What Constitutes "Reasonable Cause" Under the Streamlined Filing Compliance Procedures—and What Happens If You Don’t Have It?

The IRS’s Streamlined Filing Compliance Procedures (SFCP) offer a lifeline for taxpayers with unreported foreign income or accounts who acted non-willfully. A key eligibility requirement is that the failure to file or report must have been due to non-willful conduct—which includes mistakes, negligence, or good faith misunderstandings—and often overlaps with the concept of “reasonable cause.”

But what if you don’t qualify? This article explains what amounts to “reasonable cause” in the streamlined context and what penalties a taxpayer could face if the IRS determines that the filing failures were due to willful conduct or lacked sufficient justification. We cite relevant case law, Internal Revenue Code provisions, and IRS guidance to provide a practitioner-focused overview.

I. What Is “Reasonable Cause”?

“Reasonable cause” is a defense to avoid penalties for noncompliance with tax filing and reporting obligations. According to Treas. Reg. § 301.6651-1(c)(1):

“If the taxpayer exercised ordinary business care and prudence and was nevertheless unable to file the return within the prescribed time, then the delay is due to reasonable cause.”

This standard applies across numerous information reporting contexts, especially those involving foreign corporations, partnerships, trusts, and bank accounts. For streamlined procedures, the IRS explicitly requires a narrative explanation that outlines the facts leading to noncompliance and supports the taxpayer’s claim that the failure was due to non-willful conduct—essentially, conduct that would qualify as having reasonable cause.

II. Penalties for Failure to File International Forms

Here’s a breakdown of the statutory penalties imposed for failing to file common international information returns—absent reasonable cause.

1. Form 5471 – Foreign Corporations (IRC § 6038)

Failure to file Form 5471 (for U.S. persons with control or ownership in foreign corporations) carries significant penalties:

• $10,000 per form, per year for each failure.

• An additional $10,000 per 30 days (up to $50,000) if the failure continues after IRS notice.

These are automatic assessable penalties (not subject to Tax Court review), unless the taxpayer demonstrates reasonable cause.

See: Farhy v. Commissioner, 160 T.C. No. 6 (2023) (holding that IRS lacked authority to assess §6038(b) penalties without formal notice and demand).

2. Form 8865 – Foreign Partnerships (IRC § 6038 & 6038B)

Similar to Form 5471, the penalty for failing to file Form 8865 is:

• $10,000 per form, plus continuation penalties up to $50,000.

• Additional penalties may apply if required disclosures under § 6038B (transfers to foreign partnerships) are not made.

Penalty abatement is available only with a written showing of reasonable cause, submitted under penalties of perjury.

3. Form 5472 – Foreign-Owned U.S. Corporations (IRC § 6038A)

This form must be filed by 25%+ foreign-owned U.S. corporations and LLCs engaged in reportable transactions with related foreign parties. Penalties include:

• $25,000 per failure, and

• An additional $25,000 per month if the failure continues after notice.

There is no de minimis exception; even dormant entities can face penalties if filing requirements are triggered.

4. FBAR (FinCEN 114)

• Up to $10,000 per year (per FBAR report) for non-willful violations;

• Up to the greater of $100,000 or 50% of the account balance for willful violations;

• Up to $250,000 and 5 years imprisonment (rare, requires fraud) for criminal violations

5. 3520/3520-A

• Up to 35% of foreign gift or distribution, and 5%/penalty per month for failure to file trust returns.

6. 926 (Transfer of property to foreign corp)

• 10% of value transferred, up to $100,000, unless intentional disregard.

III. What Courts Have Said About Reasonable Cause

The legal standard for “reasonable cause” has been shaped by decades of court decisions, especially in the context of civil penalty defenses and international reporting obligations. Courts look to whether the taxpayer exercised ordinary business care and prudence under the circumstances and generally require a fact-specific analysis. Here are the most instructive decisions.

1. United States v. Boyle, 469 U.S. 241 (1985)

In Boyle, the Supreme Court held that reliance on an attorney to file a return does not constitute reasonable cause when the duty is nontechnical and clearly imposed on the taxpayer. There, the executor of an estate relied on counsel to file an estate tax return on time. The Court rejected this as reasonable cause, stressing that the obligation to file is personal and not delegable.

Relevance to Streamlined Procedures:
While Boyle is still cited by the IRS, it is often distinguished in streamlined cases where taxpayers failed to file foreign information returns, not standard returns. Courts have acknowledged that Forms 5471, 8865, FBARs, and other international filings are far more complex than an estate tax deadline.

2. James v. United States, 850 F. Supp. 2d 858 (C.D. Cal. 2012)

The court in James denied penalty relief to a taxpayer who failed to file FBARs. Although he claimed ignorance, the court emphasized his financial sophistication, access to advisors, and the ease with which he could have discovered the requirement.

Key takeaway:
A taxpayer who is educated, wealthy, or who has used tax professionals before is held to a higher standard of diligence. Courts look unfavorably on taxpayers who made no effort to inquire about their obligations, especially when they have substantial foreign accounts.

3. Moore v. United States, 151 Fed. Cl. 294 (2020)

In Moore, the taxpayer failed to file Form 5471 for multiple years. He argued that he was unaware of the filing requirement and relied on his preparer. The court rejected this defense, noting:

• Moore failed to ask questions or review what was filed.

