IRS Replaces First Time Abate With Automatic Penalty Relief: What Businesses Need to Know

For years, the IRS’s First Time Abate (FTA) program has provided an important form of administrative penalty relief for taxpayers with a history of timely compliance. But the process required taxpayers—or their representatives—to know the relief existed and actively request it.

That is now changing.

In July 2026, the IRS announced that it is transitioning from First Time Abate to a new Automatic Exemption from Penalty (AEP) program. Under AEP, eligible taxpayers will receive certain penalty relief automatically when the IRS determines that they meet the required compliance-history standards. No separate request is required for eligible returns once AEP applies.

This is a significant change for business owners, tax professionals, and corporate advisors.

Instead of assuming every penalty must be challenged manually—or automatically filing a First Time Abate request—the compliance process will increasingly involve determining whether the IRS correctly applied AEP and identifying cases where another form of relief, such as reasonable cause, may be more appropriate.

At Velin & Associates, Inc., we help corporations, S-Corporations, partnerships, and other businesses evaluate tax notices, penalty assessments, and compliance issues. Understanding the transition from FTA to AEP can help businesses avoid paying penalties that should not have been assessed while also preserving other available relief options.

What Was First Time Abate?

First Time Abate has been one of the IRS’s primary forms of administrative penalty relief.

Generally, eligible taxpayers with a strong compliance history could request relief from certain:

• Failure-to-file penalties
• Failure-to-pay penalties
• Failure-to-deposit penalties

The taxpayer normally had to contact the IRS or submit a written request. The IRS would then review the taxpayer’s account to determine whether the FTA requirements were satisfied.

Example: A corporation has filed its federal returns on time and maintained a clean compliance history for several years. One year, the company files its return late and receives a failure-to-file penalty. If the corporation meets the applicable FTA requirements, it could request administrative relief.

The problem was that many eligible taxpayers never requested the relief because they:

• Did not know FTA existed
• Did not know how to request it
• Assumed the penalty was automatically correct
• Had difficulty reaching the IRS
• Did not have professional assistance

The Taxpayer Advocate Service has highlighted this gap as one of the reasons automatic relief was needed.

What Is the New Automatic Exemption From Penalty Program?

The Automatic Exemption from Penalty, or AEP, is designed to provide certain penalty relief automatically.

Instead of assessing an eligible penalty and waiting for the taxpayer to request abatement, the IRS identifies eligible taxpayers during original return processing and suppresses the applicable penalty.

The IRS then sends a notice confirming that the relief was applied.

Example: A corporation files an eligible return late. The IRS reviews the company’s prior compliance history and determines that the corporation meets the AEP requirements. Instead of assessing the qualifying failure-to-file penalty and requiring the corporation to call the IRS, the penalty is not assessed in the first place.

This is the fundamental difference between the old process and the new system.

When Does AEP Take Effect?

AEP is being phased in during summer 2026.

The transition is not an immediate shutdown of First Time Abate.

During the transition period, FTA remains available for certain returns and periods. For example, eligible 2024 tax-year returns, certain 2025 quarterly returns, eligible 2025 tax-year returns processed before AEP begins, and certain 2026 quarterly returns processed before AEP begins may still require taxpayers to request FTA.

For eligible original returns with original due dates on or after January 1, 2027, AEP replaces FTA.

Important Point for Businesses

A penalty notice received during the 2026 transition should not automatically be treated as an AEP failure.

The return may have been processed before AEP was available.

Businesses should review the notice, determine the applicable tax year and processing period, and evaluate whether FTA, AEP, reasonable cause, or another form of relief applies.

Which Business Returns Can Qualify?

