IRS Accuracy Penalty in New York: What It Is and How to Fight It

The IRS accuracy-related penalty is a 20% charge on any tax underpayment caused by negligence, substantial understatement of income, or valuation misstatements on your return. Unlike failure to file or failure to pay penalties that accumulate monthly, the accuracy penalty is a one-time assessment, typically arising from an audit or IRS examination.

For New York taxpayers, an accuracy penalty from the IRS often signals that the NY Department of Taxation and Finance will take a closer look as well. NY routinely cross-references IRS audit adjustments, meaning a federal accuracy penalty can trigger state-level scrutiny.

How the Accuracy Penalty Is Calculated

The accuracy penalty under IRC Section 6662 is 20% of the underpayment attributable to the penalized behavior. The IRS applies this penalty to the portion of tax you should have paid but did not, based on the correct calculation of your return.

For example, if an audit determines you owe $15,000 more in tax than you reported, and the entire underpayment is attributable to negligence, the accuracy penalty is 20% of $15,000 = $3,000. Your total additional liability becomes $18,000 plus interest.

For gross valuation misstatements (overvaluing assets by 200% or more of their correct value), the penalty rate increases to 40% of the underpayment. This elevated rate most commonly applies in cases involving inflated charitable deductions or overstated basis on property sales.

Four Triggers for the Accuracy Penalty

The IRS assesses the accuracy penalty under four main categories. Understanding which one applies to your case is critical for building a defense.

Negligence or Disregard of Rules

Negligence means failing to make a reasonable attempt to comply with the tax law. This includes not keeping adequate records, not reporting income shown on information returns (W-2s, 1099s), taking positions that have no reasonable basis, or making errors that a reasonable and prudent taxpayer would have avoided.

Disregard of rules is a step beyond negligence. It includes careless, reckless, or intentional disregard of IRS rules, regulations, or published guidance. Intentional disregard carries a higher burden: the IRS must show you knew about the rule and chose to ignore it.

Substantial Understatement of Income Tax

An understatement is "substantial" if it exceeds the greater of $5,000 or 10% of the tax required to be shown on the return. For corporations, the threshold is the greater of $10,000 or 10% of the tax (or $10 million for large corporations).

This is the most common trigger for the accuracy penalty among individual taxpayers. It does not require the IRS to prove negligence, only that the understatement meets the dollar threshold. Many taxpayers are surprised to learn that honest mistakes can trigger this penalty if the resulting understatement is large enough.

Substantial Valuation Misstatement

This applies when the value or adjusted basis of property claimed on a return is 150% or more of the correct amount. For gross valuation misstatements (200% or more), the penalty rate doubles to 40%.

Common scenarios: overstating the value of donated property for charitable deduction purposes, inflating the basis of property sold to reduce capital gains, and misvaluing assets in estate or gift tax returns.

Transaction-Related Penalties

The accuracy penalty also applies to underpayments resulting from listed transactions, reportable transactions with a significant tax avoidance purpose, and certain tax shelter transactions. These carry strict penalty provisions and limited defenses.

Defenses Against the Accuracy Penalty

The IRS allows several defenses that can eliminate or reduce the accuracy penalty. The two most effective are reasonable cause/good faith and adequate disclosure.

Reasonable Cause and Good Faith

Under IRC Section 6664(c), no accuracy penalty applies if you can show that there was reasonable cause for the underpayment and that you acted in good faith. This is a facts-and-circumstances test. The IRS considers the nature of the error, your efforts to determine the correct tax, your knowledge and experience, and whether you relied on professional advice.

Reliance on a competent tax professional is a strong defense if you provided complete and accurate information to the professional, the advice was reasonable and based on the law, and you relied on the advice in good faith. Keep your engagement letter, communications, and any written advice from your tax preparer. These documents become essential if the accuracy penalty is proposed.

Adequate Disclosure

For negligence and substantial understatement penalties, disclosing your tax position on the return can eliminate the penalty. If you take a position that has a reasonable basis (even if it is aggressive), disclosing it on Form 8275 or Form 8275-R protects you from the accuracy penalty.

For substantial understatement, disclosure reduces the penalty only if your position has a "reasonable basis," which is a lower standard than the "more likely than not" threshold that applies without disclosure.

Substantial Authority

If there is "substantial authority" for your tax position, the substantial understatement penalty does not apply, even without disclosure. Substantial authority is an objective standard: it means the weight of authorities supporting your position is substantial in relation to the weight of authorities against it.

Authorities the IRS considers include the Internal Revenue Code, Treasury regulations, revenue rulings, court decisions, and congressional committee reports. Blog posts, informal IRS guidance, and opinions from non-authoritative sources do not count.

How the Accuracy Penalty Relates to IRS Audits

The accuracy penalty is almost always proposed during or after an IRS audit. The examining agent identifies an underpayment, determines whether negligence or substantial understatement criteria are met, and proposes the penalty as part of the audit findings.