• He had significant foreign investments, indicating some financial sophistication.

• There was no evidence of misleading advice.

Takeaway: Passive reliance on a preparer—without questions or engagement—is insufficient. Taxpayers must show that they made good-faith efforts to understand their filing obligations.

4. Tax Court Memo Decision on 5471 Penalties (2008–09)

In an unpublished U.S. Tax Court decision, the court waived penalties where a taxpayer failed to file Forms 5471 for 2008 and 2009. The court accepted that the taxpayer had relied in good faith on their CPA and was unaware of the specific filing obligations.

Takeaway: Courts will consider the quality of the advice received, the taxpayer’s access to legal or tax guidance, and the overall credibility of their explanation.

5. In re Wyly, 552 B.R. 338 (Bankr. N.D. Tex. 2016)

Though not a streamlined case, Wyly involved failures to report offshore trusts and companies. The court found that the taxpayer’s elaborate offshore structures and conduct lacked credibility, leading to a rejection of his claims of reasonable cause.

Takeaway: Taxpayers with complex offshore arrangements must demonstrate transparency and diligence. Complexity alone is not a defense—it increases the need for caution.

IV. Administrative Guidance on Reasonable Cause

In addition to case law, the IRS has issued substantial administrative guidance that interprets reasonable cause standards in the context of international reporting penalties. While not legally binding, this guidance often reflects the framework IRS examiners use in evaluating penalty abatement or streamlined certifications.

1. Internal Revenue Manual (IRM) § 20.1.1.3.2

This IRM section outlines the general criteria for reasonable cause, including:

• Whether the taxpayer made a reasonable effort to comply;

• Whether circumstances beyond the taxpayer’s control interfered;

• Whether the taxpayer’s actions were consistent with ordinary business care and prudence.

Examples of valid reasonable cause:

• Death or serious illness of the taxpayer or immediate family;

• Destruction of records;

• Reliance on incorrect written IRS advice;

• Good faith reliance on a qualified tax professional regarding a complex issue.

2. IRM § 4.26.16.4.4.1 – FBAR Penalties

This section provides FBAR-specific criteria for evaluating reasonable cause:

• Ignorance of the law may be reasonable cause if coupled with other factors—such as lack of sophistication, minimal account value, or residence outside the U.S.

• Consulting a tax preparer, even if they missed the requirement, may help establish good faith if the taxpayer made a reasonable inquiry.

• Corrective action upon discovery (such as immediately filing once aware) can support mitigation.

3. IRS Practice Units (Forms 5471, 8865, 5472)

The IRS Practice Units—used internally for training—reinforce that:

• Penalty relief requires a formal written statement that includes all facts.

• The taxpayer must file all missing forms with the reasonable cause statement.

• If the taxpayer acted in good faith and the failure was not due to willful neglect, penalties under §§ 6038, 6038A, and 6038B may be waived.

These internal units consistently apply a facts-and-circumstances approach, with a strong emphasis on:

• Whether the taxpayer made reasonable efforts to comply;

• Whether the taxpayer has a history of compliance;

• Whether corrective action was prompt and complete.

4. Private Letter Rulings (e.g., PLR 201147030)

This ruling involved Form 3520 (foreign gift reporting) where the taxpayer misunderstood the requirement. The IRS waived the penalty, noting:

• The taxpayer’s misunderstanding was credible and reasonable.

• The taxpayer relied on poor advice but made efforts to comply.

• Full disclosure was eventually made, with no tax avoidance intent.

Relevance: Even when an error stems from flawed advice, if the taxpayer acted in good faith and corrected the mistake swiftly, the IRS may find reasonable cause.

V. Implications for Streamlined Procedures

Under SFCP, taxpayers must file all missed returns and submit a narrative certification (Form 14653 or 14654) stating:

• The conduct was non-willful;

• The failure resulted from reasonable cause;

• The taxpayer is now fully compliant.

Although the IRS does not impose separate 6038 or FBAR penalties under the streamlined procedures, it reviews submissions carefully. If the IRS suspects willfulness or rejects the reasonable cause claim, the taxpayer can be exposed to full penalty regimes, potential examination, and even criminal investigation.

VI. Best Practices for Practitioners

• Use case law and PLRs to support reasonable cause.

• Emphasize non-willfulness and mitigating factors.

• Provide details on education, access to advisors, and steps taken after discovery.

• Include all required forms—incomplete filings negate the defense.

• Consider alternatives (e.g., voluntary disclosure or quiet disclosure) if facts are borderline.

• Each taxpayer’s situation is different—and in our experience, the difference between a successful streamlined submission and a rejected one often comes down to how the reasonable cause statement is framed.

Conclusion

“Reasonable cause” in the streamlined context is both a shield and a sword. It protects eligible taxpayers from harsh penalties but requires thorough documentation, consistency, and truthfulness. The cost of failure to file international forms can be steep—running into tens of thousands of dollars per year, per form—but where the failure was truly non-willful and supported by facts, there is still a path to compliance and relief.

For customized tax advice, contact Christine Alexis Concepción at caconcepcion@concepcionlaw.com.