; General Explanations of tax legislation prepared by the Joint Committee on Taxation (the Blue Book); private letter rulings and technical advice memoranda issued after October 31, 1976; actions on decisions and general counsel memoranda issued after March 12, 1981 (as well as general counsel memoranda published in pre-1955 volumes of the Cumulative Bulletin); Internal Revenue Service information or press releases; and notices, announcements and other administrative pronouncements published by the Service in the Internal Revenue Bulletin. Conclusions reached in treatises, legal periodicals, legal opinions or opinions rendered by tax professionals are not authority. The authorities underlying such expressions of opinion where applicable to the facts of a particular case, however, may give rise to substantial authority for the tax treatment of an item. Notwithstanding the preceding list of authorities, an authority does not continue to be an authority to the extent it is overruled or modified, implicitly or explicitly, by a body with the power to overrule or modify the earlier authority. In the case of court decisions, for example, a district court opinion on an issue is not an authority if overruled or reversed by the United States Court of Appeals for such district. However, a Tax Court opinion is not considered to be overruled or modified by a court of appeals to which a taxpayer does not have a right of appeal, unless the Tax Court adopts the holding of the court of appeals. Similarly, a private letter ruling is not authority if revoked or if inconsistent with a subsequent proposed regulation, revenue ruling or other administrative pronouncement published in the Internal Revenue Bulletin.






Pursuant to IRC Section 6664(c)(1) and Treasury Regulation Section 1.6664-4, the accuracy-related penalty does not apply to any portion of an underpayment where the taxpayer acted with “reasonable cause and in good faith”. A “reasonable cause” determination takes into account all of the pertinent facts and circumstances. The most important factor is the extent to which the taxpayer made an effort to determine the proper tax liability.


INTERNAL REVENUE MANUAL (IRM) Section (01-24-2012)

Reasonable Cause

  1. No accuracy-related penalty under IRC 6662 is imposed if it is shown that the taxpayer had reasonable cause for the position taken and that the taxpayer acted in good faith.
  2. ****
  3. IRC 6664(c) provides an exception to the imposition of any accuracy-related penalty if the taxpayer shows that there was reasonable cause and the taxpayer acted in good faith.
  4. The determination of whether the taxpayer acted with reasonable cause and in good faith is made on a case-by-case basis, taking into account all the relevant facts and circumstances.
  5. ****
  6. Generally, the most important factor in determining reasonable cause is the taxpayer’s effort to report the proper tax liability. Other factors to consider are the taxpayer’s experience, knowledge, education, and the taxpayer’s reliance on the advice of a tax advisor.
  7. All relevant facts, including the nature of the tax investment, the complexity of the tax issues, the competence of the tax advisor, the education of the taxpayer, and the quality of the opinion relied upon must be developed to determine whether the taxpayer was reasonable and acted in good faith.


INTERNAL REVENUE MANUAL (IRM) Section  (07-01-2008)

Taxpayer’s Effort to Report the Proper Tax Liability

  1. Generally, the most important factor in determining whether the taxpayer has reasonable cause and acted in good faith is the extent of the taxpayer’s effort to report the proper tax liability.



COURT FINDINGS – The courts abate the accuracy-related penalties, partially or in full, where the taxpayer showed a reasonable and good faith attempt to ascertain the correct amount of tax due. The courts most commonly find reasonable cause on the bases of maintenance of adequate records to substantiate deductions and reasonable reliance on a competent tax professional.


IRS TAX PROBLEMS – IRS Collection Process

IRS Tax Problems – The IRS Collection Process

If you do not pay in full when you file your tax return, you will receive written Notice of the amount you owe, a Bill from the IRS. This Bill starts the IRS Collection Process, which continues until your account is satisfied or until the IRS may no longer legally collect the tax; for example, when the time period for collection has expired.

The First Notice you receive from the IRS will be a Letter that explains the balance due and demands payment in full. It will include the amount of the tax, plus any penalties and interest added to your unpaid balance from the date the tax was due.

