Question

After filing and paying last year's tax liability of $40,000, the taxpayer received a notice from the IRS assessing last year's liability at $46,000. Which of the following statements concerning this situation is true?

• According to the IRS, the taxpayer has not substantially understated the tax liability.

• The taxpayer will be assessed an understatement penalty because $6,000 is greater than 10 %of $40,000

• If the $6,000 difference is attributable to a tax shelter, then adequate disclosure using Form 8275 and a reasonable basis will avoid assessment of the understatement penalty.

• The taxpayer may be assessed an accuracy-related penalty due to substantial understatement of income tax.

Answer 1

In this case, the taxpayer understated his tax for the given year (showed less than the actual tax) . For this the penalty depends on whether the understatement is substantial or not. If the understatement is more than the greater of 10% of correct tax or $5000 for individuals, then its substantial. This comes under accuracy related penalty due to substantial understatement of income tax.

So the penalty applies because understatement of $6000 is more than the 10% of correct tax i.e. $46000 = $4600 or $5000 for individual. But in the second option, 10% of 40,000 is written. So either option (b) or (d) could be the correct answer.