Zhang v. Internal Revenue Service, No. 26-cv-00525-VKD (N.D. Cal. July 30, 2026)

The compliance burden for U.S. taxpayers receiving foreign gifts has intensified over the last decade, particularly under the disclosure regime mandated by Internal Revenue Code (IRC) § 6039F. Under this section, U.S. persons who receive aggregate foreign gifts exceeding $10,000 (adjusted for inflation, with the threshold historically set at $100,000 for gifts from foreign individuals) during any taxable year must file an information return via Form 3520. Failure to timely file Form 3520 triggers severe penalties equal to 5% of the amount of the foreign gift for each month the failure continues, capped at 25% in the aggregate.

While the statute provides a “reasonable cause” exception under IRC § 6039F(c)(2), the Internal Revenue Service (IRS) routinely rejects ignorance of the law as a valid defense. When the IRS assesses these substantial penalties and denies administrative relief, taxpayers often seek judicial review. In a recent opinion, Ziyue Zhang v. Internal Revenue Service, et al., the United States District Court for the Northern District of California addressed whether a taxpayer can challenge a Form 3520 penalty assessment under the Administrative Procedure Act (APA), 5 U.S.C. § 701 et seq.. The court’s decision in this case reinforces a significant jurisdictional hurdle for taxpayers seeking to bypass the traditional tax litigation pathways in favor of APA review.

Case Background and Factual Matrix

The plaintiff, Ziyue Zhang, was born in China and resided there for most of her life before relocating to the United States shortly before the 2017 calendar year to attend graduate school. During both the 2017 and 2018 taxable years, Ms. Zhang’s family in China gifted her amounts exceeding $100,000 annually. Ms. Zhang timely filed her 2017 U.S. individual income tax return using TurboTax; however, she did not file a Form 3520 to report the 2017 foreign gifts. For the 2018 taxable year, Ms. Zhang retained an accountant to prepare her U.S. income tax return, but once again, she did not file a Form 3520 to report the 2018 foreign gifts.

Ms. Zhang asserted that she was entirely unaware of her foreign gift reporting obligations under IRC § 6039F. Upon learning of the requirement, she filed a belated Form 3520 for her 2017 tax year in March 2019, and a belated Form 3520 for her 2018 tax year in September 2020. On April 5, 2021, the IRS assessed penalties against Ms. Zhang under IRC § 6039F(c)(1)(B) in the amounts of $49,985 for 2017 and $674,008 for 2018, totaling $723,993. These assessments represented the statutory maximum penalty of 25% of the total foreign gifts received in each respective year.

Taxpayer’s Request for Relief and Procedural History

On April 30, 2021, Ms. Zhang submitted a formal letter to the IRS requesting administrative relief from the assessed penalties. The IRS rejected her request, explaining that “ordinary business care and prudence requires taxpayers to make themselves aware of their duties and that ignorance of tax laws could not serve as a basis for reasonable cause”. On May 6, 2022, Ms. Zhang appealed this denial by submitting a challenge to the IRS’s Independent Office of Appeals. The IRS Independent Office of Appeals failed to respond to her letter.

On January 16, 2026, Ms. Zhang initiated an action in the United States District Court for the Northern District of California, asserting four counts for violations of the APA. Specifically, the complaint alleged:

A violation of the due process protections of 5 U.S.C. § 555(e) and the U.S. Constitution;
Arbitrary and capricious agency action under 5 U.S.C. § 706(2)(A) with respect to the IRS’s penalty assessments and its entire appeals process;
Agency action imposing an “automatic penalty” that is contrary to law as reflected in the reasonable cause exception of 26 U.S.C. § 6039F(c)(2); and
Arbitrary and capricious agency action in violation of 5 U.S.C. § 555(e) due to the IRS’s failure to provide a basic statement explaining the grounds for its denial of her penalty removal petitions.

Ms. Zhang’s complaint sought a declaratory judgment that the defendants acted in excess of their statutory authority and with arbitrary and capricious reasoning under the APA. Additionally, she sought an order holding unlawful and setting aside the IRS and IRS Appeals determinations, a remand of the penalty appeal back to the IRS or IRS Appeals for reconsideration, and an award of attorneys’ fees and costs.

The United States moved to dismiss the action under Federal Rule of Civil Procedure 12(b)(1) for lack of subject matter jurisdiction and Rule 12(b)(6) for failure to state a claim. Because Ms. Zhang conceded at oral argument that she did not assert a standalone constitutional Due Process claim, the court deemed the Rule 12(b)(6) motion moot, focusing its entire analysis on the jurisdictional challenge under Rule 12(b)(1).