The IRS currently lists several return series eligible for AEP consideration, including:

• Form 1120 — U.S. Corporation Income Tax Return
• Form 1065 — U.S. Return of Partnership Income
• Form 940 — Employer’s Annual Federal Unemployment Tax Return
• Form 941 — Employer’s Quarterly Federal Tax Return
• Form 943 — Employer’s Annual Federal Tax Return for Agricultural Employees
• Form 944 — Employer’s Annual Federal Tax Return
• Form 945 — Annual Return of Withheld Federal Income Tax
• Form CT-1 — Employer’s Annual Railroad Retirement Tax Return

Form 1040 is also included for eligible individual taxpayers.

This is particularly relevant to businesses because AEP can apply not only to annual income tax returns but also to certain payroll tax filings.

What Penalties Can AEP Cover?

AEP can prevent assessment of certain:

• Failure-to-file penalties
• Failure-to-pay penalties
• Failure-to-deposit penalties

The IRS specifically identifies these categories as eligible for AEP when the taxpayer meets the applicable requirements.

Example: A corporation qualifies for AEP and files its return after the deadline. The IRS may prevent the applicable failure-to-file and failure-to-pay penalties from being assessed. However, the corporation still owes the underlying tax and generally remains responsible for interest and any penalties that are not covered by AEP.

Automatic penalty relief does not mean the underlying tax obligation disappears.

The Three-Year Compliance History

One of the key AEP requirements is a clean compliance history.

Generally, the same return type must have been timely filed for the prior three years.

For quarterly filers, the IRS generally looks at the prior 12 consecutive quarters.

Example: A corporation files its Form 1120:

• Year 1 — on time
• Year 2 — on time
• Year 3 — on time
• Year 4 — late

If the corporation satisfies the other applicable requirements, it may qualify for AEP for the eligible Year 4 return.

The purpose is to recognize taxpayers who have demonstrated a strong history of compliance but experienced an isolated failure.

Additional Requirements Apply to Business Taxpayers

Businesses have additional AEP requirements beyond simply having a clean filing history.

For example, the IRS indicates that the business must not have had the failure-to-deposit penalty waived four or more times during the prior three years, or 12 consecutive quarters for quarterly filers. There are also restrictions involving certain EFTPS avoidance penalties.

This means a company should not assume that three timely years automatically guarantee AEP.

The complete eligibility requirements must be reviewed.

Not Every Tax Return Qualifies

AEP is not a universal penalty waiver.

The IRS excludes certain categories, including returns filed only once or infrequently for specific events or transactions.

Examples generally include:

• Form 706 — U.S. Estate Tax Return
• Form 709 — U.S. Gift Tax Return
• Certain information reporting obligations

The IRS also excludes certain penalties, such as the Daily Delinquency Penalty.

Example: An individual files an estate tax return after an estate-related transaction. The taxpayer should not assume AEP will apply simply because the person had a good compliance history in prior years. Some event-based returns fall outside the program.

Different relief rules may need to be considered.

AEP Is Different From Reasonable Cause

This distinction is particularly important for business owners and tax professionals.

AEP is an administrative penalty waiver.

Reasonable cause relief is a separate form of relief based on the taxpayer’s specific facts and circumstances.

The IRS states that reasonable cause may apply when a taxpayer exercised ordinary care and prudence but was unable to comply because of circumstances beyond the taxpayer’s control.

Examples may include:

• Natural disasters
• Fires
• Serious illness
• Death
• Inability to obtain necessary records
• Certain electronic filing or payment system problems

Each case is evaluated based on its facts.

Why Reasonable Cause Still Matters

The transition to AEP does not eliminate reasonable cause relief.

In fact, the interaction between the two programs has become one of the most important issues highlighted by the National Taxpayer Advocate.

The Taxpayer Advocate Service has warned that AEP may be applied automatically before the IRS considers whether reasonable cause relief would have been appropriate. Because AEP is an administrative waiver, using AEP in one year could potentially affect whether the taxpayer can receive AEP in a later year. TAS has recommended that the IRS allow reasonable cause relief to take precedence when the facts support it.

