How Bad is an Incoming Link From a Penalized Site?

Matt Cutts (head of Google's Web spam team) created a solid video post addressing if any type of penalty will leak over to your site, if a site linking to you is penalized.

"If some site that is linking to my site gets penalized for purchasing links, will my site get affected by that penalty?" - Sergey, NYC

Cutts explains if a site is penalized for selling links, the punishment will be a loss of 30-50% of their PageRank. And all the outgoing links featured on that site will not be trusted anymore.

So, the punishment will not be passed on to your site. However, you will lose the value of the untrusted site's link. Watch the 90 second video to hear it in Cutts' own words:

So the answer is it depends. If the site penalized was your primary source of PageRank, then it will hurt you more than if you have a diverse strong incoming link profile from many sources. It's always a good idea to have a diverse link profile from multiple authoritative sources so one bad egg will not ruin your basket of links.