IRS Introduces Automatic Penalty Relief: What Taxpayers May Be Giving Up

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By Kelly Morrison-Lee, JD, Managing Director and Yevgeny Antonov

Key Takeaways

Automatic Exemption from Penalty (AEP) replaces First Time Abatement (FTA) for eligible returns due on or after Jan. 1, 2027 automatically waiving certain Internal Revenue Service (IRS) penalties.
Taxpayers should monitor Internal Revenue Service (IRS) transcripts because Automatic Exemption from Penalty (AEP) may automatically use one-time relief even when reasonable cause may apply.
Review penalty relief strategy before accepting Automatic Exemption from Penalty (AEP) because reasonable cause claims may preserve future administrative penalty relief eligibility.

The IRS is introducing a new Automatic Exemption from Penalty (AEP) program that will begin replacing its longstanding First Time Abatement (FTA) administrative penalty relief for eligible returns with original due dates on or after January 1, 2027. While the change is designed to simplify penalty relief by automatically waiving certain penalties for qualifying taxpayers, it also creates a new strategic consideration that many taxpayers and advisors may overlook.

How IRS Penalty Relief Works

Almost every taxpayer has missed a tax filing deadline at some point. The IRS knows this, which is why it maintains discretionary relief programs that can erase a penalty for an otherwise compliant taxpayer. Historically, the most used program was First Time Abatement (FTA) which is an administrative waiver that clears failure to file and failure to pay penalties for a taxpayer with a clean filing history

The second most common program is reasonable cause relief, available when circumstances beyond the taxpayer’s control occurs such as illness, disaster or a death in the family prevented timely compliance. The IRS describes both on its administrative penalty relief page; however, good news. The IRS is implementing a new Automatic Exemption from Penalty (AEP) program for eligible taxpayers with the intention of phasing out FTA. While AEP, like FTA, is intended to provide administrative penalty relief, the programs do not procedurally work the same way. Understanding the distinction is important.

Under the traditional FTA program, a taxpayer generally requests relief after a penalty has been assessed. Under AEP, the IRS identifies eligible taxpayers through its processing systems and simply waives the assessment of certain penalties. For many taxpayers, this represents a welcome improvement because it eliminates the need to contact the IRS to request relief.

To qualify for AEP, a taxpayer generally must have timely filed the same return type for the prior three tax years (or 12 consecutive quarters for quarterly filers), timely paid any tax due for those prior periods, and incurred no significant penalties during that compliance period (subject to certain exceptions, such as penalties removed for reasonable cause or IRS error).

The IRS announced that AEP will replace FTA for eligible returns with original due dates on or after January1, 2027, with both being available in 2026.

Implementation of AEP: More Good News

Beginning in 2026, the IRS will systemically identify qualifying accounts and stop the application of certain penalties without requiring a taxpayer request. In addition to certain deposit penalties, it covers the below, which is similar to what FTA previously covered:

Relief: Income Tax Penalties Covered

Penalty

IRC Section

Description

Failure-to-File Penalty

§ 6651(a)(1)

Penalty for failing to timely file a required tax return.

Failure-to-Pay Penalty

§ 6651(a)(2)

Penalty for failing to timely pay tax shown on a return.

AEP: Eligibility Requirements

Requirement	Description
Clean Penalty History	No significant penalties assessed for the preceding three tax years
Filing Compliance	All currently required returns have been filed (or valid extensions obtained).
Payment Compliance	All taxes due have been paid, or the taxpayer has entered into an approved payment arrangement with the IRS.

Monitor Your Account Transcripts

One practical point does not change: eligible taxpayers should still monitor their IRS account transcripts to confirm the exemption actually posted, including transcript entries such as “No penalty due to previous 3 years of timely filing/payment,” which may appear when the IRS system applies the exemption based on the taxpayer’s compliance history.

If the exemption is not automatically applied, a taxpayer may potentially request it by phone or mail. If the IRS’s record of an account is incomplete or mismatched, the exemption relief may not be applied by the IRS when it should.

The Catch: AEP is Potentially a Limited Resource

Like FTA relief, once the IRS grants AEP for a year, the taxpayer may potentially be locked out of using AEP for the next three years. The exemption becomes available again only after a new clean compliance period. This matters because FTA (and now AEP) is rarely the only path to relief.

Remember: Reasonable Cause

The other principal route, reasonable cause, is available when a taxpayer exercises ordinary business care and prudence but is unable to comply because of circumstances beyond their control, such as serious illness, a death in the family, a disaster, or the destruction of records. Unlike prior FTA or AEP application, obtaining relief on reasonable cause grounds does not limit future AEP eligibility.

For that reason, taxpayers with strong reasonable cause facts should generally pursue reasonable cause relief first. Doing so can eliminate the current penalty while preserving FTA for a future year in which no comparable justification may exist.

The challenge with AEP is that the IRS system is not designed to make that distinction. It applies the exemption to the first eligible penalty it encounters, regardless of whether reasonable cause relief may also be available. As a result, a taxpayer may consume a limited FTA opportunity (by way of the IRS applying AEP) to resolve a penalty that could have been abated on other grounds.

While the IRS announcement provides that, “Taxpayers who do not qualify for AEP may still request penalty relief based on reasonable cause”, it does not contemplate logistics for taxpayers who potentially qualify for both kinds of relief: AEP and reasonable cause.

If AEP is Automatic, What Should Taxpayers Do?

AEP changes the timing and character of the penalty relief analysis. Taxpayers generally cannot elect out of the exemption before it is applied. There is no box on the return that tells the IRS to save AEP for later. If the system identifies an eligible penalty, the exemption may be applied automatically.

That makes early monitoring more important. When a penalty notice or transcript shows that AEP has been applied, taxpayers should consider whether the same penalty may have qualified for reasonable cause relief instead. If the facts support reasonable cause, the taxpayer or advisor may need to raise that argument affirmatively with the IRS and request that the penalty be considered on that basis. Note however that procedurally the mechanics are still evolving.

The American Institute of Certified Public Accountants (AICPA} and National Taxpayer Advocate have recommended that the IRS allow taxpayers to reverse AEP and substitute reasonable cause relief where appropriate, preserving FTA for a future need. While the IRS has not yet established a formal process for doing so, taxpayers are not necessarily without options. In cases involving strong reasonable cause facts and significant future exposure, it may be worthwhile to engage with the IRS and explore whether a different form of relief can be applied.

Best Practice

Not every AEP should be challenged. For most taxpayers, automatic relief is a welcome result. However, where a taxpayer has strong reasonable cause facts, multiple years at issue, or larger potential penalties in another period, it may be worth taking a closer look before assuming the automatic result is the best one. In those cases, taxpayers and advisors should:

Review the account transcript to confirm whether AEP was automatically applied;
Determine the basis on which the penalty was abated;
Gather contemporaneous documentation supporting reasonable cause, if applicable; and
Evaluate whether asserting reasonable cause relief would be more advantageous than using the taxpayer’s one-time AEP waiver.

The goal is to avoid exhausting a limited AEP opportunity when another form of penalty relief may be available.

How PKF O’Connor Davies Can Help

AEP is a positive development for many taxpayers, but it does not eliminate the need for careful analysis. As the rules and procedures surrounding automatic abatement continue to evolve, taxpayers and advisors may face questions that the system itself cannot answer.

Our tax professionals help taxpayers evaluate penalty relief options, develop and present reasonable-cause claims, and determine the most effective strategy when multiple forms of relief may be available.