The IRS often challenges taxpayers who seek penalty abatements for late-filing penalties, particularly those related to international information returns. Generally, these cases focus on whether the taxpayer can demonstrate reasonable cause for non-compliance. Because the reasonable cause standard depends on the facts and circumstances, it is common for the government and taxpayers to disagree on whether the conduct at issue arises to a level of reasonable cause sufficient for penalty abatement.
A recent federal district court order illustrates this point well. In Huang v. United States, No. 3:24-cv-062998-RS (N.D. Cal. 5/28/25), a pro se taxpayer challenged the IRS’ assessment of roughly $40,000 of penalties related to two late-filed Forms 3520. When the government refused to concede the penalties, Huang filed a lawsuit, contending that she had reasonable cause for the late filings in that she relied on TurboTax to advise her of the forms. The government moved to dismiss her claims arguing, among other things, that Huang had failed to sufficiently allege reasonable cause. The court disagreed and concluded that her factual allegations, if true, could support a reasonable cause defense. Huang’s case will now presumably move into discovery where she will have to support her allegations and where the government can attempt to introduce other evidence that may cut against her claim.
Although Huang can move forward with her reasonable cause defense, the court did find in the government’s favor on one issue. Specifically, in addition to the reasonable cause contentions, the government moved to dismiss certain procedural arguments Huang raised against the penalties on the basis that she had failed to raise them prior to the lawsuit. The court agreed with the government and dismissed these claims under the variance doctrine.
Background.
Huang received significant monetary gifts from her foreign, non-resident parents in 2015 and 2016. These gifts were intended to help Huang relocate to the U.S. and to purchase a new home.
Generally, gifts are not subject to income tax. However, section 6039F requires U.S. persons to file a Form 3520 if gifts from a foreign donor exceed certain reporting thresholds in a tax year (currently, more than $100,000 if the foreign donors are individuals). U.S. persons who miss the Form 3520 filing deadline may be subject to penalties of up to 25% of the amount of the foreign gifts received in a year.
Huang used TurboTax to prepare and file her 2015- and 2016-income tax returns. According to her complaint, TurboTax never notified her of the Form 3520 filing obligations, resulting in her filing the information returns late. After she filed the returns, the IRS assessed over $90,000 of late-filing penalties against Huang under section 6039F.
To contest the penalties, Huang hired a tax attorney. In response to the tax attorney’s appeals protest, the agency agreed to abate all but approximately $35,000 of the penalties. Thereafter, Huang paid the remaining penalties plus interest and filed a lawsuit against the government.
The Form 3520 Penalty Litigation.
Huang’s complaint raised reasonable cause and procedural defenses against the section 6039F penalties. The government moved to dismiss her complaint, contending that she failed to allege an appropriate reasonable defense and failed to properly raise her procedural contentions during the review of her refund claim.
Reasonable Cause.
For decades, taxpayers and the IRS have fought over the scope and application of the reasonable cause defense to late-filing penalties. These disputes have resulted in rich and voluminous case law that categorize most of the reasonable cause defenses that are available to taxpayers. At its core, Huang’s contentions fell into two of these well-known defenses: professional reliance and ignorance of the law.
Although taxpayers may rely on professionals concerning substantive tax advice, the Supreme Court recognized many decades ago in U.S. v. Boyle, 469 U.S. 241 (1985) that taxpayers may not rely on professionals to file their return by a reporting deadline. A taxpayer may have reasonable cause for relying on a tax professional’s advice regarding whether a specific return should be filed but does not have reasonable cause for the act of filing the return itself.
With the rise in tax software, federal courts have also had the opportunity to review reasonable cause and whether it applies in these circumstances. In many cases, the courts have concluded that taxpayers cannot show reasonable cause reliance on tax software because the “software . . . is only as good as the information the taxpayer puts into it.” See, e.g., Bunney v. Comm’r, 114 T.C. 259 (2000). In addition, courts have generally held that Boyle applies to late filings caused by tax software in that taxpayers may not rely on their software to file a timely return. See Spottiswood v. U.S., No. 17-cv-00209-MEJ (N.D. Cal. Apr. 24, 2018) (no reasonable cause where taxpayer attempted to timely file return through TurboTax, but return was late due to error in dependent’s Social Security number).
In a recent decision, a California district court illustrated the distinction in Boyle between relying on a tax professional for reporting advice and relying on a professional to file the return. See Murphy v. U.S., No. 1:24-cv-00260 (E.D. Cal. 2025). Husband and wife taxpayers had created a revocable grantor trust which historically had reported the trust’s income and tax items on the couple’s joint individual tax returns. When the husband passed away, the wife, as trustee, was required to report the trust as a separate entity for federal income tax purposes. Although the wife advised her long-time tax advisor of her husband’s death, the tax preparer continued to report the trust’s income and other items on the wife’s returns. The errors were eventually discovered, and late trust income tax returns were filed. When the IRS assessed late-filing penalties, the wife contended that she reasonably relied on her long-time tax advisor concerning the proper income tax reporting. The Murphy court agreed and found reasonable cause because the wife justifiably relied on her tax professional to provide reporting advice.
The reasonable cause defense may apply where a taxpayer was ignorant of the tax laws, but it is often an uphill battle for taxpayers. Specifically, taxpayers must usually show ignorance of the law in combination with other factors (e.g., lack of education or business experience, complexity of the tax matter, etc.). The IRS also considers whether the taxpayer has been subject to the specific reporting requirement in prior years or subject to penalties.
In Huang, the court concluded that the taxpayer pleaded sufficient facts to show reasonable cause for the late-filed Forms 3520. In finding in favor of the taxpayer, the court found significant that: (i) Huang provided evidence that TurboTax may have suggested to her that she was not required to file an information return; (ii) the IRS has historically abated many of these penalties; and (iii) she suggested that she lacked experience or knowledge of the Form 3520 filing obligations.
Procedural Claims.
Huang also raised procedural challenges to the Forms 3520 penalties which included arguments under the Administrative Procedure Act and section 6751(b). However, the court agreed with the government that these claims were barred under the variance doctrine.
Applicable to refund claims, the variance doctrine provides that taxpayers must fully apprise the IRS of each ground for refund prior to filing a lawsuit. The doctrine is intended to inform the agency of the claims to potentially avoid costly and time-consuming litigation. If a taxpayer fails to properly raise an argument prior to filing a lawsuit, courts will refuse to entertain the new arguments in litigation.
Many tax professionals are aware of the variance doctrine and its risks—unfortunately, few pro se taxpayers know of its existence and application, resulting in many good arguments never making it before the court.
The Takeaway.
The Huang case shows that the government often takes a hard stance on penalties in international information return cases. The court order also demonstrates the dangers taxpayers may face in failing to properly raise all of their arguments under the variance doctrine pre-litigation.