IRS Introduces Automatic Exemption from Penalty and Phases Out First-Time Abatement – Some Issues for CPAs
The IRS is introducing an Automatic Exemption from Penalty program that will automatically waive certain penalties for eligible taxpayers. While the program simplifies penalty relief for many common tax returns, not all taxpayers or returns qualify.
By William R. Stromsem, CPA, J.D., George Washington University School of Business
In early July, the IRS announced that this summer it will launch a new automatic exemption from penalty (AEP) procedure for eligible returns and taxpayers. At the same time, the IRS will phase out first-time abatement (FTA) relief.
The AEP process, when it applies, should simplify penalty relief, with no action required by the taxpayer or representative, and the IRS automatically issues a simple notice to the taxpayer that the relief was granted. If AEP applies, no penalty will be assessed, relieving taxpayers and advisers of the stress of a penalty notice. This will reduce CPA hours spent seeking relief for clients, but this work may not be billable and will likely not be missed by practitioners.
However, the relief does not apply to all returns and all taxpayers.
What Returns Qualify?
Relief will be available for penalties for failure to file, failure to pay and failure to deposit for tax year 2025 returns and later, and for 2026 quarterly returns and later. Many commonly filed returns qualify, including Forms 1040, 1065, 1120 (including 1120S), 940, 941, 943, 944, 945 and CT-1. (Relief does not apply to Form 1041.) Late payroll tax deposits qualify for AEP relief but estimated tax penalties do not. Interest on penalties will be removed. Occasional and infrequent returns do not qualify for AEP relief, such as estate and gift tax returns, the daily delinquency penalty, or reporting a dependent on another filing.
Who Qualifies for AEP?
Generally, taxpayers who have a timely compliance record can qualify for AEP relief; more specifically, if the taxpayer timely filed and paid tax on the same type of return for three years (12 consecutive quarters) and either no penalty was assessed (except estimated tax penalty) or the penalty was abated. For businesses, the IRS must not have waived the failure to deposit penalty four or more times during that period, and the failure to deposit penalty must not have been charged for Electronic Federal Tax Payment (EFTPS) avoidance.
Consider Action Before First-Time Abatement is Phased Out
As AEP is phased in over the summer, first-time abatement relief will be phased out and will be completely unavailable for returns with original due dates on or after Jan. 1, 2027. Before it is phased out, tax advisers may want to advise clients to use FTA if the taxpayer’s penalty does not qualify for AEP relief; e.g., when a taxpayer receives penalty notices for a 2025 return or 2026 quarterly returns.
When the FTA is phased out, if AEP penalty relief does not apply, the taxpayer will have to rely on “reasonable cause” for penalty relief, which in the past could be uncertain and require substantial documentation. In its information release, the IRS has tried to simplify first-time abatement, saying that taxpayers must contact the IRS either by using the telephone number on the penalty notice or by sending a written statement or Form 843, Claim for Refund and Request for Abatement. The IRS says it will review the taxpayer’s account to determine whether FTA relief is appropriate and that no documentation is required, but taxpayers might be advised to submit documents to strengthen their cases.
Consider Reasonable Cause Relief Instead of AEP
A possible drawback of AEP is that once an automatic penalty is granted, it is not available, again, until after another three years of clean compliance. If there is a strong case for reasonable cause relief, the taxpayer might want to go that route and keep the AEP available for any subsequent penalty that might not have such a compelling reasonable cause claim. If AEP relief has not yet been applied to an anticipated penalty, the taxpayer might want to seek reasonable cause relief.
If the IRS has already eliminated a penalty using AEP, it may be possible to contact the IRS to request that the AEP relief be reversed and to allow the taxpayer to seek reasonable cause relief. Obviously, before declining AEP relief, the client would have to weigh the likelihood of success and the cost of pursuing reasonable cause relief. AICPA and the National Taxpayer Advocate have recommended that the taxpayer be allowed to reverse AEP relief and pursue reasonable cause relief, but the IRS has not yet provided guidance.
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