Reasonable Cause Defense Based on Bad TurboTax Advice Survives Motion to Dismiss

(Parker Tax Publishing June 2025)

A district court denied in part the IRS's motion to dismiss a refund claim in a case where the IRS penalized a taxpayer's late filing of Forms 3520, Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts, and the taxpayer claimed the late filing was due to incorrect advice received from TurboTax. The court concluded that, although ignorance of the law alone is not sufficient to constitute reasonable cause for the late filing of a return, the taxpayer plausibly alleged other factors such as her inexperience in tax matters and the complexity of the area of law which, when combined, could be found to constitute reasonable cause. Huang v. U.S., 2025 PTC 195 (N.D. Cal. 2025).

Background

In 2015 and 2016, Jiaxing Huang received gifts from her non-resident foreign parents to help her permanently relocate to the U.S. and acquire a house. She used TurboTax to file her tax returns for those years. With respect to the receipt of a gift of cash, TurboTax advised users that, "If you received the money, no matter how much or how little, you don't report anything" - the gift-giver does. So, Huang did not report the gifts from her parents.

In April 2018, Huang learned that, as the gifts were from a foreign source, she was required to file Form 3520, Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts. She promptly filed the Forms 3520 and the IRS responded by automatically assessing penalties of $62,496 and $28,743 for 2015 and 2016, respectively, for not filing the forms sooner. In response, Huang submitted a reasonable cause letter, requesting abatement of the penalties, which the IRS rejected because, it said, she had failed to show reasonable cause or due diligence.

During the course of her appeal, the IRS mysteriously caused the penalty to increase to over $153,000, amounting to nearly $190,000 with interest. The IRS Appeals Division subsequently abated $117,243 of the inflated penalty and sustained the remaining $36,495 in penalties due to lack of reasonable cause.

Huang paid the post-abatement assessment in full, with interest, and shortly thereafter filed a Form 843, Claim for Refund and Request for Abatement, checking the box for "reasonable cause" as the basis for her claim. After six months passed with no response from the IRS, Huang filed a complaint in a district court. Huang claimed (1) that she had reasonable cause for late-filing the initial Forms 3520; (2) citing Code Sec. 6039F, that the IRS's automatic assessment and then random doubling of the penalties was arbitrary and capricious under the Administrative Procedure Act (APA) and the IRS lacked authority under Code Sec. 6039F to collect the penalties; (3) that the IRS lacked statutory authority to assess and collect such penalties; and (4) that the penalties were invalid because the IRS failed to obtain written supervisory approval as required by Code Sec. 6751. According to Huang, she requested the relevant tax records and none of them provided the name of the supervisor who approved the 2015 and 2016 penalties, nor whether any approval came from the decisionmaker's immediate supervisor.

The IRS moved to dismiss Huang's complaint on two grounds: first, that the district court lacked jurisdiction, and second, that the complaint failed to state any viable claims. Huang's Form 843, the IRS said, failed to raise all the grounds she was currently raising before the court. In the alternative, the IRS argued that Huang's allegations were too threadbare to demonstrate reasonable cause since she failed to allege that she entered complete and accurate data about each gift into TurboTax's prompts, and failed to seek advice from any professionals. The IRS noted that, in Spottiswood v. U.S., 2018 PTC 114 (N.D. Calif. 2018), the court had previously rejected a reasonable cause argument based on the use of TurboTax.

The IRS also stated that, because Huang's refund action is itself an adequate remedy in court, she could not raise a parallel APA claim. For this argument, the IRS relied on Starr Int'l Co., Inc. v. U.S., 2018 PTC 418 (D.C. Cir. 2018), in which the court held that the tax refund statute in Code Sec. 7422 was the "appropriate vehicle" to challenge administrative actions, rather than the APA, because Code Sec. 7422 provided an adequate remedy.

With respect to the supervisory approval issue, the IRS pointed out that supervisory approval of a penalty need not precede the first communication to the taxpayer that purports to impose a penalty; nor does it require any particular form of written approval.

Analysis

The district court denied the IRS's motion to dismiss as to Huang's reasonable cause claim, granted it as to her three other claims. The court noted that since the Tax Court, in Olsen v. Comm'r, T.C. Summary 2011-131, has ruled that reliance on tax software in good faith can support a reasonable cause defense, it was necessary to proceed to the merits of the IRS's denial of Huang's reasonable cause claim.

With respect to the IRS's reliance on the court's previous holding in Spottiswood regarding the use of TurboTax, the court noted that what the IRS failed to mention about that case was that the court's determination as to reasonable cause came on summary judgment - not a motion to dismiss, the stage of litigation the instant case had only just reached. In Huang's case, the court said, the question was whether the statements in her complaint plausibly stated a claim for reasonable cause and the court concluded that they did because she had detailed that she acted with ordinary business care and prudence. The court observed that, although ignorance of the law alone is not sufficient to constitute reasonable cause, Huang alleged other factors such as her inexperience in tax matters, and the complexity of the area of law which, when combined, could be found to constitute reasonable cause.

With respect to the IRS's reliance on the Starr decision to claim Huang's refund action was itself an adequate remedy with respect to the IRS error in assessing additional penalties, thus negating Huang's APA claim, the court agreed, noting that the IRS had since rectified this error thus making the issue moot. Addressing the IRS's argument that Huang's Form 843 was too sparse to have put the IRS on notice of Huang's arguments, the court rejected this argument because it found that the IRS was well aware of Huang's arguments before she filed her suit due to prior communications between the two parties. Regarding Huang's lack-of-authority claim regarding Code Sec. 6039F, the court agreed with the IRS that, while this provision provides for a reasonable cause defense, Huang did not include it in her claim with the IRS and thus it was considered waived.

Finally, with respect to Huang's claim that the IRS failed to comply with Code Sec. 6751(b), which requires a supervisor's written approval before a penalty may be assessed, the court also sided with the IRS. Code Sec. 6751, the court noted, only provides that the signature must be from the "the immediate supervisor" or "such higher level official as the Secretary may designate." Further, the court said that because Huang never made this argument to the IRS, it was considered waived.

For a discussion of the abatement of penalties due to reasonable cause and acting in good faith, see Parker Tax ¶262,127. For a discussion of the requirements to file Form 3520, see Parker Tax ¶203,165.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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