Gloria, a calendar year taxpayer subject to a 35% marginal income tax rate, claimed a Form 1040 charitable contribution deduction of $800,000 for a sculpture that the IRS later valued at $100,000. The applicable overvaluation penalty is:

Question

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The applicable overvaluation penalty is 40% of the amount of the overvaluation (the difference between the claimed deduction and the IRS valuation). In this case, the overvaluation is $700,000 ($800,000 - $100,000), so the penalty is 40% of $700,000, which is $280,000. However, the maximum penalty is 20% of the underpayment of tax resulting from the overvaluation, or $56,000 ($280,000 x 20%). Since Gloria's marginal tax rate is 35%, the tax benefit from the overvaluation is $245,000 ($700,000 x 35%). Therefore, the penalty is limited to the tax benefit, which is $98,000 ($245,000 x 40%). Choice B is the correct answer.

Gloria, a Calendar Year Taxpayer Subject to a 35% Marginal