The TurboTax Defense: A New Chapter

 

The TurboTax Defense to federal tax penalties—where taxpayers cite reliance on tax software like TurboTax to avoid penalties—has historically been a tough sell. However, Huang v. United States (N.D. Cal. 5/28/2025) offers a fresh perspective, potentially strengthening this defense at least for late-filed international information returns like Form 3520. The TurboTax Defense: Origins

The TurboTax Defense argues that good-faith reliance on tax software constitutes reasonable cause for non-compliance, excusing penalties. In my 2012 post, I discussed Au v. Commissioner (T.C. Memo 2010-78), where the Tax Court rejected this defense. The court required evidence of a specific software error and diligent taxpayer effort to determine correct tax liability—neither of which the Aus provided. I wrote:

That case involved the TurboTax tax preparation software, and this defense is often referred to as the 'TurboTax Defense.' In the Au’s case, the Court found that the taxpayers did not provide evidence of a mistake in the software instructions, nor of a thorough effort by the taxpayers to determine their correct tax liability. This seemingly leaves the door open to the successful use of the TurboTax Defense if a taxpayer can actually prove up a mistake in tax preparation software or its instructions.

This suggested a narrow path for success, contingent on proving software error. Huang tests this path.

Huang v. United States: Case Summary

In Huang v. United States (No. 24-cv-06298-RS), pro se taxpayer Jiaxing Huang faced $91,238.75 in IRS penalties for late-filed Forms 3520 (2015 and 2016). Huang received large gifts from her non-resident foreign parents to relocate to the U.S. and buy a home. IRC § 6039F requires U.S. persons to report foreign gifts over a specific threshold via Form 3520. Huang, using TurboTax, claimed the software advised that only gift-givers, not recipients, needed to report. Relying on this, she filed the forms late in 2018 after learning of the filing requirement. The IRS assessed penalties, which Huang challenged, citing reasonable cause.

The government moved to dismiss, arguing Huang’s reliance didn’t establish reasonable cause. The court disagreed, finding her allegations plausible enough to survive dismissal and proceed to discovery. This ruling marks a shift from prior skepticism toward the TurboTax Defense.

Key Rulings in Huang

The court’s decision rests on several points:

1. Software as Professional Advice: Huang alleged TurboTax explicitly advised no reporting was needed for gift recipients. The court equated this to reliance on a “competent professional,” citing Olsen v. Commissioner (T.C. 2011), which recognized software reliance as potential reasonable cause.
2. Reasonable Cause Factors: Ignorance of the law alone isn’t enough, but combined with Huang’s inexperience and the complexity of Form 3520, it may support her claim. 
3. 
   
4. Distinguishing Precedent: The government cited Spottiswood v. United States (N.D. Cal. 2018), where a similar defense failed. The court noted Spottiswood was decided at summary judgment, not dismissal, allowing Huang’s case to advance.

Evolution Since 2012

In 2012, I noted the TurboTax Defense’s slim chances, requiring proof of software error and taxpayer diligence. Huang lowers this bar at the dismissal stage, accepting plausible allegations of erroneous software advice as akin to professional guidance. This reflects growing judicial recognition of tax software’s role and the complexities of international reporting, contrasting with Au’s stricter stance.

Implications

• Stronger Defense: Taxpayers relying on software in good faith may avoid penalties, especially for complex forms. This benefits pro se filers or those without access to tax professionals.
• Discovery Hurdles: Huang must prove TurboTax’s incorrect advice and reasonable reliance in discovery, highlighting the need to document software interactions. It remains to be seen what additional evidence Huang will need to prevail, such as whether she will need to prove the correct input of gift amounts and the language of and the required specificity of the advice of the program.
• Software Accountability: If the defense gains traction, providers like Intuit may face pressure to improve guidance accuracy for niche areas.
• IRS Enforcement: The IRS’ aggressive penalty assessments for late international filings suggest taxpayers must verify requirements, even with software.

Related Cases

Huang aligns with Olsen (2011), supporting software reliance, but contrasts with Au (2010) and Spottiswood (2018), where defenses failed due to evidence or procedural issues.

