IRS Announces Automatic Exemption from Penalty Program: Penalty Relief Goes from Opt-In to Automatic

By Matthew E. Foreman and Joelle M. Vilinsky

Introduction

On July 8, 2026, the Internal Revenue Service (“IRS”) announced the Automatic Exemption from Penalty (“AEP”) program, which replaces the long-standing First Time Abatement (“FTA”) process.[1] Under AEP, eligible taxpayers who failed to timely file returns or pay taxes automatically receive penalty relief without needing to contact the IRS or submit a formal request. The program begins phasing in for 2025 tax returns and 2026 quarterly information returns. AEP fully replaces FTA for eligible original returns with due dates on or after January 1, 2027.

The shift to AEP reflects a significant administrative change, moving from a penalty relief system that required taxpayers to affirmatively request relief to one in which relief is granted by default. Under the FTA, many eligible taxpayers did not receive relief due to lack of awareness or the burden of requesting penalty relief. AEP eliminates this discrepancy and ensures all eligible taxpayers rightfully receive penalty relief. The reform also advances a broader bipartisan effort to reduce taxpayer contact with the IRS, an objective that has become increasingly important in light of current IRS staffing restraints.[2]

First Time Abatement

First Time Abatement is an administrative waiver, existing only in the Internal Revenue Manual, that forgives failure to file, failure to pay, and failure to deposit penalties for taxpayers with a clean three-year compliance history.[3] FTA lacks statutory or regulatory support, and is merely an internal IRS policy. That meant a taxpayer had to know FTA existed and affirmatively request it, typically by calling the IRS, writing a letter, or by filing Form 843. In fiscal year 2025, only approximately 220,000 of 1.5 million eligible taxpayers received FTA relief through this manual process, making up a small fraction of those who qualified.[4]

Automatic Exemption from Penalty

Eligibility

To qualify for AEP, taxpayers must have timely (i) filed the same return type and (ii) paid any tax due for the prior three tax years. For quarterly filers, taxpayers must have a timely compliance history for the prior 12 consecutive quarters. Additionally, no penalties (other than estimated tax penalties) may have been assessed during the lookback period, unless a prior penalty was abated for reasonable cause or IRS error. For businesses, there is an additional requirement: the IRS must not have waived the failure to deposit penalty four or more times during the prior three years or 12 quarters, and the failure to deposit penalty must not have been charged for avoidance of the Electronic Federal Tax Payment System.

Penalties Covered

AEP covers the same penalties as FTA, regardless of the amount. These penalties include failure to file a return on time; failure to pay the tax due, including tax shown on a return but not paid by the notice or demand date; and failure to deposit tax in the correct amount, within the required timeframe, or in the required manner. The failure to deposit penalty is applicable to businesses and employers who miss payroll tax deposit deadlines.[5] For individual taxpayers, AEP covers the failure to file and failure to pay penalties. For business taxpayers, AEP covers all three.

Mechanism

AEP is applied when the taxpayer’s original return completes IRS computer processing. If a taxpayer files an eligible return late, pays the tax late, or misses a deposit deadline, the IRS will automatically check its records for the taxpayer’s compliance history. If the taxpayer qualifies for AEP, the penalty is never assessed and will be suppressed. The IRS will then send a notice explaining that, although the taxpayer filed or paid late, the applicable penalties were not assessed due to the taxpayer’s history of timely compliance. The taxpayer does not need to contact the IRS or respond to the notice. Under FTA, the penalty is assessed first and then removed after the taxpayer requests relief. Under AEP, the penalty is simply never charged.

Eligible Returns

The following returns are eligible for AEP: Forms 1040 (individual income tax), 1065 (partnership return), 1120 (corporate income tax), 940 (annual federal unemployment tax), 941 (quarterly employer tax), 943 (agricultural employees), 944 (annual employer tax), 945 (withheld federal income tax), and CT-1 (railroad retirement tax).

AEP does not apply to returns filed once or infrequently such as Form 706 estate tax returns or Form 709 gift tax returns, and perhaps curiously, AEP does not apply to Form 1120-S, S Corporation returns.

Transition Period

The IRS began implementing AEP in July 2026. AEP applies to 2025 tax returns and 2026 quarterly returns filed after the system went live in July 2026. For eligible original returns with due dates on or after January 1, 2027, AEP fully replaces FTA.

Some qualifying taxpayers whose 2025 returns or 2026 quarterly returns were processed before AEP went live may still receive penalty notices. If you believe you qualify for relief, contact the IRS and request relief under the existing FTA process.

Taxpayers who do not qualify for AEP may still request penalty abatement based on reasonable cause.[6] This is a separate request for relief that requires the IRS to evaluate your specific facts.

Conclusion

The shift to AEP reflects a broader bipartisan effort, spanning decades, to reduce the need for taxpayers to contact the IRS to resolve routine matters.[7] That objective has taken on greater urgency in light of significant staffing constraints within the IRS. Since January 2025, the IRS has lost more than 28,000 employees (approximately 27% of its workforce), leaving remaining personnel increasingly overburdened.[8] As a result, taxpayers have experienced longer phone wait times and greater difficulty obtaining timely assistance. Against this backdrop, automating routine penalty relief through AEP represents a practical, necessary, and equitable step toward improving administrative efficiency and easing strain on both taxpayers and IRS staff.

[1] IR-2026-83 (July 8, 2026).

[2] National Taxpayer Advocate, A Long-Awaited Taxpayer Win: The IRS Implements Automatic Penalty Relief, Taxpayer Advocate Serv. (July 8, 2026), https://www.taxpayeradvocate.irs.gov/news/nta-blog/a-long-awaited-taxpayer-win-the-irs-implements-automatic-penalty-relief/2026/07/.

[3] IRM 20.1.1.3.6.1.

[4] A Long-Awaited Taxpayer Win, supra.

[5] I.R.C. §§ 6651(d)(1), 6651(a)(2), 6651(a)(3), and 6656.

[6] I.R.C. § 6664(c).

[7] See Pub. L. No. 105-206; Pub. L. No. 116-25.

[8] Treas. Inspector. Gen. for Tax Admin., Snapshot Report: IRS Workforce Reduction as of May 2025, Rep. No. 2025-IE-R027 (July 18, 2025).