An understatement is said to be substantial if it crosses the required statutory limits. In case of an individual tax payer, he is said to be making a substantial understatement if he is showing tax which is more than either of the greater of the options which is 10% of the tax than it was required to be shown as return in a particular year or $5000 ($10000 in case of corporations except in case of S corporations or personal holding companies).
There is a penalty for substantial understatement of income tax if the underpayment is related to a loss, deduction or credit of a spolied item in a particular year wherein the charge of such loss, deduction or credit has arisen.
If the tax payer can show the authority a reasonable cause of such understatement or provides in good faith correct treatment of tax of the item, then he may not be imposed such penalty.
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