Automatic Exemption from Penalty (AEP): How the IRS’s New Automatic Penalty Relief Works

For many years, taxpayers with an otherwise good compliance history could rely on the IRS First Time Abate (FTA) program to obtain relief from certain failure-to-file, failure-to-pay, and failure-to-deposit penalties. The program was useful, but it had one important practical limitation: taxpayers generally had to know that the relief existed and affirmatively request it from the IRS.

The IRS is now changing that process through a new program called Automatic Exemption from Penalty (AEP).

The underlying idea remains similar to First Time Abate — a taxpayer with a history of compliance may receive administrative relief for an isolated compliance problem — but the way the relief is administered is significantly different. Instead of waiting for a taxpayer to request abatement after a penalty has been assessed, the IRS can determine eligibility automatically while processing an eligible original return and prevent the qualifying penalty from being assessed in the first place.

The transition to AEP began in 2026 and is important for both individual and business taxpayers, particularly those dealing with late-filed returns, unpaid balances, or payroll tax deposit issues.

What Is Automatic Exemption from Penalty?

Automatic Exemption from Penalty is an administrative penalty relief program based primarily on a taxpayer’s prior compliance history. It applies to certain Failure to File, Failure to Pay, and Failure to Deposit penalties. When the IRS processes an eligible original return, it reviews the taxpayer’s compliance history for the applicable lookback period. If the taxpayer meets the requirements, the qualifying penalty is automatically exempted. In most cases, the taxpayer does not need to file a separate request, call the IRS, or demonstrate reasonable cause.

This is an important procedural change from First Time Abate. Under the traditional FTA process, a penalty could be assessed first and the taxpayer would subsequently request that the IRS remove it. Under AEP, the IRS attempts to identify eligibility during return processing so that the qualifying penalty is not assessed at all. If AEP is applied, the IRS should send the taxpayer a notice explaining that the penalty was not assessed because the taxpayer qualified based on prior compliance history.

AEP does not, however, eliminate the underlying tax liability. The taxpayer remains responsible for the tax itself and any applicable interest. It also does not provide blanket protection from all IRS penalties; only specified penalties and eligible returns are covered.

When Does AEP Apply?

The IRS began implementing AEP during the summer of 2026. The program is being introduced beginning with 2025 tax-year returns and 2026 quarterly returns, with subsequent periods also eligible for consideration. This creates a transition period during which both AEP and the older First Time Abate procedures may still be relevant.

First Time Abate continues to apply to eligible earlier periods, including generally eligible 2024 tax-year returns and 2025 quarterly returns. FTA may also remain relevant for certain 2025 tax-year returns and 2026 quarterly returns that were processed before the IRS began applying AEP consideration. The more definitive dividing line is January 1, 2027. For eligible original returns with original due dates on or after January 1, 2027, AEP replaces First Time Abate as the IRS administrative relief mechanism for the penalties covered by the program.

Consequently, taxpayers dealing with penalties during the 2026 transition period should pay particular attention to when the return was due and when it was processed. The fact that a penalty was assessed does not necessarily mean that administrative relief is unavailable.

Which Tax Returns Are Eligible?

AEP does not apply universally to every federal tax return. The IRS has identified specific return series that may qualify. For individuals, the most important eligible return is Form 1040. Business taxpayers may qualify in connection with Forms 1065 and 1120, while employers may receive AEP consideration for employment tax returns including Forms 940, 941, 943, 944, and 945. Form CT-1 is also included.

Certain returns that are filed only occasionally or because of a particular transaction or event generally do not qualify. For example, estate tax returns such as Form 706 and gift tax returns such as Form 709 are outside the general AEP framework. This distinction matters because a taxpayer’s good filing history by itself does not create an automatic right to relief. Both the type of return and the type of penalty must fall within the program.

How Does a Taxpayer Qualify?

AEP is fundamentally based on compliance history.

For an annual return, the IRS generally examines whether the taxpayer timely filed the same type of return for the previous three years. For quarterly returns, the corresponding compliance period generally consists of the previous 12 consecutive quarters. The IRS also considers penalties assessed during that period. Generally, the taxpayer must not have a disqualifying penalty history for the same return type during the applicable lookback period. A prior penalty does not necessarily destroy eligibility if that penalty was subsequently abated for an acceptable reason, such as reasonable cause or an IRS error. This means that AEP is intended primarily for taxpayers whose current failure represents an exception to an otherwise compliant pattern.

