On audit, Bianca Whitfield is found to have an understatement of income tax that is both more than ten percent of the tax required to be shown on her return and more than 5,000 dollars. The understatement was not due to fraud, and she had no reasonable cause or substantial authority for the positions taken. Which penalty most directly applies to this understatement, and at what rate?
- AThe failure-to-file penalty, generally five percent of the unpaid tax for each month the return is late
- BThe accuracy-related penalty for a substantial understatement of income tax, equal to twenty percent of the underpayment Correct
- CThe failure-to-pay penalty, generally one-half of one percent of the unpaid tax for each month it remains unpaid
- DThe civil fraud penalty, equal to seventy-five percent of the portion of the underpayment attributable to fraud
Why A is wrong: The failure-to-file penalty is triggered by filing a return late, not by understating tax on a return that was filed, so it does not address Bianca's accuracy problem.
Why B is correct: An understatement that exceeds the greater of ten percent of the required tax or 5,000 dollars is a substantial understatement, triggering the twenty percent accuracy-related penalty absent reasonable cause or substantial authority, which fits Bianca's facts.
Why C is wrong: The failure-to-pay penalty applies when tax shown or assessed is not paid by the due date; it does not address an understatement caused by incorrect positions on the return, so it is the wrong penalty here.
Why D is wrong: The seventy-five percent civil fraud penalty requires a showing of fraud, and the facts state the understatement was not fraudulent, so this penalty does not apply despite the size of the understatement.