The IRS has begun rolling out a new Automatic Exemption from Penalty, or AEP, that can protect some normally compliant taxpayers from common penalties after a one-time late filing, late payment or late payroll-tax deposit. The “reward” is not a check or tax credit. It is automatic penalty relief based on a taxpayer’s prior compliance history, according to the IRS’s Automatic Exemption from Penalty guidance.
AEP applies to eligible original returns beginning with tax year 2025, eligible 2026 quarterly returns and future periods. In general, taxpayers must have timely filed the same type of return and paid any tax due for the previous three years.
Quarterly filers generally need 12 consecutive quarters of timely compliance. If IRS records confirm eligibility when the original return finishes processing, covered penalties are not assessed and the taxpayer receives a notice explaining the relief.
That is a major change from First Time Abate, the long-standing administrative waiver AEP is replacing. Under the old system, eligible taxpayers generally had to contact the IRS and ask for relief after a penalty had already been assessed.
Under AEP, the IRS identifies qualifying taxpayers automatically, suppresses covered penalties during processing and sends confirmation without requiring a separate application.
The difference could affect far more taxpayers than the policy change initially suggests. The National Taxpayer Advocate reported that nearly 220,000 taxpayers received First Time Abate through the manual process in fiscal year 2025.
It estimates that more than 1.5 million taxpayers would have received relief if AEP had operated during the same period, roughly seven times as many. National Taxpayer Advocate analysis For individual taxpayers, AEP can cover certain failure-to-file and failure-to-pay penalties.
For eligible businesses, it can also cover failure-to-deposit penalties. The IRS lists Forms 1040, 1065 and 1120; employment-tax Forms 940, 941, 943, 944 and 945; and Form CT-1 among eligible return series. Infrequent event-based returns, information-return penalties, accuracy-related penalties and daily delinquency penalties generally fall outside AEP.
The potential dollar value can be meaningful. The normal failure-to-pay penalty is generally 0.5% of unpaid tax for each month or part of a month. The failure-to-file penalty is generally 5% monthly, subject to interaction rules and statutory limits.
On $10,000 of unpaid tax, one month in which both penalties apply can produce a combined $500 penalty. If AEP applies, those covered penalties can instead be prevented from being assessed.
But AEP does not erase the tax bill. Unpaid tax and interest remain due, along with penalties outside the program. For July through September 2026, the IRS quarterly interest-rate table sets the underpayment rate at 7% annually, compounded daily.
On a $10,000 balance outstanding for 30 days, that rate produces about $58 of interest, an Investozora calculation based on the published rate. AEP therefore should not be treated as permission to intentionally pay late.
Taxpayers who cannot pay in full still have separate options. An IRS installment agreement can spread a balance over time. Those facing collection activity should understand the difference between an IRS tax lien and levy, while taxpayers with serious inability to pay may want to review whether an offer in compromise is realistic. Those programs solve different problems and should not be confused with AEP.
There is also an important transition issue. First Time Abate remains relevant for some 2024 returns, 2025 quarterly returns and eligible 2025 tax-year or 2026 quarterly returns processed before AEP became available. For original returns with due dates on or after January 1, 2027, the IRS says First Time Abate will no longer be available and AEP will replace it. IRS AEP fact sheet
One less obvious concern comes from the National Taxpayer Advocate. It has warned that automatically using AEP when a taxpayer might also qualify for reasonable-cause relief could affect access to administrative relief in a later year.
Taxpayers with documented circumstances such as serious illness or another legitimate reasonable-cause claim should therefore keep their records even if AEP automatically appears on the account.
For most taxpayers, the practical rule remains simple: keep filing and paying on time. If the IRS sends an AEP notice, no response is normally required. If it sends a penalty notice and the prior three years were compliant, review the tax period, return type and penalty carefully and contact the IRS using the number on the notice if the relief appears to be missing.
The biggest change is not that the IRS created a way to forgive every late payment. It changed who has to know the relief exists. Under AEP, a clean compliance history can trigger protection automatically, potentially extending penalty relief to far more taxpayers than the old request-based system ever reached.
