IRS Audit Penalties Explained | Kathryn Meyer Law PC

The most common is the accuracy-related penalty: 20 percent of the part of the underpayment caused by negligence or a substantial understatement of tax. It rises to 40 percent for a few serious misstatements, and the civil fraud penalty is 75 percent of the underpayment due to fraud. If a return was filed or paid late, late-filing and late-payment additions can grow with the tax the audit adds, and interest runs on all of it.

Penalties are not automatic in the way tax is. Each one has a legal test, several have procedural requirements the IRS must meet, and many can be contested on their own even when you accept the tax. This page walks through them in the order they usually appear on an examination report, as part of Kathryn Meyer's guidance on IRS audits and examinations.

How a penalty gets onto an audit report, step by step

The examiner finds an underpayment. Each adjustment is measured separately, so one report can carry a penalty on some items and none on others.
A penalty ground is chosen for each portion. Negligence, a substantial understatement, a valuation misstatement or fraud, each with its own test.
A supervisor signs off. Under section 6751(b), most penalties need the written approval of the examiner's immediate supervisor before they can be assessed.
The notice shows its work. Section 6751(a) requires each penalty notice to give the name of the penalty, the Code section and a computation.
You respond. The IRS asks for a signed explanation for each penalty you dispute, with supporting documents, following any instructions and deadlines in the notice.
Appeals or court. A disputed penalty can go to Appeals, and in a Tax Court case involving an individual the IRS bears the burden of production.

The penalties at a glance

Penalty	Amount	When it applies	Code section
Accuracy-related	20% of the affected underpayment	Negligence or disregard of rules, or a substantial understatement of income tax	6662(a), (b)
Gross valuation misstatement	40%	The most serious valuation errors	6662(h)
Undisclosed foreign financial asset understatement	40%	Underpayment tied to foreign financial assets that were not disclosed	6662(j)
Civil fraud	75% of the part due to fraud	Underpayment due to fraud	6663
Failure to file	5% a month, up to 25%	Return filed late without reasonable cause	6651(a)(1)
Failure to pay	0.5% a month, up to 25%	Tax not paid when due, or within 21 days of notice and demand (10 business days if $100,000 or more)	6651(a)(2), (a)(3)

How does the 20 percent accuracy-related penalty work?

Section 6662 imposes a penalty equal to 20 percent of the portion of an underpayment that is attributable to one of several listed causes. The IRS describes two common ones that apply to individuals:

Negligence or disregard of rules or regulations. The statute says negligence includes any failure to make a reasonable attempt to comply with the tax law, and disregard includes careless, reckless or intentional disregard. The IRS gives leaving off income that was reported on a Form 1099 as an example that may indicate negligence, which is why an unanswered CP2000 notice can carry a penalty too.
Substantial understatement of income tax. For individuals, this exists when the understatement is more than the greater of 10 percent of the correct tax or $5,000. If you claimed the qualified business income deduction under section 199A, the 10 percent becomes 5 percent. For most corporations the test is the lesser of 10 percent of the correct tax (or $10,000 if greater) or $10 million.

The understatement figure is reduced for items supported by substantial authority, and for items adequately disclosed on the return that have a reasonable basis. Those reductions do not apply to tax shelter items. The penalty is computed only on the portion of the underpayment it covers, so a report with several adjustments may apply it to some and not others.

When does the IRS charge 40 or 75 percent?

The 20 percent rate doubles to 40 percent for gross valuation misstatements, for transactions found to lack economic substance that were not disclosed, and for understatements tied to undisclosed foreign financial assets. The civil fraud penalty in section 6663 is 75 percent of the portion of the underpayment attributable to fraud. Once the IRS proves that any part of an underpayment is due to fraud, the entire underpayment is treated as fraud except any part the taxpayer proves was not. On a joint return, the fraud penalty does not apply to a spouse unless some of the underpayment is due to that spouse's own fraud.

Fraud also removes the time limit on assessment, which is why a fraud penalty proposal changes the nature of a case. See how far back the IRS can audit for the time limits. The warning signs that a civil audit could turn criminal explain what examiners look for.

Can late-filing and late-payment penalties grow after an audit?

Yes. The failure-to-file addition in section 6651(a)(1) is 5 percent of the tax required to be shown on the return for each month or part of a month the return is late, up to 25 percent. Because it is based on the correct tax, an audit that increases the tax on a late return increases this addition too. For a return more than 60 days late, there is a minimum: the lesser of a dollar floor or 100 percent of the tax required to be shown. The IRS lists the floor as $525 for returns due after December 31, 2025, and Revenue Procedure 2025-32 sets it at $535 for returns required to be filed in 2027.

Additional tax from an audit that was not shown on the return carries its own late-payment addition under section 6651(a)(3) if it is not paid within 21 calendar days of the IRS's notice and demand, or 10 business days if the amount is $100,000 or more. When both late-filing and late-payment additions apply for the same month, the late-filing amount is reduced by the late-payment amount.

What defenses and safeguards apply?

Reasonable cause and good faith. With narrow exceptions, section 6664(c) bars the accuracy-related and fraud penalties for any portion of an underpayment where there was reasonable cause and the taxpayer acted in good faith. The IRS says it considers your efforts to report correctly, the complexity of the issue, your experience and knowledge, and whether you sought advice from a competent advisor who had all the facts. Building that record before a dispute is part of strategic tax counsel.
Written supervisory approval. Under section 6751(b), most penalties cannot be assessed unless the initial determination was personally approved in writing by the immediate supervisor of the person who made it. Exceptions include the late-filing and late-payment additions, the estimated tax penalties, and any penalty calculated automatically through electronic means.
The IRS's burden in court. In a court case involving an individual, section 7491(c) puts the burden of production for any penalty on the IRS.
Appeal. The Taxpayer Bill of Rights describes an administrative appeal of most IRS decisions, "including many penalties." See what happens at an IRS Appeals conference.