Example: A business files a return late in Year 1 because a serious natural disaster prevented access to critical accounting records. Those circumstances may support reasonable cause.

If AEP is automatically applied instead, the taxpayer receives penalty relief—but the administrative waiver may effectively be used for that year.

If the same company later has another isolated late filing in Year 3 without reasonable-cause circumstances, its AEP history could become relevant.

This is why tax professionals should not necessarily treat automatic relief as the end of the analysis.

What Should Businesses Do When AEP Is Applied?

Businesses should still review the notice.

The IRS will issue a notice explaining that AEP was applied.

Example: A corporation receives a notice stating that a penalty was not assessed because of its timely compliance history. The company should retain that notice with its tax records. There is generally no need to contact the IRS simply because the AEP notice was received.

However, businesses should continue monitoring their accounts and maintaining documentation supporting their overall compliance history.

What If a Business Receives a Penalty Notice?

This is where professional review becomes especially valuable.

A company receiving a penalty notice should determine:

• Which tax year is involved
• Which return was filed
• When the return was processed
• What penalty was assessed
• Whether the return is AEP-eligible
• Whether an AEP notice was issued
• Whether FTA remains available during the transition
• Whether reasonable cause applies
• Whether another form of penalty relief is available

The IRS and Taxpayer Advocate Service specifically advise taxpayers not to assume that an assessed penalty is final when the taxpayer believes relief should apply.

Example: A 2025 Corporate Return During the Transition

A corporation files its 2025 Form 1120 late. The corporation has a strong compliance history for the prior three years. However, its return was processed before AEP was active for that filing. The corporation receives a failure-to-file penalty notice. Management should not simply pay the penalty assuming the old system no longer applies. Because of the transition, FTA may still be available for that return depending on the applicable rules and processing date.

The company should review the account and request appropriate relief if it qualifies.

Example: A 2026 Quarterly Payroll Return

A corporation files a quarterly Form 941 late during the AEP transition period.

Because quarterly returns have additional eligibility considerations, the company should determine whether the return was processed before or after AEP became active for the applicable period.

If an eligible return is processed under AEP and the company meets the requirements, the IRS can automatically prevent eligible failure-to-file, failure-to-pay, and failure-to-deposit penalties.

If the penalty is nevertheless assessed, the company should investigate why.

The Good News for Taxpayers

The automatic system addresses one of the biggest weaknesses of First Time Abate.

Taxpayers no longer have to know that a particular relief program exists before receiving the benefit—when AEP applies and the eligibility requirements are satisfied.

The Taxpayer Advocate Service estimates that nearly 220,000 taxpayers received FTA relief through the manual process in fiscal year 2025. TAS estimates that more than 1.5 million taxpayers could have received relief under AEP for the same period—approximately seven times as many.

For eligible businesses, that represents a meaningful reduction in administrative burden.

AEP May Also Reduce Repeat Contacts With the IRS

The new approach addresses another problem with the old FTA system.

Under FTA, a taxpayer could receive penalty relief and later have additional tax assessed for the same period. The taxpayer could then need to contact the IRS again to request relief on the additional covered penalties.

Under AEP, the IRS says that once relief is granted for an eligible tax period, covered penalties should not subsequently be assessed for that same period even if additional tax is later assessed.

Example: A corporation receives AEP relief for an eligible tax period. Later, an additional tax assessment is made for that same period. Under the new approach, covered penalties should not simply reappear for that period after the AEP relief was granted.

This can reduce repeated correspondence and administrative work.

AEP Does Not Mean Businesses Can File Late Without Consequences

One of the most important messages for business owners is that AEP should not be treated as permission to file late.

The IRS continues to encourage businesses to:

• File on time
• Pay on time
• Make required deposits on time
• Maintain accurate records

AEP is designed to provide relief for taxpayers with a strong compliance history—not to replace normal tax compliance.

Example: A corporation assumes it can file late every few years because AEP exists. That strategy can quickly eliminate the compliance history required for future automatic relief.

