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20.1.5.8
(07-01-2008)
IRC Section 6662(d): Substantial Understatement
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If the correct income tax liability for a taxable year exceeds the amount
reported by the taxpayer by the greater of 10 percent of the correct tax or
$5,000 ($10,000 in the case of a corporation other than an S corporation or
personal holding companies, for taxable years beginning on or before October
22, 2004), then a substantial understatement exists and a penalty may be imposed
equal to 20 percent of the underpayment of tax attributable to the understatement.
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The substantial understatement penalty is limited to underpayments of
income tax.
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An
understatement
is the
excess of the amount of:
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The tax required to be shown on the return, over
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The amount of tax imposed, which is shown on the return, reduced by any
rebate. See Treas. Reg. 1.6662-4(b)(2).
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An understatement is
substantial
when
it exceeds the greater of:
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10 percent of the tax required to be shown on the return for a taxable
year or
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$5,000 ($10,000 for corporations, other than S corporations and personal
holding companies, for taxable years beginning on or before October 22, 2004).
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For taxable years beginning after October 22, 2004, a corporation (other
than an S corporation or a personal holding company) has a substantial understatement
of income tax if the amount of the understatement exceeds the lesser of:
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10 percent of the tax required to be shown on the return for a taxable
year (or, if greater, $10,000), or
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$10,000,000.
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For purposes of determining whether an understatement is substantial,
the amount of the understatement is increased by the aggregate amount of reportable
transaction understatements. See IRC section 6662A(e)(1)(A).
See IRM 20.1.5.13 for further information relating to reportable
transaction understatements.
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The substantial understatement penalty applies only to the excess of
the amount of the substantial understatement (after determining that a substantial
understatement exists) over the aggregate amount of the reportable transaction
understatements. See IRC section 6662A(e)(1)(B). Thus, the substantial understatement
penalty does not apply to any amount attributable to a reportable transaction
understatement and is subject to IRC section 6662A.
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The substantial understatement penalty will be automatically asserted
on Wage & Investment (W&I) and SB/SE campus cases when mathematically
applicable under the correspondence examination batch program. For consistency,
the substantial understatement penalty should be asserted on all discretionary
program cases.
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When the substantial understatement penalty is applicable, it should
be included on the first audit report to the taxpayer.
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