Question

Rico received a letter from the IRS indicating that his federal income tax was understated by $3,000. His corrected tax is $16,000. If Rico cannot provide adequate disclosure and a reasonable basis for the understatement, what penalty amount will he have to pay?
$150
$600
$3,000
$3,200

Answer 1

$600.

Explanation: The understatement is $3,000. The substantial-understatement threshold is the greater of 10% of corrected tax (10% of $16,000 = $1,600) or $5,000, so the threshold is $5,000. Because $3,000 < $5,000 it isn’t a "substantial" understatement, but an accuracy-related penalty applies (20% of the understatement) when no adequate disclosure/reasonable basis is shown: 20% × $3,000 = $600.