Adequate disclosure avoids Sec. 6662 penalty.

• Author: Goldberg, Michael J.
• Position: Item on a tax return; substantial-understatement penalty

In Rev. Proc. 2001-5, the IRS recently updated the circumstances under which disclosure of an item on a tax return was adequate for avoiding the Sec. 6662 20% substantial-understatement penalty. Generally, under Sec. 6662, there is a substantial understatement of income tax if the understatement amount for any tax year exceeds 10% of the tax required to be shown on the return for that year.

Normally, the understatement is reduced by the portion attributable to a particular item if there is either substantial authority supporting its treatment or adequate disclosure. An item is adequately disclosed when (1) the facts affecting the tax treatment of an item are disclosed on the taxpayer's return or on a statement attached to the return and (2) a reasonable basis exists for the taxpayer's treatment of that item.

A taxpayer can make disclosure on Form 8275, Disclosure Statement, or Form 8275-R, Regulation Disclosure Statement. However, in certain circumstances, disclosure on the tax return constitutes adequate disclosure. Disclosure is considered adequate if the taxpayer (1) clearly furnished all information required by the applicable forms and instructions, (2) disclosed the information on the return in an appropriate manner, (3) listed the items separately (rather than combining them) and (4) can verify the amounts entered on the forms. An amount is verifiable if, on audit, the taxpayer can demonstrate its origin and show that it acted in good faith in...