If you are unable to immediately pay your balance in full, the IRS, upon request, may be able to offer you a monthly Installment Payment Agreement. If you cannot full pay under an Installment Payment Agreement, you may propose an Offer in Compromise (OIC). An OIC is an agreement between a taxpayer and the IRS that resolves the taxpayer’s tax liability by payment of an agreed upon reduced amount.

If you are unable to pay anything because of a current financial hardship, the IRS may temporarily suspend certain collection actions, such as issuing a levy, until your financial condition improves. The IRS may, however, file a Notice of Federal Tax Lien while your account is suspended. Interest and late payment penalties will continue to accrue while collection is suspended. If you are a member of the Armed Forces, you may be able to defer payment.

It is important to contact the IRS and make arrangements to pay the tax due voluntarily. If you do not contact the IRS, the IRS may take action to collect the liability. Some of the actions the IRS may take to collect taxes include:

  1. Filing a Notice of Federal Tax Lien
  2. Serving a Notice of Levy, or
  3. Offsetting a Refund to which you are entitled

The Federal Tax Lien is a legal claim to your property, including property that you acquire after the Lien arises. The Federal Tax Lien arises automatically when you fail to pay in full the taxes you owe within ten (10) days after the IRS sends its First Notice of taxes owed and demand for payment, and the IRS makes an Assessment of the tax. The IRS also may file a Notice of Federal Tax Lien in the public records. The Notice of Federal Tax Lien publicly notifies your creditors that the IRS has a claim against all your property, including property acquired by you after the Notice of Federal Tax Lien is filed. The filing of a Notice of Federal Tax Lien may appear on your credit report and may harm your credit rating. Once a Lien arises, the IRS generally cannot release the Lien until the taxes, penalties, interest, and recording fees are paid in full or until the IRS may no longer legally collect the tax.

The IRS will withdraw a Notice of Federal Tax Lien if the Notice was filed while a bankruptcy automatic stay was in effect. The IRS may withdraw a Notice of Federal Tax Lien if the IRS determines that (1) the Notice was filed too soon or not according to IRS procedures; (2) you enter into an Installment Payment Agreement to satisfy the liability unless the Installment Payment Agreement provides otherwise; (3) withdrawal will allow you to pay your taxes more quickly; or (4) withdrawal is in your best interest, as determined by the National Taxpayer Advocate, and the best interest of the IRS.

The IRS also may use a Levy to collect taxes. The IRS may Levy assets such as wages, bank accounts, Social Security benefits, and retirement income. The IRS also may seize your property for the purpose of selling the property to satisfy a tax debt including your car, boat, or real estate. In addition, any future federal tax refunds or state income tax refunds that you are owed, may be applied to your federal tax liability.

IRS TAX PROBLEMS – What is “Bartering” Income?

IRS TAX PROBLEMS – What is Bartering Income?

Bartering is the trading of one product or service for another. Often there is no exchange of cash. Some businesses barter to get products or services they need. For example, a gardener might trade landscape work with a plumber for plumbing work.

If you barter, you should know that the value of products or services from bartering is taxable income. This is true even if you are not in business.

Here are a few facts about bartering:

  • Bartering income.  Both parties must report the fair market value of the product or service they get as income on their tax return.
  • Barter exchanges.  A barter exchange is an organized marketplace where members barter products or services. Some operate out of an office and others over the Internet. All barter exchanges are required to issue IRS Form 1099-B, “Proceeds from Broker and Barter Exchange Transactions”. Exchanges must give a copy of the form to its members who barter each year. They must also file a copy with the IRS.
  • Trade Dollars.  Exchanges trade barter or trade dollars as their unit of exchange in most cases. Barter and trade dollars are the same as U.S. currency for tax purposes.  If you earn trade and barter dollars, you must report the amount you earn on your tax return.
  • Tax implications.  Bartering is taxable in the year it occurs. The tax rules may vary based on the type of bartering that takes place. Barterers may owe income taxes, self-employment taxes, employment taxes or excise taxes on their bartering income.
  • Reporting rules.  How you report bartering on a tax return varies. If you are in a trade or business, you normally report it on IRS Form 1040, Schedule “C”, “Profit or Loss from Business”.


