You have filed on time and paid on time for years. Then one quarter goes sideways — a missed estimated payment, a late employment tax deposit, a return that slips past the deadline during your busiest month — and the IRS tacks a penalty onto your account. For decades, getting that first penalty removed meant knowing the magic words ("First Time Abate"), calling the IRS, and asking. Starting in the summer of 2026, you no longer have to ask: the IRS now removes qualifying penalties automatically.
This guide explains the new Automatic Exemption from Penalty (AEP) program, who qualifies, which penalties it covers, what it does not cover, and the practical steps that keep your business in the automatically-forgiven group.
What AEP Is and Why the IRS Created It
In July 2026, the IRS announced the Automatic Exemption from Penalty, a systemic administrative relief program that waives certain penalties during return processing for taxpayers with a history of timely compliance. The key word is automatic: if you qualify, the penalties are simply never assessed, and the IRS sends you a notice confirming the relief was granted. No phone call, no written request, no waiting on hold.
AEP replaces the long-standing First Time Abate (FTA) administrative waiver. FTA was the most common form of administrative penalty relief, but it was opt-in — you only got it if you knew to request it. That design quietly punished the taxpayers who needed relief most: busy small business owners who did not know the program existed or could not spare an afternoon on the phone with the IRS. The agency framed the change as a fairness move: taxpayers who historically pay on time should not have to file a formal request for relief that is routinely granted anyway.
Which Penalties AEP Covers
When you qualify, the IRS does not assess these three penalties during processing:
- Failure to file. Normally 5 percent of the unpaid tax for each month or part of a month the return is late, up to 25 percent. This is the expensive one — ten times the monthly rate of the failure-to-pay penalty.
- Failure to pay. Normally 0.5 percent of the unpaid tax per month, also capped at 25 percent. When both penalties apply in the same month, the combined charge is 5 percent rather than 5.5 percent.
- Failure to deposit. The employment tax deposit penalty that hits employers who miss federal tax deposit deadlines for withheld income tax and FICA. Depending on how late the deposit is, this penalty runs from 2 percent to 15 percent of the underpayment.
For returns due after December 31, 2025, filing more than 60 days late also triggers a minimum penalty of $525 or 100 percent of the tax due, whichever is smaller — another reason a single slip can sting. AEP wipes the qualifying penalties off the account before they ever land.
Who Qualifies: The Three-Year Clean Record
Eligibility mirrors the old FTA standard, with the same compliance-history test:
- Annual filers must have a history of timely filing the return and paying any tax due in the three prior years.
- Quarterly filers (such as employers filing Form 941) must show timely filing and payment for 12 consecutive quarters.
AEP applies to eligible original returns beginning with tax year 2025 and 2026 quarterly returns, plus future tax periods. Note the word original: amended returns are a different track. And the test is per return type — a clean history on your individual return is what protects your individual return, while your payroll compliance history is what protects your employment tax deposits.
The practical takeaway: your compliance history is now an asset with a dollar value. Every on-time filing and every on-time payment extends a streak that buys you a free pass the next time something goes wrong. Conversely, one unrelieved late period can break the streak and cost you automatic relief when you need it next.
What AEP Does Not Cover
Automatic relief has boundaries. Know them before you count on it:
- Information returns are generally excluded. The W-2s, 1099s, and similar forms you file to report payments to others follow their own penalty rules and are not part of AEP.
- One-off and infrequent-event returns are generally excluded. Returns filed only in response to specific transactions, such as Form 706 (estate tax) and Form 709 (gift tax), do not qualify.
- Tax and interest are still due. AEP removes qualifying penalties; it does not touch the underlying tax or the interest that accrues on it from the due date until you pay.
- Non-qualifying penalties still stand. Accuracy-related penalties, fraud penalties, and other penalties outside the big three are unaffected.
- Reasonable cause is still the backstop. If you do not qualify for AEP, you can still request penalty relief based on reasonable cause — fire, casualty, serious illness, erroneous IRS advice, and similar grounds — and the IRS will review the request and notify you of the outcome.
