Refundable credits produce a $1,000 penalty underpayment

Plain-English summary

Chief Counsel confirmed that a penalty calculator correctly produced a $1,000 underpayment for purposes of the IRC § 6662 accuracy-related penalty. Under the regulation's formula, refundable credits reduce both the tax imposed and the tax shown, but neither amount is reduced below zero by those credits. After the examination adjustments, the tax imposed was $1,000 because $500 of allowable credits reduced $1,500 of tax. The tax originally shown remained zero, so the underpayment against which the penalty applied was $1,000.

Ruling snapshot

• Question: What underpayment amount should be used to calculate the IRC § 6662 penalty after applying refundable credits?
• Outcome: Advice given, the underpayment was $1,000
• Key authorities: IRC § 6662; Treas. Reg. § 1.6662-4

Full text (IRS public release)

ID: CCA-120813-14
UILC: 6662.00-00

Number: 201504013
Release Date: 1/23/2015
From:
Sent: Monday, December 08, 2014 13:37
To: --------------------
Cc: ---------------------------------------------------------------------------------- Bcc: Subject: RE: Rand case penalty calculation

Mike,

As we discussed, the Rand penalty calculator result of $1,000 for the underpayment is correct.

§1.6662-4 says that the underpayment = W – (X + Y – Z)

W is the amount of tax imposed on the return, taking into account allowable refundable tax credits as negative amounts of tax, but not less than zero. X is the amount of tax shown on the return, less (1) claimed refundable credits, but not below zero and then less (2) excess withholding credits, which can drive it below zero. Y and Z are both zero in this hypo.

The takeaway from the Rand case is the rule that refundable credits reduce both tax owed and tax shown, but not below zero. Thus in this hypo, the allowable credits do reduce the tax imposed as a result of the omitted income.

The amount of tax imposed after exam’s adjustments is $1,000 ($1,500-$500), the tax shown originally is $0 (not reduced below zero by claimed refundable credits), so the underpayment is $1,000 ($1,000 – $0), and that’s the amount against which the §6662 penalty is properly applied.

This can get tricky, so please let me know if you have any further questions.

Thanks,
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