Lesson 6-Substantiation and Disclosure of Tax Positions

Question 1

The IRC imposes (in Section 6662) a 20% penalty on various types of underpayments, including

Answer 1

1. Underpayments attributable to negligence or disregard of rules or regulations.
2. Any substantial understatement of income tax.

Question 2

An “understatement” in this category is reduced by the amount attributable to any item where:

Answer 2

1. The relevant facts affecting the tax treatment are disclosed and there is a “reasonable basis” (≥20% chance of being sustained)
2. undisclosed position must be supported by “substantial authority,” (≥40% chance of being sustained.)

Question 3

No Section 6662 penalty is imposed if (a) there was “reasonable cause” for the underpayment and (b) the taxpayer acted with “good faith.” Site examples of this:

Answer 3

Examples of reasonable cause:

1. Reliance on tax adviser and/or
2. Reliance on advice of IRS employee
3. Reliance on erroneous W-2, with no red flags to indicate its inaccuracy.

Question 4

Accuracy-related penalties may be imposed for underpayments caused by negligence, which include:

Answer 4

1. Failure to keep adequate books and records.

2. Failure to substantiate items that gave rise to the underpayment

Question 5

Among others, taxpayers are required to substantiate:

Answer 5

1. Charitable contributions—Donations ≥ $250 must be documented with a receipt. Donations > $5,000 generally require a qualified appraisal.
2. Business use of an automobile—The taxpayer must track the miles driven for business use in a timely kept log.

Question 6

How long should tax records and returns be retained?

Answer 6

1. All tax returns for the previous seven years

2. All records that pertain to a return for the previous three years

Question 7

What is a substantial underpayment?

Answer 7

greater of $5000 or 10% of tax due