What does substantial authority mean on the CPA exam?
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Substantial authority. The standard between reasonable basis and more likely than not: roughly a 40 percent chance, judged on the weight of published authorities rather than on the preparer's confidence.
Defined against Treas. Reg. 1.6662-4(d).
Worked example
An individual's return shows tax of $96,000, but the correct tax is $150,000. Of the $54,000 difference, $40,000 comes from a deduction supported by a Tax Court decision and a revenue ruling directly on point, which together amount to substantial authority. The rest comes from an item with no support, nothing was disclosed, no item is connected with a tax shelter, and the taxpayer claimed no qualified business income deduction.
Does the 20% accuracy-related penalty for a substantial understatement apply?
| Understatement: tax required to be shown less tax shown150,000 - 96,000 | 54,000 |
| Threshold: the greater of 10% of the correct tax or $5,000150,000 x 10% | 15,000 |
| Understatement after removing the portion with substantial authority54,000 - 40,000 | 14,000 |
Answer: No. Once the $40,000 supported by substantial authority is removed, the understatement is $14,000, which does not exceed the $15,000 threshold, so the understatement is not substantial and that penalty does not apply. Without the authority, the penalty would have been 20% of $54,000, or $10,800. Whether the unsupported item draws a negligence penalty is a separate question.
The trap: Testing the full $54,000 against the threshold. Substantial authority does not just excuse a position; it takes that portion out of the understatement before the threshold comparison is made.
Based on IRC Sec. 6662(d)(1)(A); IRC Sec. 6662(d)(2)(B)(i).
Which CPA exam sections use substantial authority?
Substantial authority appears in the REG section of the CPA exam.
Related terms
- reasonable basis: The lowest standard at which a return position may be taken without penalty if it is disclosed.
- more likely than not: A greater than 50 percent chance of being sustained on its merits.
- valuation allowance: The contra account reducing a deferred tax asset to the portion more likely than not to be realized, meaning a likelihood above 50%.
- level of assurance: How much confidence the practitioner expresses.
- qualified business income: The net income from a domestic pass-through trade or business, excluding investment income and reasonable compensation.
- audit sampling: Selecting and evaluating less than 100% of a population of audit relevance so the sample is expected to be representative, giving a reasonable basis for conclusions about the whole population.