The single most important limitation: AEP forgives the penalty, not the debt. Interest keeps compounding daily on unpaid tax whether or not penalties are waived, so paying the underlying balance quickly remains the highest-value move.
The Transition: What Happens Between Now and January 2027
AEP began phasing in during the summer of 2026, with First Time Abate phasing out alongside it. Full replacement happens for eligible returns with original due dates on or after January 1, 2027.
During the transition, the system may not catch everyone. The IRS has said that some qualifying taxpayers may still receive penalty notices for tax year 2025 returns and 2026 quarterly returns even though they are eligible. If that happens to you:
- Do not ignore the notice. A penalty notice during the transition is a processing artifact, not a final answer — but it becomes final if you never respond.
- Request First Time Abate. FTA is still available during the phaseout. If you believe you qualify for AEP but the relief was not applied, contact the IRS and ask for FTA under the old process.
- Keep paying the underlying tax. While the penalty dispute is pending, chip away at the tax and stop interest from growing.
Watch for additional IRS guidance as implementation continues — the agency has signaled that more instructions may follow as the rollout matures.
A Small Business Playbook for Automatic Relief
AEP rewards boring, consistent compliance. Here is how to make sure your business is in the forgiven group when a bad quarter hits:
File every return, even when you cannot pay
This is the highest-leverage habit in the entire penalty system. The failure-to-file penalty runs at 5 percent per month; the failure-to-pay penalty runs at 0.5 percent. On a $10,000 balance, filing late costs you $500 a month while filing on time and paying late costs $50. An extension to file is not an extension to pay, but it still stops the larger penalty from accruing. File the paper, then solve the cash problem.
Deposit employment taxes on schedule
Failure-to-deposit relief is part of AEP, which matters enormously for employers: payroll deposit penalties are among the easiest to trigger accidentally (a missed semiweekly deposit during a holiday week) and the fastest to escalate. Know whether you are a monthly or semiweekly depositor, calendar every deposit date, and treat the deposit schedule as non-negotiable. Twelve consecutive clean quarters is the streak that protects your Forms 941.
Keep a compliance calendar, not just a tax calendar
Most businesses track April 15 and the estimated-tax dates. A compliance calendar goes further: every filing deadline, every deposit date, every information-return deadline, with owners assigned and reminders set a week out. The three-year lookback means a single forgotten deadline in 2025 can still be disqualifying you in 2028. One shared calendar, reviewed monthly, is cheap insurance.
Respond to every IRS notice within days
During the transition especially, a notice is the start of a conversation, not a bill carved in stone. Open IRS mail immediately, confirm whether the penalty should have been automatically relieved, and respond before the deadline printed on the notice. If you use a tax pro, forward notices the same day — "I never saw the letter" is not reasonable cause.
Track penalties and relief in your books
When a penalty is assessed and later abated, both events belong in your records: the assessment as a tax-penalty expense and the abatement as its reversal, each dated and tied to the notice number. Clean penalty tracking does two things: it keeps your profit-and-loss honest, and it gives you (or your accountant) an instant compliance history the next time eligibility is questioned. If your books cannot answer "which quarters had penalties and how were they resolved?" in under a minute, your chart of accounts needs a dedicated penalty line. If you keep your books in Beancount, a dedicated Expenses:Taxes:Penalties account with per-notice metadata makes this a one-command query — the documentation shows how to structure accounts for exactly this kind of tracking.
Keep Your Compliance Streak Visible
AEP turns your filing and payment history into something tangible: a three-year streak that automatically erases your next qualifying penalty. But a streak only protects you if you can see it breaking. Calendar every deadline, file even when cash is tight, deposit payroll taxes on schedule, and record every notice and abatement where you can find it again. The businesses that get automatic relief are simply the ones whose records prove they deserve it.
Maintaining that kind of visibility takes bookkeeping that shows the full picture — deadlines met, taxes paid, penalties tracked — in one place. Beancount.io provides plain-text accounting that gives you complete transparency and control over your financial data, so your compliance history is always a query away instead of a shoebox mystery. Get started for free and keep your next penalty from ever being assessed.
