Introduction

Receiving an IRS penalty notice can be stressful, especially when the underlying mistake was a one-time issue rather than a pattern of noncompliance. A return may have been filed late because of an oversight, a payment may have missed its deadline, or a payroll tax deposit may have been submitted incorrectly. Until recently, many compliant taxpayers had to contact the IRS and request First Time Abate relief to have certain penalties removed, but now that process is changing.

On July 8, 2026, the IRS announced the Automatic Exemption from Penalty (AEP). The new system is designed to automatically provide certain penalty relief to qualifying taxpayers with a strong history of filing and paying on time. AEP will gradually replace the traditional First Time Abate, or FTA, process for eligible returns.

From the perspective of an accounting and consulting firm, this is a meaningful improvement. Taxpayers who qualify should no longer miss out on relief simply because they did not know the program existed, could not reach the IRS by phone, or did not have a tax professional helping them make the request.

What Was First Time Abate?

First Time Abate has been one of the IRS’s most common forms of administrative penalty relief. It generally allows an individual or business with a good compliance history to request removal of certain penalties for a single tax period.

The key word was “request.” Even when a taxpayer appeared to qualify, the penalty was generally assessed first. The taxpayer or an authorized representative then had to contact the IRS by phone or submit a written request. The IRS would review the account and determine whether the requirements were met.

This created an uneven result. Taxpayers who knew about FTA were more likely to receive relief, while those who were unaware of the program might simply pay the penalty.

The National Taxpayer Advocate reported that nearly 220,000 taxpayers received FTA relief through the manual process during fiscal year 2025. It also estimated that more than 1.5 million taxpayers might have received relief also if the automatic system had already been in place.

How Does AEP Work?

AEP changes when and how the IRS applies relief. Instead of assessing an eligible penalty and waiting for the taxpayer to ask for removal, the IRS system will review the taxpayer’s compliance history while processing the original return.

When the taxpayer qualifies, the IRS will generally prevent the covered penalty from being assessed. The IRS will send a notice explaining that the penalty was not charged because the taxpayer had a history of timely compliance. A taxpayer who receives that notice does not need to call the IRS or respond.

The program is expected to begin during the summer of 2026. It applies to eligible 2025 tax year returns, 2026 quarterly returns, and later periods. The IRS has stated that AEP will replace FTA for eligible returns with original due dates on or after January 1, 2027.

Which Penalties Can AEP Cover?

AEP can provide relief from three common penalties:

• Failure to file, which may apply when a required return is submitted after its due date, including an applicable extension.
• Failure to pay, which may apply when tax reported on a return is not paid by the required deadline.
• Failure to deposit, which may apply when a business does not make a federal tax deposit in the correct amount, by the correct deadline, or through the required method.

These are some of the most common penalties encountered by individuals and businesses. Failure to deposit penalties are especially important for employers because payroll taxes generally must be deposited according to a specific schedule, rather than simply being paid when the related payroll tax return is filed.

Which Tax Returns Are Eligible?

The IRS currently lists Forms 1040, 1065, and 1120 as eligible for consideration. These forms generally cover individual income tax returns, partnership returns, and corporate income tax returns.

Certain employment and withholding tax returns are also included, such as Forms 940, 941, 943, 944, 945, and form CT-1.

Not every form qualifies. Information returns and returns filed only when a specific transaction or infrequent event occurs generally are not eligible. Examples include Form 706 for estate tax and Form 709 for gift tax.

The IRS also excludes the Daily Delinquency Penalty and certain information reporting penalties that depend on another filing.

Who Qualifies?

The central requirement is a history of timely compliance.

For an annual return, the taxpayer generally must have timely filed the same type of return for the prior three years. For a quarterly return, the IRS generally reviews the prior 12 consecutive quarters.

The taxpayer generally must not have had a penalty assessed during the review period, other than an estimated tax penalty. A taxpayer may still qualify when a prior penalty was assessed but later removed because of reasonable cause or an IRS error.

Business taxpayers have additional requirements. The IRS must not have waived the failure to deposit penalty four or more times during the three-year or 12-quarter review period. The business also cannot receive relief for a failure to deposit penalty involving avoidance of the Electronic Federal Tax Payment System requirements.

It is important to understand that eligibility is based on the same type of return. A clean history for an individual or business income tax return does not necessarily establish a clean history for payroll tax filings.

