IRS Publication 550 — Investment Income and Expenses

valuation overstatement, no reasonable cause exception is available. See section 6664(c)(3). Note, however, that the accuracy-related penalty for reportable transaction understatements doesn’t apply to any portion of an understatement on which the gross valuation misstatement is imposed.

Transaction lacking economic substance. The economic substance doctrine only applies to an individual who entered into a transaction in connection with a trade or business or an activity engaged in for the production of income. A transaction has economic substance for you as an individual taxpayer only if:

• The transaction changes your economic position in a meaningful way (apart from federal income tax effects), and

• You have a substantial purpose (apart from federal income tax effects) for entering into the transaction. For purposes of determining whether economic substance exists, a transaction’s profit potential will only be taken into account if the present value of the reasonably expected pre-tax profit from the transaction is substantial compared to the present value of the expected net tax benefits that would be allowed if the transaction were respected. If any part of your underpayment is due to any disallowance of claimed tax benefits by reason of a transaction lacking economic substance or failing to meet the requirements of any similar rule of law, that part of your underpayment will be subject to the 20% accuracy -related penalty even if you had a reasonable cause and acted in good faith concerning that part.

Additionally, the penalty increases to 40% if you do not adequately disclose on your return or in a statement attached to your return the relevant facts affecting the tax treatment of a transaction that lacks economic substance. Relevant facts include any facts affecting the tax treatment of the transaction.

For the understatement of tax related to reportable transactions, no penalty is imposed to any portion of an understatement if you can demonstrate the understatement was due to reasonable cause. The reasonable cause exception does not apply if the underpayment is due to a transaction that lacks economic substance. For underpayments, no penalty will be assessed if a reasonable cause exception applies. A reasonable cause exception is generally not available for an underpayment attributable to a transaction lacking economic substance, or for an underpayment associated with a disallowed deduction for a conservation easement. Penalty for erroneous refund claim. You may be subject to a 20% penalty based on the excessive amount of an erroneous claim for an income tax refund or credit. If that excessive amount results from a transaction found to be lacking economic substance, it will NOT be treated as due to reasonable cause. After July 4, 2025, an erroneous claim for an employment tax refund or credit is subject to the 20% penalty under section 6676(a), unless it is shown that the claim for the excessive amount is due to reasonable cause. Undisclosed foreign financial asset understatement. For tax years beginning after March 18, 2010, you may be liable for a 40% penalty for an understatement of your tax liability due to an undisclosed foreign financial asset. An undisclosed foreign financial asset is any asset for which an information return, required to be provided under sections 6038, 6038B, 6038D, 6046A, or 6048 for any tax year, is not provided. The penalty applies to any part of an underpayment related to the following undisclosed foreign financial assets.

• Any foreign business you control reportable on Form 5471, Information Return of U.S. Persons With Respect T o Certain Foreign Corporations, or Form 8865, Return of U.S. Persons With Respect to Certain Foreign Partnerships.

• Certain transfers of property to a foreign corporation or partnership reportable on Form 926, Return by a U.S. Transferor of Property to a Foreign Corporation, or certain distributions to a foreign person reportable on Form 8865.

• Your ownership interest in an otherwise undisclosed foreign financial asset reportable on Form 8275 or 8275-R. See the Instructions for Form 8275 or Form 8275-R.

Instead of or in addition to Form 8275 or 8275 -R, you may have to file Form 8938, Statement of Specified Foreign Financial Assets, with your tax return. See the Instructions for Form 8938 for details.

• Your acquisition, disposition, or substantial change in ownership interest in a foreign partnership, reportable on Form 8865.

• Creation or transfer of money or property to certain foreign trusts, reportable on Form 3520, Annual Return T o Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts.

Penalty for incorrect appraisals. The person who prepares an appraisal of the value of property may have to pay a penalty if:

• He or she knows, or reasonably should have known, that the appraisal would be used in connection with a return or claim for refund; and

• The claimed value of the property on a return or claim for refund based on that appraisal results in a substantial valuation misstatement or a gross valuation misstatement. See Substantial valuation misstatement, earlier.

For details on the penalty amount and exceptions, see Pub. 561.

Penalty for failure to disclose a reportable transaction. If you fail to include any required information regarding a reportable transaction on a return or statement, you may have to pay a penalty of 75% of the decrease in tax shown on your return as a result of such transaction (or that would have resulted if the transaction were respected for federal tax purposes). See Reportable transaction, earlier. For an individual, the minimum penalty is $5,000 and Publication 550 (2025) Chapter 2 Tax Shelters and Other Reportable Transactions 43