If the IRS adjusts a crypto return, odds are good the adjustment comes with a 20 percent penalty attached. That is the accuracy-related penalty under IRC 6662. It shows up in CP2000 notices, examination reports and notices of deficiency.

It is also the crypto penalty with the most ways to fight it. Here is how it works, when it applies, and where the defenses are.

The basic rule

IRC 6662(a) adds to the tax an amount equal to 20 percent of the portion of an underpayment to which the section applies. Under IRC 6662(b), it applies to the portion attributable to one or more listed grounds. In crypto cases, two matter most: negligence or disregard of rules or regulations, and a substantial understatement of income tax.

The penalties do not stack within 6662. One 20 percent penalty applies to a given portion of the underpayment, even if more than one ground fits.

Negligence

IRC 6662(c) defines negligence to include “any failure to make a reasonable attempt to comply with the provisions of this title,” and disregard to include “any careless, reckless, or intentional disregard.”

In crypto cases, the IRS argues negligence when there was no reasonable attempt to track and report transactions: no records kept, no effort to compute basis, activity on some platforms simply left off. Given how long the IRS has publicized crypto reporting, it will argue that a reasonable attempt includes knowing that swaps and staking rewards are reportable.

Substantial understatement

Under IRC 6662(d)(1)(A), an individual has a substantial understatement if the understatement for the year exceeds the greater of 10 percent of the tax required to be shown on the return, or $5,000. IRC 6662(d)(1)(C) substitutes 5 percent for 10 percent for taxpayers who claim the section 199A deduction.

This test is mechanical. Unreport a large enough crypto gain and you cross it regardless of intent. That is why it appears in so many automated notices.

IRC 6662(d)(2)(B) reduces the understatement by the portion attributable to an item for which there is or was substantial authority, or an item adequately disclosed on the return or an attached statement with a reasonable basis for its treatment. In crypto cases where the law is unsettled on a particular transaction type, that reduction can matter.

When 6662 does not apply

Three limits are worth knowing.

  • No penalty where fraud applies. The last part of IRC 6662(b) says the section does not apply to any portion of an underpayment on which a fraud penalty is imposed under IRC 6663. The IRS gets one or the other for a given portion.
  • No penalty on a substitute for return. IRC 6664(b) says the penalties in this part apply only where a return was filed, other than a return prepared by the IRS under IRC 6020(b). If you never filed and the IRS prepared the return, the accuracy penalty does not apply, though failure to file and pay additions to tax under IRC 6651 may.
  • Reasonable cause and good faith. IRC 6664(c)(1) says no penalty is imposed under 6662 or 6663 for any portion of an underpayment if you show reasonable cause for that portion and that you acted in good faith.

Reasonable cause in crypto cases

Reasonable cause is the main defense, and it is fact-intensive. Common crypto arguments include reliance on a qualified preparer who had complete information, a genuinely unsettled legal question, data failures by a platform outside your control, and serious personal circumstances during the filing period.

The IRS will weigh those against its public guidance. IRM 25.1.2.11.2 tells IRS personnel to consider the history of notices and releases on digital asset reporting when evaluating reasonable cause. A taxpayer who received one of the 2019 letters, or who answered the digital asset question incorrectly, faces a harder argument. See the reasonable cause defense in detail and the digital asset question.

Procedural defenses: approval and burden

IRC 6751(b)(1) says no penalty shall be assessed unless the initial determination is personally approved in writing by the immediate supervisor of the individual who made it, or a designated higher-level official. The exceptions in 6751(b)(2) cover additions to tax under 6651, 6654 and 6655, 6662 penalties only under subsections (b)(9) and (b)(10), and penalties automatically calculated through electronic means. Negligence and substantial understatement penalties are not in that list.

That means a 6662 penalty proposed by an examiner needs timely written supervisory approval. A penalty in an automated CP2000 may not, unless you challenge it and an IRS employee considers your response, under Treas. Reg. 301.6751(b)-1(a)(3)(vi). See supervisory approval of crypto penalties.

In court, IRC 7491(c) gives the IRS the burden of production on any individual’s penalty. The IRS has to come forward with evidence that the penalty applies, including, where required, compliance with 6751(b).

What 20 percent really costs

The penalty is 20 percent of the underpayment attributable to the covered items, not 20 percent of your crypto proceeds. On a $40,000 underpayment, it is $8,000. Interest is added on top of the tax and penalty, which is why delay is expensive.

And because the penalty is calculated on the underpayment, every dollar of tax you remove by proving basis also removes the penalty on that dollar. Fight the tax first. The penalty often shrinks with it.

A worked example

Assume a 2025 return reports $160,000 of wages and $30,000 of tax. A Form 1099-DA shows $70,000 of crypto proceeds the return left out. The CP2000 treats all $70,000 as gain and computes $16,000 of additional tax.

Is that a substantial understatement? Under IRC 6662(d)(1)(A), the test is whether the $16,000 understatement exceeds the greater of 10 percent of the tax required to be shown, which is 10 percent of $46,000, or $4,600, and $5,000. It does. The notice proposes a $3,200 penalty, 20 percent of $16,000.

Now the taxpayer proves basis of $62,000. The real gain is $8,000. Suppose the corrected additional tax is about $1,800. That is below the $5,000 floor, so there is no substantial understatement. The IRS could still argue negligence for leaving the sale off the return, and the taxpayer could answer with reasonable cause. Either way, the penalty math changed completely once basis came in.

The numbers in this example are illustrations, not tax computations for your situation. The point is the sequence: fix the tax, then test the penalty against the corrected numbers.

Where you will see this penalty

In a CP2000, the penalty is usually proposed as a substantial understatement, calculated automatically. In an examination report, it may be proposed on negligence, substantial understatement, or both in the alternative. In a notice of deficiency, it appears as a separate line after the tax. Each stage is a chance to contest it. Do not wait until the last one.

When you contest it, be specific. Identify which ground the IRS relied on, whether the numbers support it after any corrections to the tax, whether written supervisory approval was required and obtained in time, and what facts support reasonable cause and good faith. A one-line request to “waive the penalty” gives the IRS nothing to evaluate.

The bottom line

The 20 percent penalty is not automatic, even when the notice makes it look that way. Check whether it was properly approved, whether reasonable cause applies, and whether the underlying tax is right. Those three questions resolve more crypto penalty disputes than any amount of arguing about fairness.

And if you have not been contacted yet, the cheapest penalty defense is a correct return. Amending an open year before the IRS raises it is the clearest evidence of good faith you will ever have.