Being called negligent by the IRS stings. It sounds like a judgment of character. It is not. It is a defined term in the Code, and the definition is narrower than the word suggests.

IRC 6662(c) says negligence includes any failure to make a reasonable attempt to comply with the tax law, and disregard includes any careless, reckless or intentional disregard. The penalty is 20 percent of the underpayment attributable to it, under IRC 6662(a) and (b)(1). Understanding how the regulations fill in that definition tells you where the defense is.

What negligence means

Treas. Reg. 1.6662-3(b)(1) defines negligence as any failure to make a reasonable attempt to comply with the internal revenue laws or to exercise ordinary and reasonable care in preparing a return. It also includes any failure to keep adequate books and records or to substantiate items properly.

Then the key sentence: a return position that has a reasonable basis is not attributable to negligence.

So the negligence question is not whether you were wrong. It is whether you tried, whether you were careful, whether you kept records, and whether your position had a reasonable basis. A taxpayer can be wrong without being negligent.

When the IRS says negligence is strongly indicated

The regulation lists situations where negligence is strongly indicated, including:

  • Failing to include on a return income shown on an information return.
  • Failing to make a reasonable attempt to check a deduction, credit or exclusion that would seem to a reasonable and prudent person to be too good to be true.
  • A partner or S corporation shareholder failing to treat items consistently with the entity's return, or to notify the IRS of the inconsistency.

IRM 20.1.5.8.1 lists other indications examiners look for: unreported or understated income, significantly overstated deductions or credits, careless or exaggerated deductions, unexplainable items, inadequate records, substantial errors on an issue that was adjusted in a prior year, and incorrect or incomplete information given to the preparer.

If your case involves unreported income from a Form 1099, understand that you are starting from a regulation that says negligence is strongly indicated. Your defense has to explain why that inference does not fit your facts.

What does not make you negligent

The manual also limits the penalty. IRM 20.1.5.8.1 says the negligence penalty will not be asserted solely for filing a return late. It also says the penalty will not be asserted solely because the taxpayer failed to appear for an audit or respond to an inquiry, unless the taxpayer failed to report income shown on an information return, though other facts in the file may still support it.

Late filing has its own penalty under IRC 6651. Not showing up to an audit has its own consequences. Neither, by itself, is negligence on the return.

Defense one: reasonable basis

Because a position with a reasonable basis is not negligent, the first defense is to show one. Treas. Reg. 1.6662-3(b)(3) describes reasonable basis as a relatively high standard of reporting, significantly higher than not frivolous or not patently improper, and not satisfied by a position that is merely arguable or merely colorable. If a position is reasonably based on one or more recognized authorities, such as the Code, regulations, rulings or cases, it will generally meet the standard even if it falls short of substantial authority.

This is the right defense when the dispute is about the law: whether something was deductible, how an item should be characterized, whether a rule applied. Identify the authorities you, or your preparer, relied on. The list of what counts is in substantial authority and adequate disclosure.

Defense two: you kept records and tried

When the dispute is about facts, such as whether you incurred an expense or how much, negligence turns on records and effort. The regulation's definition includes failure to keep adequate books and records or to substantiate items. Flip it around. If you kept records, made a reasonable attempt to comply and gave your preparer complete information, the core of the negligence finding is missing even if some items did not survive the audit.

Show the system you used. Bank statements, receipts, a mileage log, a bookkeeping file. Show that you gave your preparer complete information; the IRM specifically lists incomplete information given to the preparer as an indicator of negligence, so the opposite is evidence against it.

Defense three: reasonable cause and good faith

Even if a position lacks a reasonable basis, Treas. Reg. 1.6662-3(b)(3) says the reasonable cause and good faith exception in Treas. Reg. 1.6664-4 may still provide relief. That exception looks at your effort to report the right tax, your experience and education, reliance on information returns and on professional advice. See reasonable cause and good faith under section 6664.

For unreported 1099 income, this is often the main argument. A reasonable, documented explanation, such as a Form 1099 sent to an old address that you never received, combined with a clean history and prompt correction, speaks to good faith.

Disregard of rules and the disclosure exception

The disregard half of the penalty has its own definitions. Treas. Reg. 1.6662-3(b)(2) says disregard is careless if you did not exercise reasonable diligence to determine whether a position contrary to a rule was correct, reckless if you made little or no effort to find out whether a rule existed, and intentional if you knew of the rule. Rules include the Code, temporary and final regulations, and revenue rulings and notices published in the Internal Revenue Bulletin.

Under Treas. Reg. 1.6662-3(c), you can avoid the disregard penalty for a position contrary to a rule or regulation by disclosing it on Form 8275 or 8275-R, if the position has a reasonable basis and is substantiated, and for a position contrary to a regulation, if it is a good faith challenge to the regulation's validity. Disclosure does not help with negligence itself.

Repeat issues are a red flag

The IRM gives an example that shows how history affects this penalty. A taxpayer had a commuting expense deduction disallowed in two consecutive examinations, then claimed the same deduction again on the next return and did not appear for the audit. The manual says the negligence penalty should be asserted for the later year, because the taxpayer knew the expense was not deductible.

The lesson runs both ways. If an issue was adjusted against you before, repeating it invites a negligence finding unless something material changed. If you have never been adjusted on the issue, and your position was supported, your clean history is part of your good faith story. Say so.

Check the alternatives

Examiners often assert negligence and substantial understatement together as alternatives. The IRM says the examiner should assert the one most strongly supported and write up the other as an alternative, because under the no-stacking rule only one 20 percent penalty applies to the same portion. Defeating negligence does not end the matter if the substantial understatement penalty also fits. Address both. The accuracy-related penalty defenses overview walks through how they interact.

Negligence is a word with a sting and a definition with limits. Make the IRS live within the definition. Ask the examiner which facts support negligence specifically, and answer those facts one by one.