You have the right to contest the penalty before it is formally assessed. During the audit, you can present your reasonable cause defense, provide documentation of professional reliance, or demonstrate adequate disclosure. The examining agent has the authority to remove the proposed penalty if your defense is persuasive.

If the examining agent upholds the penalty, you can appeal to the IRS Office of Appeals before the penalty is formally assessed. The appeals process is independent of the audit division, and appeals officers frequently reduce or eliminate accuracy penalties when the taxpayer presents a strong case.

The NY State Connection

New York State routinely cross-references IRS audit adjustments. When the IRS increases your federal tax through an audit, the IRS notifies you using Form CP2000 or an examination report. You are required to report federal audit changes to NY State within 90 days by filing an amended NY return (Form IT-201-X or IT-203-X).

If the IRS assessed an accuracy penalty, the NY DTF may impose its own penalty on the state-level underpayment. NY's penalty provisions are separate from federal law, so the defenses and thresholds may differ.

Failing to report federal audit changes to NY State within 90 days can trigger additional NY penalties. This is a frequently missed deadline that creates unnecessary penalties for New York taxpayers.

Accuracy Penalty vs. Other IRS Penalties

The accuracy penalty is distinct from other common penalties. The failure to file penalty and failure to pay penalty are based on timing: how late you filed or paid. The accuracy penalty is based on the correctness of the return you filed.

You can face an accuracy penalty and a failure to pay penalty on the same tax year. If an audit finds you underpaid by $10,000, you owe 20% ($2,000) as the accuracy penalty plus 0.5% per month on the additional $12,000 balance until it is paid.

The accuracy penalty is not covered by first-time penalty abatement. FTA only applies to failure to file, failure to pay, and failure to deposit penalties. Accuracy penalties must be challenged through reasonable cause, adequate disclosure, or substantial authority defenses.

When to Get Professional Help

The accuracy penalty is more complex than timing-based penalties. It involves the substance of your return, audit findings, and legal standards that require careful analysis. Professional representation is particularly important when the proposed penalty exceeds $5,000, the underlying audit involves multiple issues, you relied on a tax professional whose advice is now being questioned, the penalty involves valuation issues, or you plan to appeal the penalty through the IRS Office of Appeals.

Jennifer O'Neill, EA, MBA, at New York IRS penalty relief specialist has defended New York taxpayers against accuracy penalties for over 40 years. As an enrolled agent with unlimited IRS practice rights and BBB accreditation, she can represent you during audits, prepare reasonable cause defenses, and handle appeals. Call 1-800-477-4357 for a consultation.

The accuracy penalty is not automatic and not inevitable. With the right defense strategy, many accuracy penalties are reduced or eliminated through reasonable cause arguments, disclosure defenses, or the appeals process.

Frequently Asked Questions

What is the accuracy-related penalty?

The IRS accuracy-related penalty is 20% of the tax underpayment attributable to negligence, disregard of rules, substantial understatement of income, or substantial valuation misstatement. It is assessed after an audit or examination finds errors on your return. For gross valuation misstatements, the rate increases to 40%.

How much is the accuracy penalty?

The standard accuracy penalty is 20% of the underpayment amount. On a $10,000 underpayment, the penalty is $2,000. For gross valuation misstatements (property valued at 200% or more of its correct value), the penalty doubles to 40%. Interest accrues on both the additional tax and the penalty from the original due date.

How do I dispute the accuracy penalty?

You can dispute the accuracy penalty by demonstrating reasonable cause and good faith, showing adequate disclosure of your tax position (Form 8275), proving substantial authority for your position, or appealing through the IRS Office of Appeals. The strongest defense depends on the specific facts of your case. An enrolled agent can evaluate your options and present the most effective argument.

Can the accuracy penalty be removed after it is assessed?

Yes. You can request penalty abatement based on reasonable cause even after the penalty has been formally assessed. If you have already paid, you can file a claim for refund using Form 843. The standard limitations period for refund claims is two years from the date of payment or three years from the date the return was filed, whichever is later.

Does the accuracy penalty apply to state taxes too?

NY State has its own penalty provisions for underpayment of state tax. When the IRS adjusts your federal return through an audit, you must report those changes to NY State within 90 days. The NY DTF may impose its own penalties on the state-level underpayment. Federal and state penalty defenses are evaluated separately.

Is the accuracy penalty the same as fraud?

No. The accuracy penalty (20%) addresses negligence and understatement, while the civil fraud penalty (75%) applies to intentional tax evasion. The IRS must prove fraud by clear and convincing evidence, a much higher standard. If the IRS asserts fraud, the accuracy penalty does not also apply to the same underpayment. Fraud cases are significantly more serious and require immediate professional representation.