If the IRS determines that a transaction lacks economic substance, the underpayment of tax attributable to the disallowance of tax benefits will be subject to a 20% penalty. The penalty will increase to 40% if the taxpayer does not adequately disclose the relevant facts affecting the tax treatment on their return or on a statement attached to the return.
Amending the Return
An amendment made to a return is not taken into account if it is filed after the taxpayer has been contacted for an audit. This is because the IRS does not accept changes that happen after the taxpayer is being subject to legal action for their underpayment due to a lack of economic substance.
Adequate Disclosure Form 8275
In order for a taxpayer to make adequate disclosure and avoid the 20% penalty for lack of economic substance, they need to file Form 8275(Disclosure Statement) or Form 8275-R(Regulation Disclosure Statement) in order to properly state their transaction.