The IRS Just Made Penalty Relief Automatic: What Taxpayers and Practice Owners Need to Know

Tax filing and payment mistakes can be expensive. A late return, missed tax payment, or delayed payroll tax deposit may result in penalties that continue growing until the issue is resolved.

Until recently, taxpayers who otherwise had a strong compliance history generally had to contact the IRS and specifically request First Time Abate relief. Many eligible taxpayers never received that relief because they did not know it existed, did not understand how to request it, or could not reach the IRS.

That process is now changing.

On July 8, 2026, the IRS announced the new Automatic Exemption from Penalty program, commonly referred to as AEP. Beginning in summer 2026, the IRS will start automatically identifying eligible taxpayers and preventing certain penalties from being assessed in the first place.

What Is the Automatic Exemption from Penalty Program?

AEP is the IRS’s replacement for its long-standing First Time Abate program.

Under the previous system, the IRS would generally assess a penalty first. The taxpayer, or the taxpayer’s representative, would then need to contact the IRS and request that the penalty be removed.

Under AEP, the IRS reviews the taxpayer’s compliance history while processing an eligible original return. When the taxpayer qualifies, the IRS does not assess the covered penalty. The taxpayer will instead receive a notice explaining that relief was automatically applied, and no response to that notice should be necessary.

The Taxpayer Advocate Service estimates that nearly 220,000 taxpayers received First Time Abate relief through the manual process during fiscal year 2025. It estimates that more than 1.5 million taxpayers could have received relief if the automatic system had already been in place.

Which Penalties Can Be Automatically Exempted?

The new program generally applies to three common IRS penalties:

• Failure-to-file penalties for filing an eligible return after its deadline

• Failure-to-pay penalties for failing to pay tax by the applicable due date

• Failure-to-deposit penalties for failing to make certain federal tax deposits correctly or on time

There is no stated dollar limit on the amount of an otherwise eligible penalty that may qualify for relief.

The failure-to-deposit protection may be particularly important for healthcare practice owners. Medical, dental, and other healthcare practices frequently have significant payroll obligations, and an administrative oversight involving a federal payroll tax deposit can result in a substantial penalty.

AEP provides a valuable safety net, but it should not be treated as permission to delay a filing, payment, or payroll tax deposit. Maintaining reliable accounting, payroll, and tax compliance procedures remains the best way to avoid unnecessary expenses and IRS correspondence.

Who Qualifies for Automatic Penalty Relief?

Eligibility generally depends on the taxpayer’s history for the same type of return.

To qualify, IRS records must generally show that the taxpayer:

1. Timely filed the same return type during the previous three years, or the previous 12 consecutive quarters for quarterly returns;

2. Paid the tax due for those prior periods on time; and

3. Did not have a disqualifying penalty assessed during the applicable lookback period.

An estimated tax penalty does not automatically prevent a taxpayer from qualifying. A prior penalty that was later removed because of reasonable cause or IRS error may also be disregarded when the IRS evaluates the taxpayer’s compliance history.

The return-specific requirement is important. A problem involving one type of return does not necessarily determine eligibility for an entirely different return. For example, the IRS evaluates the prior compliance history associated with the particular return being processed.

Business taxpayers must satisfy additional requirements involving prior failure-to-deposit penalty waivers and penalties connected with avoiding the Electronic Federal Tax Payment System.

Which Tax Returns Are Eligible?

The IRS has identified several eligible return categories, including many of the returns most commonly filed by individuals and business owners:

• Forms 1040, 1065, and 1120

• Forms 940, 941, 943, 944, and 945

• Form CT-1

These categories include individual income tax returns, partnership and corporate returns, and several federal employment tax returns.

Not every return or penalty is eligible. The program generally does not apply to information returns, returns filed only because of a specific transaction or infrequent event, or certain information-reporting penalties. The IRS specifically identifies estate tax returns filed on Form 706 and gift tax returns filed on Form 709 as examples of returns that generally do not qualify.

When Does the New Program Begin?

The IRS is introducing AEP in phases beginning in summer 2026.

The initial rollout applies to eligible original:

• 2025 tax-year returns

• 2026 quarterly returns

The IRS expects AEP to fully replace First Time Abate for eligible returns with original due dates on or after January 1, 2027.

Because the system is being introduced gradually, some taxpayers who qualify may still receive penalty notices involving 2025 tax-year returns or 2026 quarterly returns. Taxpayers who believe they qualify but receive a penalty notice may still contact the IRS and request First Time Abate relief during the transition.

Does AEP Eliminate the Tax or Interest Owed?

No. Automatic penalty relief does not eliminate the underlying tax liability.

Even when AEP applies, the taxpayer remains responsible for:

• Unpaid tax

• Interest charged on the unpaid tax

• Any other penalties that are not covered by the program

When an eligible penalty is reduced or removed, the IRS will generally also reduce or remove the interest associated specifically with that penalty. Interest accruing on the underlying unpaid tax remains due.

What Happens if You Do Not Qualify?

A taxpayer who does not qualify for AEP may still have other relief options.

The IRS may remove or reduce certain penalties when a taxpayer can demonstrate reasonable cause and show that the taxpayer acted in good faith. Reasonable cause relief depends on the taxpayer’s individual facts and circumstances, including whether the taxpayer exercised ordinary business care and prudence but was unable to comply because of circumstances beyond the taxpayer’s control.

Reasonable cause relief is not automatic. It must generally be requested, supported, and evaluated separately by the IRS.

What Should You Do if You Receive an IRS Penalty Notice?

Do not assume that the IRS has already considered every available form of relief, particularly while the new automatic system is being implemented.

When you receive a notice:

1. Review the tax period, return type, and penalty listed on the notice.

2. Compare it with your filing and payment records.

3. Determine whether you had a timely compliance history for the same return type.

4. Check whether the notice states that AEP was applied.

5. Contact The Phillips Group or your own tax professional promptly before paying the penalty or responding to the IRS.

IRS notices frequently include response deadlines. Addressing the notice early gives your tax professional more time to confirm whether AEP, First Time Abate, reasonable cause relief, or another correction may be available.

The Bottom Line

The new Automatic Exemption from Penalty program is a meaningful improvement for taxpayers who generally comply with their filing and payment responsibilities but make an isolated mistake.

Eligible taxpayers will no longer need to know the correct terminology, navigate an IRS phone call, or submit a separate request simply to receive relief that the IRS routinely grants. However, the program does not cover every penalty, return, or situation, and the transition may result in some qualifying taxpayers continuing to receive penalty notices.

If you receive an IRS penalty notice or believe a penalty was assessed incorrectly, please send the complete notice to your Dedicated Support Team (if on a Monthly Plan) or our general support team at The Phillips Group as soon as possible. We can review the notice and your compliance history, determine which relief provisions may apply, and help you identify the appropriate next steps.

Not yet a client? The Phillips Group provides accounting, tax, and advisory services exclusively to healthcare professionals. If you are looking for a proactive team that understands the financial and tax challenges of running a healthcare practice, we invite you to learn more about working with us and schedule an introductory call.

This article is intended for general informational purposes and does not constitute individualized tax or legal advice. Eligibility for IRS penalty relief depends on the taxpayer’s specific facts, filing history, return type, and applicable IRS procedures.