Automatic Exemption from Penalty (AEP): The IRS Replacement for First-Time Abatement

For twenty-five years, first-time abatement worked the same way. The IRS assessed the penalty. You noticed it. You called or wrote. Someone checked your history and took it off.

That model rewarded people who knew to ask. Plenty of taxpayers who qualified never asked, because they did not know the waiver existed. They paid penalties the IRS would have removed in a five-minute phone call.

The IRS is changing that. Its page on administrative penalty relief says first-time abatement is transitioning to a new program called Automatic Exemption from Penalty, or AEP, starting summer 2026. The core difference is in the name. It is automatic.

What AEP does

According to the IRS, AEP is applied when your original return completes processing. If you file an eligible original return late or pay late, and IRS records show a history of timely compliance over the prior three years (or 12 consecutive quarters for quarterly filers), the IRS will not assess the failure-to-file, failure-to-pay or failure-to-deposit penalty.

Not assessed. Not assessed and later removed. Never assessed. The IRS comparison chart puts it plainly: under FTA, the penalty is assessed first and then removed; under AEP, no penalty assessment is made.

You do not have to contact anyone. The IRS says it will send a notice explaining that AEP relief was applied, and you do not need to respond to it.

Which returns and years it covers

The IRS lists the return series eligible for AEP consideration:

• Forms 1040, 1065 and 1120.
• Employment and related returns: Forms 940, 941, 943, 944 and 945.
• Form CT-1, the railroad retirement tax return.

AEP starts with 2025 tax year returns and 2026 quarterly returns, and applies to later years and quarters. Everything earlier stays under the old first-time abatement rules, which means you still have to ask. The IRS also says FTA continues to apply to eligible 2025 tax year and 2026 quarterly returns that were not considered for AEP.

If your return type is not on the list, do not assume AEP covers it. Look at the first-time abatement rules and at reasonable cause instead.

The qualification test has not changed

AEP uses the same timely compliance history the IRS uses for FTA:

• The same return type was timely filed for the prior three years, or 12 consecutive quarters.
• No penalty other than the estimated tax penalty was assessed in that period, or any penalty that was assessed was later abated for reasonable cause or IRS error.
• Business taxpayers must also show the IRS did not waive the failure-to-deposit penalty four or more times in the prior three years, and that the deposit penalty was not charged for EFTPS avoidance.

The same exclusions apply. No relief for returns filed once or infrequently, for the daily delinquency penalty, or for information reporting that depends on another filing.

The failure-to-pay difference

This is the most important practical change, and it gets overlooked.

Under old-style FTA, if you still owed tax, the IRS could abate what had been assessed so far, but the failure-to-pay penalty kept accruing on the unpaid balance until you paid in full. You had to come back and ask again for the rest.

Under AEP, the IRS says the failure-to-pay penalty does not accrue and is not assessed on the unpaid tax. That is a real improvement for someone who files on time but cannot pay the whole balance immediately.

It is not a free pass. The IRS is explicit that you remain liable for any unpaid tax, interest, and any other penalty not subject to AEP. Interest keeps running on unpaid tax. And the accuracy-related penalty, the estimated tax penalty and information return penalties are outside the program entirely.

Two illustrations

Consider two hypothetical taxpayers. Neither is a real client; they simply show how the rules sort people.

The first files Form 1040 for 2025 two months late and pays the balance with the return. She filed and paid on time for 2022, 2023 and 2024 and has never had a penalty. Under AEP as the IRS describes it, the failure-to-file and failure-to-pay penalties are not assessed when the return processes, and she gets a letter saying so. She does nothing.

The second taxpayer files the same late 2025 return, but his 2023 return was also late and the failure-to-file penalty from that year is still on his account. His three-year history is not clean, so AEP does not apply. He gets a penalty notice. His options are the ones that existed before AEP: ask whether the 2023 penalty can be removed for reasonable cause, which would restore his history, and make a reasonable cause case for 2025 on its own facts.

Notice what decided both cases. Not the size of the penalty, not the reason for being late. The record.

Quarterly filers and payroll

Employers get the most out of this change. A business that files Forms 941 every quarter can trip a deposit penalty with one late EFTPS payment. Under old-style FTA, that penalty was assessed, a notice went out, and someone had to call.

Under AEP, for 2026 quarters and later, the IRS says the failure-to-deposit penalty is not assessed if the business has 12 consecutive quarters of timely compliance and meets the two business tests: fewer than four deposit penalty waivers in the prior three years and no EFTPS avoidance. The deposit penalty has its own statutory rules too, which I cover in failure-to-deposit penalty relief.

What to check when you get the notice

The IRS says you will know you received AEP because you will get a letter explaining that the applicable penalties were not assessed due to your history of timely compliance. Keep it. It documents that the relief was applied and why.

The more important scenario is the opposite one. If you receive a notice showing an assessed penalty and believe you should have qualified, the IRS tells you to contact it. Automatic systems make mistakes. A payment applied to the wrong year, an extension that never posted, or a spouse's history being read incorrectly can all make a clean record look dirty. The Internal Revenue Manual already tells employees to fix the account before considering any relief, and those same account errors can block an automatic exemption.

If the penalty stays on after you call, you are back in familiar territory: ask for reasonable cause or a correction of IRS error, and appeal if that is denied. The penalty relief categories explain the order the IRS uses.

Your clean history is still a one-time asset

AEP takes the asking out of the process. It does not change the arithmetic of the history test.

Read the criteria literally. The test requires timely filing of the same return type for the prior three years. A year in which you filed late, even one where AEP spared you the penalty, is not a year of timely filing. The IRS page does not spell out how AEP years are treated in later look-backs, so do not plan on using it two years in a row. Plan on earning it again.

The same logic applied under the old rules, where the manual treats a penalty removed under FTA as disqualifying for the next three years. The relief was always meant to be for a first stumble. It still is.

What this means for you

If you were late on a 2024 or earlier return, nothing about AEP helps you directly. You still have to ask for first-time abatement, and the common FTA mistakes still apply.

If you were late on a 2025 return or a 2026 quarterly return and your history is clean, watch your mail. You should see an AEP letter instead of a penalty notice. If you see a penalty notice instead, call.

And if your history is not clean, AEP was never going to save you. That is where reasonable cause, the statutory exceptions and the appeal rights come in. Those rules did not change. Knowing them is how you get the penalty off when the computer says no.