The best protection in an IRS audit is accuracy before the audit ever begins. For federal tax purposes, accuracy means more than avoiding math errors. It means reporting income correctly, classifying deductions properly, maintaining records that support each return position, and taking positions that satisfy the standards in the Internal Revenue Code and Treasury Regulations. When a return position creates an underpayment, can impose an accuracy-related penalty, generally at 20 percent of the portion of the underpayment to which the section applies.
Why accuracy matters in an audit
The audit issue is often not whether a taxpayer had a business purpose or incurred a real cost. The issue is whether the return position was reported accurately enough to survive scrutiny. imposes a 20 percent penalty on the portion of an underpayment covered by the statute. Under, that can include negligence or disregard of rules or regulations, a substantial understatement of income tax, substantial valuation misstatements, and several other categories.
The regulations summarize the same point: the accuracy-related penalty applies to underpayments attributable to negligence or disregard, substantial understatement, or substantial valuation misstatement, and no penalty applies if the taxpayer qualifies for the reasonable cause and good faith exception under.
In practice, that means audit protection starts with three things:
- accurate reporting,
- adequate substantiation,
- supportable legal positions.
The core penalty rules
General rule
And (b) impose a 20 percent penalty on the portion of an underpayment attributable to covered misconduct.
For the issues most commonly seen in ordinary audits, the two most important categories are:
- negligence or disregard of rules or regulations under, and
- substantial understatement of income tax under.
The regulations also make clear that the penalty does not stack on the same portion of an underpayment. If one portion of an underpayment is attributable to both negligence and substantial understatement, the maximum penalty on that same portion is still 20 percent, not 40 percent.
Negligence and disregard
Provides that negligence includes any failure to make a reasonable attempt to comply with the Code, and disregard includes careless, reckless, or intentional disregard.
The regulation expands on that:
- negligence includes failure to exercise ordinary and reasonable care in preparing a return,
- failure to keep adequate books and records,
- failure to substantiate items properly.
The regulation also says negligence is strongly indicated where a taxpayer:
- omits income shown on an information return,
- claims a deduction, credit, or exclusion that would seem too good to be true without making a reasonable attempt to verify it,
- fails consistency rules for partnership or S corporation items.
That is why accuracy in an audit context is not just about honesty. It is about process. If the taxpayer did not keep records or did not verify a questionable position, the IRS has a direct path to a negligence penalty.
Substantial understatement
Provides that, for most taxpayers, there is a substantial understatement if the understatement exceeds the greater of:
- 10 percent of the tax required to be shown on the return, or
- $5,000.
For corporations other than S corporations and personal holding companies,uses a different threshold: the lesser of:
- 10 percent of the tax required to be shown on the return, or if greater $10,000, and
- $10,000,000.
There is also a stricter threshold for taxpayers claiming a deduction. substitutes 5 percent for 10 percent in applying the general substantial understatement rule.
That matters because a taxpayer can face the penalty even without negligence if the understatement is large enough and the taxpayer cannot reduce it through substantial authority or adequate disclosure with reasonable basis.
How taxpayers reduce penalty exposure
Substantial authority
Reduces the understatement by the portion attributable to an item for which there is or was substantial authority for the taxpayer’s treatment.
This is one of the most important audit defenses for legal positions. If the taxpayer’s treatment is supported strongly enough by applicable authority, that portion of the understatement is removed from the substantial understatement computation.
Adequate disclosure plus reasonable basis
Also reduces the understatement for an item if:
- the relevant facts affecting the item’s tax treatment are adequately disclosed on the return or in a statement attached to the return, and
- there is a reasonable basis for the treatment.
The regulations reinforce that disclosure can help avoid the penalty for disregard of rules or regulations and for substantial understatement in appropriate cases, but not for negligence itself or for substantial valuation misstatements.
For disregard of rules or regulations, the regulation states that disclosure generally must be made on a properly completed Form 8275 or 8275-R, as appropriate, and the taxpayer must identify the relevant statute, regulation, or ruling. The disclosure exception does not apply if the position lacks reasonable basis or if the taxpayer failed to keep adequate books and records or substantiate items properly.
Reasonable basis is not a low standard
The regulation defines reasonable basis as a relatively high standard of tax reporting, significantly higher than not frivolous or not patently improper. It is not satisfied by a merely arguable or colorable claim.
That is a critical audit point. Many taxpayers assume a position is safe if it is not absurd. That is not the rule. The standard is materially higher.
