The 20 Percent Accuracy Penalty and Reasonable Cause
When the IRS adds 20 percent to an underpayment, the three grounds it uses, the defences that remove it, and the procedural requirement examiners sometimes miss.
Reviewed by the Fairlight Accounting cross-border tax team — U.S. & Canadian Tax Desks
The accuracy-related penalty adds 20 percent to the part of an underpayment caused by negligence, a substantial understatement, or a large valuation error. The defence is reasonable cause and good faith — commonly reliance on a competent professional given full information — and the penalty fails if the IRS skipped written supervisory approval.
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What triggers it?
| Ground | Test |
|---|---|
| Negligence or disregard of rules | Failure to make a reasonable attempt to comply, keep records, or substantiate items |
| Substantial understatement (individuals) | Understatement exceeds the greater of 10 percent of the correct tax (5 percent if you claim the Section 199A deduction) or $5,000 |
| Substantial understatement (corporations) | Exceeds the lesser of 10 percent of the correct tax (or $10,000 if greater) or $10 million |
| Substantial valuation misstatement | Value or basis claimed is 150 percent or more of the correct amount, and the resulting underpayment exceeds $5,000 ($10,000 for most C corporations) |
| Gross valuation misstatement | 200 percent or more; the penalty rises to 40 percent |
Accuracy penalties do not stack: the maximum on any portion of the underpayment is 20 percent (40 percent for a gross valuation misstatement), and none applies to a portion that draws the 75 percent civil fraud penalty.
What are the defences?
- Reasonable cause and good faith. The strongest form is reliance on a qualified professional: the adviser was competent, you gave them complete and accurate information, and you actually relied on their advice. Courts apply this three-part test. Reliance on software, or on an adviser you did not fully inform, generally fails.
- Substantial authority. For the understatement ground, a position supported by substantial authority — statutes, regulations, cases, rulings — is excluded from the understatement.
- Adequate disclosure. A position with a reasonable basis that is disclosed on Form 8275 (or 8275-R for a position contrary to a regulation) is also excluded from the understatement calculation.
- Supervisory approval. Section 6751(b) requires the examiner's immediate supervisor (or a designated higher-level official) to personally approve the initial penalty determination in writing. Under Treasury regulations finalized in December 2024, for penalties assessed on or after December 23, 2024, approval must come no later than the date a notice of deficiency including the penalty is mailed (or, for penalties the Tax Court cannot review before assessment, before assessment). If the IRS cannot show timely approval, the penalty cannot be assessed regardless of the merits. Penalties calculated automatically by computer are exempt.
How is it contested?
Raise the defence in the response to the examiner's report, then at Appeals, then in Tax Court if a notice of deficiency issues. The IRS bears the initial burden of production for penalties against individuals, including proof of supervisory approval; the taxpayer then carries the burden on reasonable cause.
What does not work?
First-time abatement does not apply to accuracy penalties. "I did not know the rule" is not reasonable cause for a business owner expected to seek advice. And an adviser's error is a defence only where the taxpayer's own conduct was reasonable.
Frequently asked questions
Does the penalty apply if I agree to the adjustment?
Agreeing to the tax does not waive the penalty defence; the penalty is a separate item you can contest.
Can the penalty be reduced for part of the adjustment?
Yes. It applies only to the portion attributable to the triggering ground; items with reasonable cause are carved out.
Is interest charged on the penalty?
Yes, from the return's due date (including extensions), not just from when the penalty is assessed.
What if the underpayment is small?
Negligence applies regardless of size; the substantial understatement and valuation grounds have the dollar thresholds above.
Official sources
The statute provides: “If this section applies to any portion of an underpayment of tax required to be shown on a return, there shall be added to the tax an amount equal to 20 percent of the portion of the underpayment to which this section applies.” — Legal Information Institute, Cornell Law School, 26 U.S. Code § 6662 - Imposition of accuracy-related penalty on underpayments, https://www.law.cornell.edu/uscode/text/26/6662
The IRS explains: “We may be able to remove or reduce some penalties if you acted in good faith and can show reasonable cause for why you weren’t able to meet your tax obligations.” — Internal Revenue Service, Accuracy-related penalty, https://www.irs.gov/payments/accuracy-related-penalty
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