Conclusion

Huang v. United States revitalizes the TurboTax Defense, moving it from a long shot to a viable argument, at least early in litigation. As I noted in 2012, proving software error could open the door to success. Huang steps through, leveraging alleged TurboTax misguidance to challenge penalties. While discovery will test her claims, the case underscores tax software’s growing influence and the need for careful documentation. Taxpayers and professionals should verify complex requirements and preserve evidence of software advice, as the TurboTax Defense reshapes reasonable cause in the digital era.

Sources:

• Huang v. United States, No. 3:24-cv-062998-RS (N.D. Cal. 5/28/2025)
• "TurboTax Defense Fail"
• Olsen v. Commissioner, 2011 WL 5885082 (T.C. 2011)

Section 7872 Defeats IRS Claim of Gift Involving Family Loan

 

In a recent U.S. Tax Court case, Estate of Barbara Galli, Deceased, Stephen R. Galli, Executor, et al. v. Commissioner of Internal Revenue, the court addressed a tax dispute involving a $2.3 million purported loan transfer between Barbara Galli and her son, Stephen, in 2013. The case, decided via summary judgment, centered on whether this transfer was a loan, a gift, or a partial gift. Since the IRS did not assert that the entire transaction was not a loan but instead was a part loan/part gift, the court found no gift at all because the loan documents provided for adequate interest under Section 7872.

FACTS: Barbara Galli, who passed away in Florida in 2016, transferred $2.3 million to her son, Stephen, in 2013. The transfer was documented as a loan with a 9-year term and an interest rate of 1.01%, matching the mid-term Applicable Federal Rate (AFR) at the time. The loan was unsecured, lacked standard commercial enforcement provisions, and required annual interest payments with the principal due at the end of the term. Stephen made interest payments in 2014, 2015, and 2016, and the unpaid loan was included in Barbara’s estate tax return, valued at $1.624 million. The premise of the IRS’ claim was that there was a question about whether Stephen had the financial wherewithal to repay the loan, and thus the principal amount should be discounted by appraisal taking into the ability to repay. The excess of the principal amount over the discounted value was asserted to be a taxable gift. Bolstering its argument, the IRS sought to apply the consistency doctrine, since Barbara’s estate reported a lower than face value amount as to the value of the note for estate tax purposes, taking into account similar considerations that warranted a reduced value for the note. The taxpayer moved for summary judgment on the gift issue citing Frazee v. Commissioner (1992), which held that §7872 provides comprehensive treatment for loans at or above the AFR for both income and gift tax purposes, displacing traditional fair market valuation methods for gift tax purposes. The court agreed, also acknowledging that the consistency doctrine did not apply due to the different rules that applied under §7872 versus estate tax valuation.

COMMENTS: There are several takeaways from this case. The first is that the court accepted the premise of the taxpayer’s argument that traditional valuation principles that value a promissory note for estate tax purposes, which include judgments relating to the likelihood of repayment, do not apply in determining whether a loan transaction constitutes a partial gift if there is loan and it is not considered a below-market loan under §7872. Secondly, if the IRS could have shown that there was no valid loan element at all, then §7872 would not apply and presumably the entire transfer would have been a taxable gift. Therefore, if factually there are substantial questions about whether loan treatment at all is proper, a gift can result. In this case, even though the note was unsecured, that the interest was timely paid was probably a useful fact in this regard. The decision can provide some comfort to taxpayers that there appears to be an all or nothing approach to the IRS being able to obtain gift treatment if there is adequate interest under §7872  but there may be some question as to ability to repay– assuming adequate interest either the transaction is entirely free of gift tax as a loan, or fully a gift if it can be shown that there was no bona fide loan at all. This case can be compared to Estate of Bolles v. Comm’r, 133 AFTR 2d 2024-1235 (9th Cir 2024), affirming TC Memo 2020-71, in which loans were entirely reclassified as gifts where there were no repayments and there was evidence of lack of ability of the borrower to repay the loans.

CITES: Estate of Barbara Galli v Comm’r, Docket Nos. 7003-20 and 7005-20 (March 5, 2025); Frazee v. Comm’r, 98 T.C. 554 (1992); Estate of Bolles v. Comm’r, 133 AFTR 2d 2024-1235 (9th Cir 2024), affirming TC Memo 2020-71; Code § 7872.