IRS REMINDER – Employers Who Use A “Payroll Service”

IRS REMINDER – Tips For Employers Who Use A Payroll Service


IRS focuses on businesses that have employees and use a payroll service. Payroll services help employers meet their payroll tax responsibilities.


But it’s important for employers to remember: You can outsource your payroll tax duties but not your payroll tax responsibilities. At the end of the day, you’re responsible for meeting your payroll tax responsibilities and could be financially liable for responsibilities not met.


To protect yourself, you should know your payroll tax responsibilities even if you use a payroll service.

IRS TAX PROBLEMS – You Can View Your IRS Tax Account Online

IRS TAX PROBLEMS – View Your Tax Account Online


As part of the IRS commitment to improve and expand taxpayer services, a new online tool allows you to view your federal tax account balance online. This new tool is available to individual taxpayers and is rolling out in phases. The first phase, available now, allows you to view your balance, select IRS Direct Pay, debit or credit card, or apply for an installment agreement. It’s safe, secure and available on the “payments page”.


Launching in phases gives the IRS an opportunity to gather and evaluate feedback and to improve the customer experience. A key part of the IRS Future State initiative is for taxpayers to have a more complete online experience. Future features will allow a taxpayer to see 18 months of payment history and get tax account transcripts in a single online session.


Before accessing the new online tool, you must authenticate your identity through the Secure Access process. This is a two-step authentication process, which means that if you are a returning user, you must use your credentials (username and password) and request a new security code (sent via text) each time you log in.


If you already have a user name and password from Secure Access for Get Transcript Online or IP PIN, you may use the same username and password. To register for the first time, you must have an email address, a text-enabled mobile phone in your name and specific financial information such as a credit card number or specific loan numbers. You may review the “Secure Access” process prior to starting registration.



IRS TAX PROBLEMS – Payment Options – Taxpayers Who Owe Taxes

IRS TAX PROBLEMS – Taxpayers Who Owe Taxes

The IRS offers a variety of payment options where taxpayers can pay immediately or arrange to pay in installments. Those who receive a bill from the IRS should not ignore it. A delay may cost more in the end. As more time passes, the more interest and penalties accumulate.

Here are some ways to make payments using IRS electronic payment options:

  • Direct Pay. Pay tax bills directly from a checking or savings account free with IRS “Direst Pay”. Taxpayers receive instant confirmation once they’ve made a payment. With Direct Pay, taxpayers can schedule payments up to 30 days in advance. Change or cancel a payment two business days before the scheduled payment date.
  • Credit or Debit Cards. Taxpayers can also pay their taxes by Debit or Credit Card online, by phone or with a mobile device. A payment processor will process payments.  The IRS does not charge a fee but convenience fees apply and vary by processor.

    Those wishing to use a mobile devise can access the “IRS2Go” app to pay with either Direct Pay or debit or credit card. IRS2Go is the official mobile app of the IRS. Download IRS2Go from Google Play, the Apple App Store or the Amazon App Store.

  • Installment Agreement. Taxpayers, who are unable to pay their tax debt immediately, may be able to make monthly payments. Before applying for any payment agreement, taxpayers must file all required tax returns. Apply for an installment agreement with the “Online Payment Agreement” tool.

    Who’s eligible to apply for a monthly installment agreement online?

    • Individuals who owe $50,000 or less in combined  tax, penalties and interest and have filed all required returns
    • Businesses that owe $25,000 or less in combined tax, penalties and interest for the current year or last year’s liabilities and have filed all required returns

Those who owe taxes are reminded to pay as much as they can as soon as possible to minimize interest and penalties. Visit for all payment options.


IRS REMINDER – Small Business “Research Credits” Eligibility

IRS REMINDER – Eligible Small Business Startups Can Choose New Option for Claiming “Research Credit”

Eligible small business startups can now choose to apply part or all of their research credit against their payroll tax liability, instead of their income tax liability, according to the Internal Revenue Service (IRS).