The IRS's first-time abatement program, which is moving to an Automatic Exemption from Penalty starting in summer 2026, covers late-filing, late-payment and late-deposit penalties for taxpayers with a clean three-year history. Its list of eligible penalties does not include the accuracy-related penalty, so relief from an audit penalty generally depends on reasonable cause or the other rules above. How relief works for the late filing, payment and deposit penalties is covered in whether IRS penalties can be removed.

What about interest?

Interest is charged on the additional tax and on penalties, and it keeps running until the balance is paid. By law, the IRS can remove or reduce interest only when the related penalty is removed or reduced. If you expect to owe after an audit, Publication 3498 explains that an advance payment or a section 6603 deposit stops interest from accumulating on the amount paid. Our page on the IRS 30-day letter explains how that fits the end of an audit.

What changes the answer

Which part of the underpayment. The 20 percent penalty applies only to the portion caused by a listed ground (section 6662(a)), so it is argued adjustment by adjustment.
Authority and disclosure. The understatement is reduced for items with substantial authority, and for disclosed items with a reasonable basis (section 6662(d)(2)(B)).
Fraud on the same dollars. The accuracy-related penalty does not apply to any portion of an underpayment on which the 75 percent fraud penalty is imposed (section 6662(b)).
The QBI deduction. Claiming the section 199A deduction lowers the substantial understatement threshold from 10 to 5 percent of the correct tax. For law firm owners, deduction planning is the fourth-quarter topic of the firm's Quarterly Tax Health Checkup.
Reasonable cause and good faith. Section 6664(c) bars the accuracy and fraud penalties for any portion where both are shown.
How the penalty was calculated. Penalties computed automatically by electronic means, and late-filing and late-payment additions, do not need supervisory approval (section 6751(b)(2)).

For example: testing a substantial understatement

For example, suppose an individual reported $48,000 of tax and an audit finds the correct tax is $60,000, an understatement of $12,000. Ten percent of the correct tax is $6,000, which is more than $5,000, so the threshold is $6,000. Because $12,000 is above it, the understatement is substantial, and a 20 percent penalty on that portion would be $2,400.

Now suppose $4,000 of the understatement comes from a position supported by substantial authority. Under section 6662(d)(2)(B) the understatement is reduced to $8,000. That is still above $6,000, so the penalty would generally apply to the remaining $8,000, or $1,600. If the reduced figure had fallen to $6,000 or less, the substantial understatement ground would not apply at all, and the IRS would need another ground, such as negligence, for any penalty. This is a hypothetical, not a real case.

Common mistakes with audit penalties

Signing the report without reading the penalty line. Agreeing to the tax does not require agreeing to the penalty.
Counting on first-time abatement. It does not reach the accuracy-related penalty.
Relying on an advisor's word without the full facts. The IRS weighs whether the advisor was competent and had all the facts.
Never asking how the penalty was approved and computed. Sections 6751(a) and (b) set requirements the IRS must meet.
Forgetting the late-filing addition. On a late return it rises with every dollar of tax the audit adds.

What to do this week

Find each penalty on the report or notice and note its name, Code section and computation.
Match each penalty to the adjustment it covers.
For each one, write down the facts that show reasonable cause and good faith, such as advice you relied on and what the advisor knew.
Gather the documents behind each disputed item; our page on the records the IRS requires to support business deductions lists what deductions need.
Note the response deadline in the notice and decide whether to dispute the penalty, the tax, or both.

Frequently asked questions

Can you dispute the penalty but accept the tax?

Yes. The IRS asks for the notice, the penalty you want reconsidered, and a signed explanation with supporting documents for each penalty. If the notice sets instructions or deadlines for disputing it, follow those.

Can the IRS charge both the 20 percent and the 75 percent penalty on the same dollars?

No. Section 6662(b) says the accuracy-related penalty does not apply to any portion of an underpayment on which the fraud penalty is imposed.

Is interest charged on penalties?

Yes. The IRS charges interest on penalties, and the start date varies by the type of penalty. It cannot remove the interest unless the penalty itself is removed or reduced.

Does a payment plan help with penalties?

The IRS says you may reduce future penalties by setting up a payment plan when you cannot pay in full. Our page on IRS payment plan options explains how the failure-to-pay rate changes under a plan.

What happens to the penalty in a Tax Court case?

Section 6665 treats penalties as tax, so accuracy and fraud penalties proposed in a notice of deficiency are part of what the court decides. For individuals, section 7491(c) puts the burden of production on the IRS; our page on what to do when you receive a notice of deficiency explains the deadline to petition.

Can a penalty you already paid be recovered?

Generally through a refund claim, which has its own time limit. See how long you have to claim a tax refund.

Reviewing a penalty proposal with counsel

Penalties can change an audit result significantly. Reviewing them means checking the legal test for each one, the record of supervisory approval, and the facts that support reasonable cause, before you sign anything. Kathryn Meyer can review an examination report and advise whether a penalty is worth contesting. Contact the firm or call (571) 560-8674 to discuss your situation.

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