Consider an individual who timely filed Forms 1040 for 2022, 2023, and 2024 but then files the 2025 Form 1040 late. If the taxpayer otherwise satisfies the AEP requirements, the IRS may automatically exempt the applicable Failure to File penalty when processing the 2025 return. The taxpayer generally would not need to contact the IRS separately to request First Time Abate.

The same general concept applies to businesses, although Failure to Deposit penalties involve additional requirements. The IRS considers prior Failure to Deposit relief during the applicable compliance period, and repeated prior waivers can make a taxpayer ineligible. Certain deposit violations, including penalties associated with avoidance of required electronic payment procedures, may also prevent AEP relief.

AEP Compared With First Time Abate

Although AEP is replacing First Time Abate for eligible future periods, the two programs share the same broad policy objective. Both recognize that an otherwise compliant taxpayer may occasionally fail to meet a filing, payment, or deposit obligation and that administrative penalty relief may be appropriate.

The major difference is how and when the relief is provided. Under First Time Abate, taxpayers generally had to affirmatively request relief. This could happen by telephone, through written correspondence, or through an authorized tax representative. The IRS would review the taxpayer’s compliance history and, if the requirements were satisfied, abate the qualifying penalty.

AEP moves that determination to the return-processing stage. The IRS reviews eligibility automatically and, when the requirements are met, prevents the qualifying penalty from being assessed. Therefore, the taxpayer generally does not need to know that the program exists in order to receive the benefit.

The difference can be particularly significant for the Failure to Pay penalty. Under the traditional system, a Failure to Pay penalty could continue accruing while the underlying tax remained unpaid until appropriate relief was granted. Under AEP, if the Failure to Pay penalty qualifies for the exemption, it is not assessed and therefore does not continue accumulating merely because the tax balance remains unpaid. The unpaid tax itself is a different matter. AEP does not forgive the tax, and statutory interest on the unpaid tax generally continues to accrue until payment is made.

What Happens If the IRS Assesses a Penalty Anyway?

Because AEP is being implemented through a transition process, taxpayers should not assume that every penalty appearing on a 2025 or 2026 account is necessarily correct. A return may have been processed before AEP consideration became available, or the IRS’s records may not have produced the expected result. The IRS has specifically indicated that taxpayers who believe they should have qualified for relief but nevertheless received a penalty assessment should contact the agency. This makes review of the actual tax account important. The appropriate analysis may include the return involved, its original due date, the processing date, prior filing history, previous penalties, and the reason any earlier penalties were abated. Depending on those facts, the taxpayer may qualify for AEP, may still be able to request First Time Abate under the transition rules, or may need to consider another basis for penalty relief.

AEP Is Not the Same as Reasonable Cause

Automatic Exemption from Penalty should also be distinguished from reasonable cause relief. AEP is primarily compliance-history based. The IRS is essentially asking whether the taxpayer has demonstrated a sufficient history of timely compliance to receive administrative relief for the current failure.

Reasonable cause is different. It focuses on the circumstances surrounding the failure itself. Depending on the penalty involved, the IRS may consider whether the taxpayer exercised ordinary business care and prudence but nevertheless was unable to comply because of circumstances beyond the taxpayer’s control. As a result, a taxpayer who does not qualify for AEP is not necessarily out of options.

For example, a taxpayer may have a prior penalty that prevents AEP eligibility but may have experienced circumstances supporting reasonable cause for the current failure. Conversely, qualifying for AEP may eliminate the need to develop and substantiate a reasonable-cause argument at all. This distinction can be important in IRS representation because administrative relief and reasonable-cause relief should not automatically be treated as interchangeable strategies.

What AEP Does Not Cover

AEP is limited to specified penalties. It should not be interpreted as a general three-year “clean record” rule under which any IRS penalty disappears automatically. Accuracy-related penalties, many information-return penalties, Daily Delinquency Penalties, and other penalties outside the specified Failure to File, Failure to Pay, and Failure to Deposit framework may require separate analysis.

Likewise, AEP does not eliminate interest or the underlying tax. A taxpayer who owes $20,000 of tax may qualify for exemption from an applicable Failure to Pay penalty while still owing the $20,000 tax balance plus statutory interest. For that reason, receiving AEP relief should not be confused with resolving the underlying tax debt. If the taxpayer cannot pay the remaining balance in full, a separate collection solution — such as an installment agreement or another appropriate resolution option — may still be necessary.