The Court’s Analysis of Sovereign Immunity and the APA Framework

The court began its analysis by reiterating the foundational principles of federal jurisdiction and sovereign immunity. Citing Kokkonen v. Guardian Life Insurance Co. of America, 511 U.S. 375, 377 (1994), the court noted that “Federal courts are courts of limited jurisdiction” and “possess only that power authorized by Constitution and statute”. In actions against the federal government, “the United States is a sovereign, and, as such, is immune from suit unless it has expressly waived such immunity and consented to be sued” (Dunn & Black, P.S. v. United States, 492 F.3d 1084, 1087-88 (9th Cir. 2007)). Such a waiver “cannot be implied but must be unequivocally expressed” (United States v. Mitchell, 445 U.S. 535, 538 (1980)).

While the APA generally waives sovereign immunity for non-monetary claims against federal agencies under 5 U.S.C. § 702, this waiver is strictly bounded by the requirements of 5 U.S.C. § 704. Under § 704, judicial review under the APA is restricted to “agency action made reviewable by statute” and “final agency action for which there is no other adequate remedy in a court”.

The court emphasized that “If Congress ‘has enacted a special statutory review process for administrative action, that process applies to the exclusion of the APA’” (Wilson v. Commissioner of Internal Revenue, 705 F.3d 980, 990 (9th Cir. 2013)). This preclusion prevents the duplication of existing procedures and the creation of additional remedies where Congress has already provided a special and adequate review framework (Zhang v. Internal Revenue Serv., No. 24-cv-08210-AMO, 2026 WL 1210079, at *6 (N.D. Cal. May 4, 2026); Citizens for Responsibility & Ethics in Washington v. U.S. Department of Justice, 846 F.3d 1235, 1244 (D.C. Cir. 2017) (“CREW”)). Crucially, an alternative remedy “need not provide relief identical to relief under the APA,” but it must provide “relief of the same genre” (CREW, 846 F.3d at 1245).

Application of the Law: The Adequacy of a Tax-Refund Claim

The United States argued that 5 U.S.C. § 704 barred APA jurisdiction because Ms. Zhang possessed two adequate alternative remedies: a tax-refund claim and a Collection Due Process (CDP) hearing.

Under 28 U.S.C. § 1346(a)(1), federal district courts and the U.S. Court of Federal Claims share concurrent jurisdiction over civil actions against the United States for the recovery of any internal-revenue tax or penalty claimed to have been collected without authority. To maintain a tax-refund suit, a taxpayer must satisfy two key statutory and jurisprudential hurdles:

File an administrative refund claim with the IRS prior to bringing suit under 26 U.S.C. § 7422(a); and
Comply with the “full-payment rule,” which “requires full payment of the [challenged] assessment before an income tax refund suit can be maintained in a Federal District Court” (Flora v. United States, 362 U.S. 145, 177 (1960) (“Flora II”); see also Flora v. United States, 357 U.S. 63, 75-76 (1958) (“Flora I”)).

Ms. Zhang attempted to bypass these requirements by arguing that a tax-refund claim was inadequate because she “is not seeking to recover [a] tax imposed or collected by the IRS” and was instead challenging only “the administrative procedures by which the IRS arrived at its decision to assess and uphold the Section 6039F penalty”.

The court rejected Ms. Zhang’s procedural recasting as being “at odds with her complaint”. The court noted that her complaint requested that “the IRS’s determinations . . . be vacated and set aside,” seeking “an order holding unlawful and setting aside IRS’s and IRS Appeals’s determination to uphold the Section 6039F penalties”. Pointing to other decisions within the Northern District of California, the court noted:

“Other courts in this District have rejected similar attempts to recast substantive challenges to penalties as procedural challenges to the IRS’s procedures.”

Specifically, in Zhang v. Internal Revenue Service, 2026 WL 1210079, at *7, the court dismissed a taxpayer’s APA claims on the ground that a tax-refund suit provided an adequate alternative remedy. The Zhang court reasoned that the taxpayer was “not entitled to the precise forms of relief she wants in circumstances where Congress already crafted adequate relief,” and that her requested remedies sought “the same genre of relief afforded by a tax-refund suit”. Similarly, in Madrid v. Internal Revenue Service, No. 24-cv-04862-JD, 2025 WL 2780149, at *1 (N.D. Cal. Sept. 29, 2025), the court rejected a taxpayer’s argument that she only sought “agency transparency” and “the IRS’s rationale” for a § 6039F penalty, dismissing the complaint because it ultimately sought to set aside the penalty.

