Tax Law Center Blog

Can a taxpayer’s good-faith reliance on tax preparation software serve as a defense against IRS penalties?

The U.S. District Court for the Northern District of California recently addressed this issue in Huang v. United States. By denying the Government’s motion to dismiss, the court has opened the door for a deeper examination of whether automated tax preparation software may constitute “reasonable cause” under the Internal Revenue Code.

The High Stakes of Form 3520 Compliance

The case centers on Jiaxing Huang, a taxpayer who received significant financial gifts from her non-U.S. parents. Under IRC § 6039F, U.S. persons must report foreign gifts exceeding certain thresholds on Form 3520. The penalties for non-compliance are draconian—reaching up to 25% of the gift amount—and are often assessed automatically.

Ms. Huang utilized TurboTax to prepare her returns. Despite entering information regarding the foreign funds, the software allegedly provided explicit guidance that she had no reporting obligation (it is uncertain whether she actually correctly entered the foreign information). When she later discovered the error and voluntarily filed the forms, the IRS assessed penalties of almost $190,000.

The “Reasonable Cause” Standard in the Digital Age

To avoid penalties under IRC § 6677 or § 6039F, a taxpayer must demonstrate that the failure to file was due to “reasonable cause” and not “willful neglect.” Historically, the benchmark for reasonable cause has been the Supreme Court’s ruling in United States v. Boyle, 469 U.S. 241 (1985), which emphasizes reliance on a “competent professional.”

The IRS argued that tax software is a tool, not a professional, and that reliance on it cannot satisfy the Boyle standard. However, the District Court’s refusal to dismiss the case suggests a more nuanced view:

• Complexity of the Law: The court noted that foreign reporting requirements are “obscure” and complex for a layperson.
• Good Faith Efforts: The taxpayer provided the software with accurate data and followed its specific prompts, demonstrating an active attempt at compliance.
• The Modern Marketplace: As software is marketed as a “complete” and “trusted” solution, the court appears willing to consider whether such reliance is “ordinarily prudent” for a non-expert.

Implications for Tax Professionals

While Huang does not yet establish a definitive rule, it signals a potential shift in how courts view automated advice. For practitioners, this case highlights several critical points:

1. The Limitation of Retail Software: Standard consumer software often fails to capture the nuances of international information returns (Forms 3520, 5471, 8938), leaving clients exposed to massive “blind-side” penalties.
2. The Fact-Intensive Defense: A successful reasonable cause defense requires a meticulous record of the taxpayer’s efforts. Documentation of the specific software prompts and the data entered is essential.
3. The Opportunity for Advocacy: The IRS’s rigid stance on “automatic” penalties is being challenged. Professionals can use the reasoning in Huang to bolster abatement requests for clients who acted in good faith but were misled by technology.

The Huang case serves as a stark reminder that “user-friendly” software is no substitute for sophisticated legal and tax analysis, particularly in the realm of international reporting. When the IRS issues a penalty notice, the penalty defense must be as rigorous.

If your clients are facing penalties related to international information returns or are navigating the fallout of software errors, our firm provides the technical expertise and controversy experience necessary to challenge IRS assessments.

Contact us for a consultation to learn more about how we can support your tax controversy needs.