For example, a corporation may have filed its Form 1120 on time for several years but still have compliance problems involving Form 941. Each return series may need to be reviewed separately when determining whether AEP applies.

What AEP Does Not Eliminate

AEP is penalty relief, not forgiveness of the underlying tax.

Even when the IRS prevents an eligible penalty from being assessed, the taxpayer must still pay any unpaid tax. Interest may also continue to apply to the unpaid tax balance. Other penalties not covered by AEP remain due.

A business should not intentionally delay filing, paying, or depositing taxes because it expects AEP to solve the problem. AEP should be viewed as protection for a generally compliant taxpayer who makes an occasional mistake, not as a substitute for tax planning, accurate bookkeeping, or dependable payroll procedures.

Extensions must also be handled carefully. An extension of time to file an income tax return generally does not provide an extension of time to pay the tax. A taxpayer who properly extends a return but does not pay the estimated balance by the original deadline could still owe interest and may face a failure to pay penalty if AEP or another form of relief does not apply.

What Happens During the Transition?

The transition from FTA to AEP will not happen all at once. The IRS has warned that some taxpayers who appear to qualify may still receive penalty notices for 2025 tax year returns or 2026 quarterly returns while the system is being implemented.

Do not ignore any notices received & review the tax period, penalty type, payment history, and filing history. If the taxpayer appears eligible but AEP was not applied, the taxpayer or an authorized representative should contact the IRS using the telephone number shown on the notice.

During the transition, the IRS may still consider relief under the traditional First Time Abate process.

Receiving a penalty notice does not necessarily mean that the IRS has already reviewed every form of available relief. It may mean that the return was processed before the automated system was fully implemented or that information in the taxpayer’s account needs to be corrected.

Businesses should retain copies of tax returns, filing confirmations, payment records, payroll reports, bank statements, and IRS correspondence. These records can help determine whether the penalty is correct and whether the taxpayer qualifies for AEP, FTA, reasonable cause relief, or another available option.

What If a Taxpayer Does Not Qualify?

A taxpayer who does not qualify for AEP may still request reasonable cause relief.

Reasonable cause generally depends on the taxpayer’s specific facts and circumstances. It may apply when the taxpayer exercised ordinary care and prudence but could not comply because of circumstances beyond their control.

Unlike AEP, reasonable cause is not automatic. The taxpayer may need to explain what happened and provide supporting documentation. The IRS will review the request and issue a decision.

Examples of circumstances that could potentially support reasonable cause include a serious illness, a natural disaster, the death of a key employee, the destruction of business records, or another event that prevented compliance despite reasonable efforts. Qualification is not guaranteed, and the IRS evaluates each situation individually.

The National Taxpayer Advocate has also raised a concern about situations in which both AEP and reasonable cause might apply. If AEP is used automatically in a year when the taxpayer had valid reasonable cause, it could affect access to administrative relief for a later mistake.

Taxpayers with strong reasonable cause facts should discuss the situation with a qualified tax professional to determine the most appropriate approach.

Practical Steps for Businesses

Businesses should continue treating every tax deadline as mandatory. We recommend maintaining a reliable tax calendar, reconciling payroll reports to the general ledger, confirming that federal tax deposits have cleared, saving electronic filing confirmations, and reviewing IRS notices immediately.

Businesses should also review responsibilities whenever payroll or bookkeeping duties change. A staff departure, software conversion, bank account change, or new payroll provider can create missed filings and deposits if duties are not clearly assigned.

Using a payroll service does not completely remove the employer’s responsibility. Business owners should review payroll reports, verify that withdrawals occurred, and investigate rejected or reversed payments promptly.

Conclusion

The Automatic Exemption from Penalty program is a great change for taxpayers who have a history of doing the right thing. By reviewing compliance history automatically, the IRS can provide relief more consistently and reduce the number of taxpayers who must call or write to request help.

However, being automatic does not mean this is universal. The eligibility depends on the return type, prior filing/payment history, the penalty involved, and additional requirements for businesses. Additionally, tax, interest, and penalties outside the program remain payable.

Businesses and individuals should continue filing and paying on time, monitor all IRS correspondence, and seek professional assistance when a penalty notice does not appear correct. AEP may make penalty relief easier, but careful compliance remains the best way to avoid penalties. If you would like to ensure that you remain compliant, Volpe Consulting can help you!