Is Reliance on Software a Defense Against IRS Tax Penalties?

 Posted on July 25, 2026 in Taxation Law

Many taxpayers use software programs to prepare and file tax returns. Unfortunately, these programs may not always address specific issues that taxpayers may face. Failure to file forms correctly within the proper deadlines can lead to serious tax penalties. Some taxpayers may wonder whether their reliance on software can serve as a defense against IRS penalties. A case that is ongoing in the U.S. District Court for the Northern District of California may address this issue, and decisions that have been made have already affected some of the options available to taxpayers.

The issues that may affect taxpayers who own foreign investments or receive income from foreign sources can be complex. Failure to file the proper forms or pay taxes as required can lead to serious penalties and significant financial losses. To address these issues, taxpayers can work with an attorney who has a strong understanding of the tax laws that apply in cases involving foreign income or assets. This can help ensure that they will meet their legal requirements and will be able to address any penalties that are assessed.

IRS Requirements for Filing Form 3520 When Receiving Gifts or Inheritances

Taxpayers, including U.S. citizens and people who reside in the United States for tax purposes, may be required to report gifts or inheritances received from foreign sources. In cases where a person receives at least $100,000, they must report this to the IRS. This is done by filing Form 3520, Part IV. The due date for this form is April 15 of the year following the tax year in which gifts or inheritances were received.

In most cases, gifts and inheritances that taxpayers receive are not considered taxable income. However, penalties may be assessed if Form 3520 is not filed correctly. For each month that Form 3520 is late, a penalty of 5% of the total gifts/inheritances may be assessed, up to a maximum of 25% of the amount received. Even though no taxes would be assessed if a form was filed correctly, late filing can result in the loss of a significant percentage of the total amount of a gift or inheritance.

Zhang v. IRS and Reliance on Tax Preparation Software

In the case currently being heard, a Chinese citizen who became a U.S. resident for tax purposes in 2017 received wedding gifts totaling over $287,000 from family members in China. She used TurboTax to file her tax return for 2017, but the software did not provide the option to prepare and file Form 3520. After learning about this requirement in 2018, she filed Form 3520 with the IRS. In response, the IRS assessed a penalty of more than $71,000.

The taxpayer contacted the IRS to request abatement of the penalty, arguing that her reliance on tax preparation software was a reasonable cause for her late filing. The IRS rejected this request, finding that she did not perform due diligence and did not have reasonable cause. After an appeal, the amount of the penalty was reduced to around $57,000. The woman paid this penalty, but she has filed a claim for a refund, and this led to the lawsuit that is currently being addressed in court.

The judge in the case has rejected certain claims made by the taxpayer. They found that the IRS had the authority to assess penalties for the failure to report foreign gifts. They also dismissed a claim under the Administrative Procedure Act because the lawsuit for the refund claim is an adequate remedy for the penalty. They also dismissed a claim that the fine was excessive, ruling that because tax penalties are remedial rather than punitive, they are not covered under the Eighth Amendment.

Certain claims were allowed to proceed, including the claim that the taxpayer had a reasonable cause for failing to file Form 3250 due to reliance on tax preparation software and because she was unaware of her requirement to report foreign gifts due to her recent arrival in the United States. The court will also look at whether written approval from a supervisor was provided by the IRS before assessing a penalty. The court’s final decisions in this case, as well as any appeals that may follow, may determine whether reliance on tax preparation software may be used as a reasonable cause defense by taxpayers in the future or whether it may be possible to challenge tax penalties that were automatically assessed by computer systems without receiving written approvals from human supervisors.

Contact Our San Jose, CA Tax Penalty Abatement Lawyer

Taxpayers who are uncertain about their legal requirements when reporting foreign income or investments or who need to respond to penalties assessed by the IRS can work with a lawyer to ensure that these issues will be addressed correctly. At John D. Teter Law Offices, our San Jose tax law attorney can provide representation when dealing with the IRS while working to avoid or minimize the penalties that may affect taxpayers. Contact our firm at 408-866-1810 to arrange a consultation.