Beyond Reasonable Cause: Exploring Alternative IRS Penalty Defenses

The Internal Revenue Code (Code) contains more than 100 penalties. Used as a means to deter and punish unwanted taxpayer behavior, penalties may apply where a taxpayer files a return late, where a taxpayer pays tax late, or where a taxpayer files an inaccurate return. When these penalties are on the table, taxpayers routinely rely on reasonable cause as a defense.

Reasonable cause will remain a bedrock of penalty defense and should always be asserted where the facts support a valid reasonable cause defense. However, taxpayers should be mindful that other potential penalty defenses may apply outside of reasonable cause. Because the IRS routinely analyzes penalty defenses under the lens of “hazards of litigation,” taxpayers should raise these defenses where appropriate.

Section 6751(b)

Section 6751(b) of the Code provides: “No penalty . . . shall be assessed unless the initial determination of such assessment is personally approved (in writing)” by the proper IRS official. Enacted in 1998 pursuant to taxpayer relief legislation, section 6751(b) is a relative newcomer as a defense to penalties. Specifically, the Second Circuit held in 2017, in Chai v. Commissioner, 851 F.3d 190 (2d Cir. 2017), that the IRS’ failure to comply with the written managerial approval requirement rendered the penalty unlawful.

Since Chai, the IRS has become better at compliance with section 6751(b). Nevertheless, the IRS is not perfect and there remain ambiguities in the scope of the provision’s penalty protection. Taxpayers who intend to raise section 6751(b) as a defense should recognize that it does not apply to all penalties. Rather, the statute excludes from section 6751(b)’s reach: (i) late-filing or late-payment penalties under section 6651; (ii) failure to make estimated tax payments under section 6654 (individuals) and section 6655 (corporations); and (iii) “any other penalty automatically calculated through electronic means.” Taxpayers can find additional guidance on section 6751(b) in final regulations that are effective as of December 23, 2024.

To request a copy of the IRS’ written managerial approval form, taxpayers should formally request it through a Freedom of Information Act (FOIA) request.

Constitutional Arguments

Recent court decisions show that constitutional defenses to penalties can sometimes carry the day. Under the Eighth Amendment of the United States Constitution, “excessive bail shall not be required, nor excessive fines imposed, nor cruel and unusual punishments inflicted.” Taxpayers have had success invoking the Eighth Amendment’s Excess Fines Clause against willful FBAR penalties, which can equal 50% of the unreported foreign account’s balance per year. See U.S. v. Schwarzbaum, 127 F.4th 259 (11th Cir. 2025); U.S. v. Leeds, No. 1:22-cv-00379 (D. Idaho Mar. 7, 2025). Notably, though, not all courts have agreed that the Eighth Amendment applies in these circumstances. See, e.g., U.S. v. Toth, 33 F.4th 1 (1st Cir. 2022).

Seventh Amendment contentions are also a hot issue. Under the Seventh Amendment of the United States Constitution, individuals must usually be afforded the right to a jury trial, and the Supreme Court has held that the Seventh Amendment can apply to government penalty cases. More recently, the Supreme Court held in SEC v. Jarkesy, 603 U.S. 109 (2024) that an SEC penalty violated the Seventh Amendment where the individual was not permitted a jury. The Court reasoned that the penalty was “designed to punish and deter . . . [and] not to compensate” and therefore fell under the Seventh Amendment’s common law fraud claims. Post-Jarkesy, taxpayers have had mixed results in asserting Seventh Amendment violations with respect to IRS penalty determinations. Compare U.S. v. Sagoo, No. 4:24-00159 (N.D. Tex. Sept. 19, 2025) (willful FBAR penalty invalid) with Silver Moss Props. LLC v. Comm’r, 165 T.C. No. 3 (2025) (no right to jury for fraud penalty in Tax Court).

APA Arguments

The Administrative Procedure Act (APA) provides limitations and specified procedures on a government agency’s rule-making authority. In recent years, taxpayers have had success in asserting APA violations to avoid penalties. See, e.g., Green Valley Invs., LLS v. Comm’r, 159 T.C. 80 (2022) (IRS Notice 2017-10, rendering syndicated conservation easements a listed transaction, held invalid); CIC Svcs. LLC v. IRS, 2022 WL 985619 (E.D. Tenn. Mar. 21, 2022) (IRS Notice 2016-66, rendering micro-captive transactions as listed transactions, held invalid).

In addition, the Supreme Court recently held in Loper Bright Enterprises v. Raimondo, 603 U.S. 369 (2024) that, under the APA, government agencies should not receive Chevron deference for their interpretation of a statute. The Supreme Court held that the judiciary had an independent duty to interpret the law. To the extent penalty provisions are interpreted broadly in Treasury Regulations or other administrative guidance, taxpayers should consider raising Loper Bright challenges.

Procedural Arguments

Taxpayers have also had success in challenging penalties based on procedural defects. In Farhy v. Comm’r, 160 T.C. 399 (2023), the Tax Court held that section 6038 penalties (i.e., for late Forms 5471) could not be assessed administratively by the IRS but rather had to be recovered through federal district court litigation. The Farhy decision was later reversed by the D.C. Circuit Court of Appeals, but the Tax Court has continued to apply Farhy in cases that are appealable outside the D.C. Circuit. See, e.g., Muhki v. Comm’r, 162 T.C. 177 (2024) (Eighth Circuit); Cauchon v. Comm’r, Dkt. No. 23863-22L (Second Circuit). At least one other federal district court has agreed with the D.C. Circuit’s decision in Farhy. See Huang v. U.S., No. 24-cv-06298 (N.D. Cal. May 28, 2025).

Conclusion

There is an old adage: “If you don’t ask, you don’t get.” This certainly applies in the context of penalty abatement requests with the IRS. The agency will not independently review all potential penalty defenses but rather will focus on the penalty defenses raised by the taxpayer. Accordingly, taxpayers with penalties should be mindful of raising all appropriate penalty defenses to preserve the defenses and have them reviewed by the IRS. As more recent decisions have shown, taxpayers who request penalty defenses that are outside the scope of the standard reasonable cause defense may have more success in having the penalty abated by the IRS.

For any questions about this blog post or any other legal or tax-related matter, please feel free to contact mroberts@meadowscollier.com.