Question

3. The hospital where Brian Campbell works has made some questionable investments. Specifically, it was involved in a reportable transaction. Participation in the transaction reduced the hospital’s 2016 income tax liability by $1,000,000. The hospital did not disclose its involvement in the transaction on the return.

a. What penalty can the hospital expect will be asserted for underreporting its tax?

b. How much can the hospital expect to pay under this penalty?

c. What penalty can the hospital expect will be asserted for its failure to disclose? How much can the hospital expect to pay under this penalty?

d. Can the IRS assert both penalties at the same time?

Answer 1

There are actually two different penalties that may apply. One is the negligence penalty. The other is the penalty for substantial understatement. "Substantial" understatement sounds like a vague term, but it actually has a very specific definition. It refers to understatement of your tax liability by 10 percent or more. The penalty for this type of understatement is 20 percent of the portion of tax related to the understated income. The negligence penalty is also 20 percent of the tax related to the understated income. Unlike the substantial understatement penalty, there is no set threshold for when it applies. But in practice, it is for misstatements of tax liability of less than 10 percent. (The substantial understatem). Of course, underreporting income is quite another matter when willful tax evasion becomes an issue. But our primary point in this post is that when underreporting is not willful, waiver of tax penalties may be possible.