The court also distinguished Scholl v. Mnuchin, 494 F. Supp. 3d 661 (N.D. Cal. 2020) and Amador v. Mnuchin, 476 F. Supp. 3d 125 (D. Md. 2020), which Ms. Zhang cited to support APA jurisdiction. The court observed that both Scholl and Amador involved challenges to blanket IRS policies prohibiting emergency cash assistance during the COVID-19 pandemic to specific groups, rather than “individual tax refund disputes”.

Finally, the court addressed Ms. Zhang’s argument that the refund pathway was inadequate because she had not paid her penalties and therefore could not file a claim under IRC § 7422(a). Citing the Second Circuit’s decision in Larson v. United States, 888 F.3d 578, 588 (2d Cir. 2018), the court held that a taxpayer’s “failure to comply with the scheme established by Congress—by failing to prepay the assessed the penalties—does not render the review procedures inadequate”. The court cited several other precedents establishing that a taxpayer must pay the penalty and file a refund claim first, including Devries v. Internal Revenue Service, 359 F. Supp. 2d 988, 993 (E.D. Cal. 2005) and Oom Inc. v. United States, No. 22-cv-2762, 2023 WL 3058493, at *3 (D.N.J. Apr. 24, 2023).

Application of the Law: The Collection Due Process Alternative

The United States also argued that Ms. Zhang possessed an adequate alternative remedy through the Collection Due Process (CDP) framework.

Under 26 U.S.C. §§ 6320(b)(1) and 6330(b)(1), before the IRS can levy on property or file a notice of a federal tax lien, it must provide the taxpayer with notice and an opportunity to request an administrative CDP hearing with the Office of Appeals. During a CDP hearing, a taxpayer may “raise at the hearing challenges to the existence or amount of the underlying tax liability” if they “did not otherwise have an opportunity to dispute such tax liability” (26 U.S.C. § 6330(c)(2)(B)). An Appeals Office determination in a CDP hearing is appealable to the U.S. Tax Court, and from there to a federal court of appeals under 26 U.S.C. §§ 6330(d)(1) and 7482(a)(1) (citing Farhy v. Commissioner of Internal Revenue, 100 F.4th 223, 228 (D.C. Cir. 2024)). Crucially, the CDP process does not require prepayment of penalties (Our Country Home Enterprises, Inc. v. Commissioner of Internal Revenue, 855 F.3d 773, 780 (7th Cir. 2017)).

Ms. Zhang argued that a CDP hearing was inadequate because she would be forced to wait for the IRS to initiate a collection action. She noted that because more than five years had passed since the IRS assessed the penalties, “it is safe to assume that the IRS has no intention of ever issuing the plaintiff a ‘Final Notice’”.

The United States countered, and the court agreed, that the IRS has a ten-year statutory window to collect an assessment under 26 U.S.C. § 6502. If the IRS fails to initiate collection within that decade, Ms. Zhang’s liability will expire. If and when the IRS does initiate collection, the CDP process becomes available to contest her underlying liability. Citing Perry v. Wright, No. 12-cv-0721 CM, 2013 WL 950921, at *5 (S.D.N.Y. Mar. 8, 2013), the court concluded that the potential availability of a CDP hearing constitutes an adequate alternative remedy that “forecloses judicial review under the APA for the same relief”.

Judicial Conclusions and Practical Implications

Because Ms. Zhang had two possible adequate alternative remedies (a tax-refund claim and a CDP proceeding), her APA claims were dismissed for lack of subject matter jurisdiction under Rule 12(b)(1). Because Ms. Zhang conceded at oral argument that no amendment could address these jurisdictional defects, the court dismissed the claims without leave to amend.

For tax practitioners representing clients with foreign gift penalty assessments, Zhang v. IRS underscores several critical takeaways:

The APA is Not a Shortcut: Practitioners cannot bypass the full-payment rule of Flora by framing a penalty dispute as a procedural challenge to the IRS’s decision-making process under the APA. Courts will look to the substance of the relief sought (i.e., setting aside the penalty) rather than the procedural label on the complaint.
Prepayment vs. Non-Prepayment Strategies: Taxpayers facing significant IRC § 6039F penalties must choose between two main routes:
- The Refund Route: Paying the penalty in full, filing an administrative claim for refund on Form 843, and upon denial (or six months of inaction), filing a refund suit in federal district court or the Court of Federal Claims.
- The Collection Route: Waiting for the IRS to initiate formal collection action (liens or levies) and then raising a reasonable cause defense in a CDP hearing. This route avoids prepayment but carries the risk of accumulating interest, potential impact on credit, and the stress of waiting for up to ten years under the collection statute of limitations.

Prepared with assistance from Gemini Notebook.