The Internal Revenue Service determined that Covington Ltd. should have been using a transfer price of $400 for the purchase of goods from its U.S. subsidiary but had set the price at $50. What is the rate of penalty that the IRS can impose on the taxpayer?

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The penalty rate for transfer pricing adjustments is typically 40% of the taxes underpaid. This is meant to incentivize taxpayers to use arm's length transfer pricing methods to avoid underpaying taxes. In this case, Covington Ltd. should have paid $150 in taxes on the $350 ($400-$50) of additional income it generated from the transfer pricing adjustment, so the penalty could be as high as $60 ($150 x 40%).

The Internal Revenue Service Determined That Covington Ltd