This new option will be available for the first time to any eligible small business when filing its 2016 federal income tax return. Before 2016, the research credit, like most tax credits, could only be taken against income tax liability. The option to elect the new payroll tax credit may especially benefit any eligible startup that has little or no income tax liability.

To qualify for the new option for the current tax year, a small business must have gross receipts of less than $5 million and could not have had gross receipts prior to 2012. A small business meeting this standard with qualifying research expenses can then choose to apply up to $250,000 of its research credit against its payroll tax liability.

To choose this option, fill out IRS Form 6765, “Credit for Increasing Research Activities”, and attach it to a timely-filed business income tax return. Because many business taxpayers request a tax-filing extension, they still have time to make the choice on a timely-filed return. A number of special rules and computations apply to this credit. See the instructions to IRS Form 6765 for details.

For eligible small businesses that already filed and failed to choose this option, there is still time to make the choice. Under a special rule for tax-year 2016, they can still do so by filing an amended return. This return must be filed by Dec. 31, 2017.

Amended return forms vary depending upon the type of business. Sole proprietors file IRS Form 1040X. Regular corporations file IRS Form 1120X. S corporations file IRS Form 1120S, identifying it as a corrected return (line H(4). For information on amending a partnership return, see the instructions to IRS Form 1065.

After choosing this option, either on an original or amended return, a small business claims the payroll tax credit by filling out IRS Form 8974, “Qualified Small Business Payroll Tax Credit for Increasing Research Activities”. This form must be attached to its payroll tax return, usually IRS Form 941, “Employer’s Quarterly Federal Tax Return”.

Further details on how and when to claim the credit are in IRS notice 2017-23, available on The notice also provides interim guidance on other technical issues, such as controlled groups and the definition of gross receipts.


IRS REMINDER – “Work Opportunity Tax Credit” Can Help Employers Hire New Employees

IRS REMINDER: “Work Opportunity Tax Credit” can Help Employers Hiring New Workers

The Internal Revenue Service (IRS) is reminding employers planning to hire new workers that there’s a valuable tax credit available to those who hire long-term unemployment recipients and others certified by their state workforce agency.

The “Work Opportunity Tax Credit” (“WOTC”) is a long-standing income tax benefit that encourages employers to hire designated categories of workers who face significant barriers to employment. The credit, usually claimed on IRS Form 5884, is generally based on wages paid to eligible workers during the first two years of employment.

To qualify for the credit, an employer must first request certification by filing IRS Form 8850 with the state workforce agency within 28 days after the eligible worker begins work. Other requirements and further details can be found in the Instructions to Form 8850.

There are now 10 categories of WOTC-eligible workers. The newest category, added effective Jan. 1, 2016, is for long-term unemployment recipients who had been unemployed for a period of at least 27 weeks and received state or federal unemployment benefits during part or all of that time. The other categories include certain veterans and recipients of various kinds of public assistance, among others.

The Ten (10) categories are:

  • Qualified IV-A Temporary Assistance for Needy Families (TANF) recipients
  • Unemployed veterans, including disabled veterans
  • Ex-felons
  • Designated community residents living in Empowerment Zones or Rural Renewal Counties
  • Vocational rehabilitation referrals
  • Summer youth employees living in Empowerment Zones
  • Food stamp (SNAP) recipients
  • Supplemental Security Income (SSI) recipients
  • Long-term family assistance recipients
  • Qualified long-term unemployment recipients.

Eligible businesses claim the WOTC on their income tax return. The credit is first figured on Form 5884 and then becomes a part of the general business credit claimed on IRS Form 3800.

Though the credit is not available to tax-exempt organizations for most categories of new hires, a special rule allows them to get the WOTC for hiring qualified veterans. These organizations claim the credit on IRS Form 5884-C. Visit the “WOTC” page on for more information.

IRS TAX PROBLEMS – Hobby or Business Determination

IRS TAX PROBLEMS – Hobby or Business?