The best tax strategy remains timely filing and payment.

What This Means for Corporate Tax Planning

For corporations, AEP should become part of the broader compliance review process.

Tax professionals should consider adding questions such as:

• Is the return eligible for AEP?
• Does the company have the required compliance history?
• Was AEP actually applied?
• Did the IRS issue an AEP notice?
• Does the company have reasonable-cause facts?
• Is FTA still available because of the transition?
• Are there penalties outside AEP’s scope?

This approach shifts the advisor’s role from simply requesting penalty relief to auditing the IRS’s application of the relief system.

Preserve Documentation for Reasonable Cause

Even when AEP automatically removes a penalty, businesses should document significant circumstances that could support reasonable cause.

Examples may include:

• Natural disasters
• Serious illness
• Loss of records
• Major system failures
• Other circumstances beyond the taxpayer’s control

Example: A corporation’s payroll system is disrupted by a documented technology failure that prevents a timely filing. AEP may remove a qualifying penalty automatically. However, the company should still preserve records documenting what happened, when it happened, and what steps were taken to restore compliance.

Good documentation can become important if future penalty issues arise.

What Businesses Should Do During the Transition

The transition period requires a slightly different approach.

Businesses should continue to:

• File and pay on time.
• Review every IRS penalty notice.
• Do not assume AEP was automatically applied.
• Request FTA when it remains available during the transition.
• Evaluate reasonable cause separately when the facts support it.
• Keep AEP notices and compliance records.

The IRS specifically states that FTA remains available for certain returns during the transition and that taxpayers should contact the IRS if an eligible penalty appears to have been assessed incorrectly.

How Velin & Associates, Inc. Can Help

The transition from First Time Abate to Automatic Exemption from Penalty changes the way businesses should approach penalty issues.

At Velin & Associates, Inc., we help corporations and business owners:

• Review IRS penalty notices
• Determine whether AEP applies
• Evaluate First Time Abate eligibility during the transition
• Analyze reasonable cause opportunities
• Prepare penalty relief requests when necessary
• Review federal and state compliance
• Identify underlying filing problems
• Develop stronger tax compliance procedures

Our goal is not simply to remove a penalty. It is to understand why the penalty occurred, determine which relief provisions apply, and help prevent the same problem from happening again.

Final Thoughts

The IRS’s transition from First Time Abate to the Automatic Exemption from Penalty program is a significant change in how certain penalty relief will be delivered.

For eligible taxpayers with a strong compliance history, AEP can eliminate the need to manually request relief for certain failure-to-file, failure-to-pay, and failure-to-deposit penalties. The IRS expects the system to reach substantially more eligible taxpayers than the old manual process.

However, businesses should not assume that every penalty will disappear automatically.

AEP has eligibility requirements, certain returns and penalties are excluded, and First Time Abate remains relevant during the transition. Most importantly, reasonable cause relief remains a separate avenue for taxpayers whose specific circumstances justify it. The Taxpayer Advocate Service has specifically raised concerns about how automatic AEP relief interacts with future reasonable-cause claims.

For businesses, the new system means less time spent requesting routine administrative relief—but potentially more attention required to reviewing whether the IRS applied the correct relief in the first place.

Automatic relief is a significant improvement, but it is not a substitute for proactive tax compliance.

Need Help With IRS Penalties or Corporate Tax Compliance?

If your business operates in California or multiple states, proper tax planning is critical. Whether you received an IRS penalty notice, are dealing with a late corporate filing, or need help evaluating AEP, First Time Abate, or reasonable-cause relief, proactive guidance can help reduce unnecessary costs and protect your business. For more information about our tax planning services, contact us today: our website. 

Velin & Associates, Inc.

8159 Santa Monica Blvd STE 198/200
West Hollywood, CA 90046
📞 323-902-1000
📧 dmitriy@losangelescpa.org

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