Tax shelter limitation
Provides that the substantial-authority and disclosure-based understatement reductions do not apply to items attributable to a tax shelter. The statute defines tax shelter broadly to include arrangements where a significant purpose is the avoidance or evasion of federal income tax.
So even technically careful reporting may not avoid the penalty if the item is treated as tax shelter-related.
Accuracy starts with records
The negligence regulation is explicit that negligence includes failure to keep adequate books and records or to substantiate items properly.
That means audit protection depends heavily on documentation such as:
- invoices,
- receipts,
- bank and credit card records,
- contracts,
- workpapers,
- contemporaneous explanations of tax treatment,
- support for valuation or basis positions.
For positions involving depreciation, cost segregation, or asset classification, the 2025 IRS audit techniques guidance emphasizes that taxpayers must substantiate depreciation deductions and classifications of property, and that better-documented studies are more reliable and easier to defend. It repeatedly stresses reconciliation to actual costs, use of contemporaneous documentation, and support for legal classifications.
That guidance is not itself the substantive law governing, but it shows how the IRS evaluates whether a taxpayer’s reporting was careful, documented, and supportable.
The reasonable cause and good faith exception
The regulations state that no accuracy-related penalty may be imposed on any portion of an underpayment if there was reasonable cause for, and the taxpayer acted in good faith with respect to, that portion.
That exception is found in, which the regulations reference.
Although the detailed reasonable-cause regulation itself is not among the cited materials here, the sources make clear that this exception remains available generally, except where the Code specifically limits it. One important statutory limitation appears in: for a net transfer price adjustment, the taxpayer is not treated as having reasonable cause unless the documentation and method requirements in are satisfied.
So the practical lesson is:
- reasonable cause is a real defense,
- but it works best when the taxpayer acted carefully, documented the position, and complied with procedural requirements.
What happens during an audit
IRS Publication 556 explains that examinations may occur by mail or in person, and that if changes are proposed, the taxpayer can agree or disagree and pursue administrative appeal rights. It also notes that many examinations result in no change or even a refund.
That publication also explains several procedural protections relevant to audit defense:
- the taxpayer may be represented,
- the taxpayer may request a conference with the examiner’s supervisor,
- the taxpayer generally receives a 30-day letter before a notice of deficiency,
- the taxpayer may petition the Tax Court after a 90-day letter.
For penalties specifically, Publication 556 notes that in court proceedings involving an individual taxpayer, the IRS has the burden of initially producing evidence with respect to liability for penalties, additions to tax, or additional amounts.
That does not eliminate the taxpayer’s need for records and legal support, but it does matter procedurally in litigation.
Accuracy issues that commonly create audit trouble
The sources point to several recurring problem areas.
1. Income omitted despite third-party reporting
The negligence regulation specifically says negligence is strongly indicated where a taxpayer fails to include income shown on an information return.
2. Positions that seem too good to be true
The same regulation flags deductions, credits, or exclusions that a reasonable and prudent person would view as too good to be true if the taxpayer did not make a reasonable attempt to verify them.
3. Poor substantiation
Again, failure to keep adequate books and records or substantiate items properly is itself negligence.
4. Asset classification and valuation issues
And (h) impose valuation-misstatement penalties, and the IRS cost segregation guidance shows how aggressively the IRS reviews unsupported allocations, residual methods, and weak documentation.
5. Late attempts to fix disclosure
For nondisclosed noneconomic substance transactions, says amended returns filed after the earlier of IRS contact regarding examination or another specified date do not count for disclosure purposes.
That reflects a broader audit reality: disclosure is most protective when made on the original return, not after the IRS has already started asking questions.
If the IRS proposes changes
Publication 556 explains that if the taxpayer agrees, the case can be closed by signing the agreement and paying the additional tax, interest, and applicable penalties. If the taxpayer disagrees, the taxpayer can pursue Appeals and, if necessary, court review.
The same publication also explains that interest and certain penalties may be suspended if the IRS does not timely mail a notice within the statutory 36-month period under, subject to important exceptions. One of those exceptions is that the suspension does not apply to penalties, interest, additions to tax, or additional amounts with respect to any gross misstatement.
So even procedural relief provisions may not help where the issue is a gross misstatement.
Practical audit-defense themes
A taxpayer is usually in the strongest position when the return file shows:
- complete books and records,
- contemporaneous substantiation,
- a clear explanation of unusual items,
- disclosure where appropriate,
- authority supporting the position,
- consistency between return reporting and underlying records.