Millions of people enjoy hobbies that are also a source of income. From catering to cupcake baking, crafting homemade jewelry to glass blowing — no matter what a person’s passion, the Internal Revenue Service (IRS) offers some tips on hobbies.

Taxpayers must report on their tax return the income earned from hobbies. The rules for how to report the income and expenses depend on whether the activity is a hobby or a business. There are special rules and limits for deductions taxpayers can claim for hobbies. Here are some tax tips to consider:

  1. Is it a Business or a Hobby?  A key feature of a business is that people do it to make a profit. People engage in a hobby for sport or recreation, not to make a profit. Consider Nine (9) Factors when determining whether an activity is a hobby.

In making the distinction between a hobby or business activity, take into account all facts and circumstances with respect to the activity. No one factor alone is decisive. You must generally consider these factors to establish that an activity is a business engaged in making a profit:

  • Whether you carry on the activity in a businesslike manner.
  • Whether the time and effort you put into the activity indicate you intend to make it profitable.
  • Whether you depend on income from the activity for your livelihood.
  • Whether your losses are due to circumstances beyond your control (or are normal in the startup phase of your type of business).
  • Whether you change your methods of operation in an attempt to improve profitability.
  • Whether you or your advisors have the knowledge needed to carry on the activity as a successful business.
  • Whether you were successful in making a profit in similar activities in the past.
  • Whether the activity makes a profit in some years and how much profit it makes.
  • Whether you can expect to make a future profit from the appreciation of the assets used in the activity.

You may find more information on this topic in Section 1.183-2(b) of the Federal Tax Regulations.

Make sure to base the determination on all the facts and circumstances. For more about ‘not-for-profit’ rules, see IRS Publication 535, “Business Expenses”.

  1. Allowable Hobby Deductions.  Within certain limits, taxpayers can usually deduct ordinary and necessary hobby expenses. An ordinary expense is one that is common and accepted for the activity. A necessary expense is one that is appropriate for the activity.
  2. Limits on Hobby Expenses.  Generally, taxpayers can only deduct hobby expenses up to the amount of hobby income. If hobby expenses are more than its income, taxpayers have a loss from the activity. However, a hobby loss can’t be deducted from other income.
  3. How to Deduct Hobby Expenses.  Taxpayers must itemize deductions on their tax return to deduct hobby expenses. Expenses may fall into three types of deductions, and special rules apply to each type. See IRS publication 535 for the rules about how to claim them on Schedule “A”, Itemized Deductions.


IRS TAX PROBLEMS – Employee or Independent Contractor Classification Rules

IRS TAX PROBLEMS – Employee or Independent Contractor?

The IRS encourages all businesses and business owners to know the rules when it comes to classifying a worker as an employee or an independent contractor.

An employer must withhold income taxes and pay Social Security, Medicare taxes and unemployment tax on wages paid to an employee. Employers normally do not have to withhold or pay any taxes on payments to independent contractors.

Here are two key points for small business owners to keep in mind when it comes to classifying workers:

  1. Control. The relationship between a worker and a business is important. If the business controls what work is accomplished and directs how it is done, it exerts behavioral control. If the business directs or controls financial and certain relevant aspects of a worker’s job, it exercises financial control. This includes:
    • The extent of the worker’s investment in the facilities or tools used in performing services
    • The extent to which the worker makes his or her services available to the relevant market
    • How the business pays the worker, and
    • The extent to which the worker can realize a profit or incur a loss


  1. Relationship. How the employer and worker perceive their relationship is also important for determining worker status. Key topics to think about include:
    • Written contracts describing the relationship the parties intended to create
    • Whether the business provides the worker with employee-type benefits, such as insurance, a pension plan, vacation or sick pay
    • The permanency of the relationship, and
    • The extent to which services performed by the worker are a key aspect of the regular business of the company
    • The extent to which the worker has unreimbursed business expenses


The IRS can help employers determine the status of their workers by using form IRS Form SS-8, “Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding”. IRS Publication 15-A, “Employer’s Supplemental Tax Guide”, is also an excellent resource.