IRS Penalty Abatement: Reasonable Cause, AEP and First Time Abatement
An IRS penalty notice does not necessarily mean that every penalty shown on the notice is final.
Depending on the penalty, the tax period, the taxpayer's compliance history, and the circumstances that caused the filing or payment problem, several forms of penalty relief may need to be considered.
Two particularly important categories are reasonable cause relief and the IRS Automatic Exemption from Penalty program, known as AEP. During 2026, AEP is replacing the longstanding First Time Abatement program, commonly referred to by the IRS as First Time Abate or FTA, for eligible returns.
These forms of relief operate differently. AEP is administrative relief based principally on prior compliance. Reasonable cause depends on the facts and the legal standard applicable to the particular penalty.
Can an IRS Penalty Be Removed?
The answer depends on the particular penalty and the basis for relief.
A penalty review should normally determine:
- What specific penalty the IRS assessed
- The Internal Revenue Code section imposing the penalty
- Whether the penalty calculation is correct
- Whether the return and payment dates shown on the IRS account are correct
- Whether AEP should have prevented the penalty from being assessed
- Whether First Time Abatement remains available during the transition
- Whether the taxpayer can establish reasonable cause
- Whether another statutory or procedural defense applies
- Whether a response, appeal, collection, or Tax Court deadline must be protected
AEP, First Time Abatement, and reasonable cause should not be treated as interchangeable.
What Is the Automatic Exemption from Penalty?
The IRS began implementing the Automatic Exemption from Penalty program during summer 2026.
AEP provides administrative relief to qualifying taxpayers with a history of timely compliance.
Unlike First Time Abatement, AEP generally does not require the taxpayer to contact the IRS and request relief after a penalty has been assessed.
Instead, when an eligible original return is processed and the IRS account satisfies the AEP requirements, the IRS system prevents certain penalties from being assessed.
The IRS then sends a notice explaining that the qualifying penalty was not assessed because of the taxpayer's compliance history.
Which Penalties Can AEP Cover?
AEP can prevent assessment of certain penalties under:
- IRC Section 6651(a)(1) for failure to file
- IRC Sections 6651(a)(2) and 6651(a)(3) for failure to pay
- IRC Section 6656 for failure to make a required federal tax deposit
- IRC Section 6698(a)(1) for failure to timely file a partnership return
- IRC Section 6699(a)(1) for failure to timely file an S corporation return
AEP does not generally apply to accuracy related penalties, information return penalties, daily delinquency penalties, or other penalties outside the covered categories.
Which Returns Are Eligible for AEP?
The IRS June 17, 2026 procedural guidance expressly identifies the following return series as eligible:
- Form 1040
- Form 1065
- Form 1120
- Form 1120-S
- Form 940
- Form 941
- Form 943
- Form 944
- Form 945
- Form CT-1
AEP begins with eligible 2025 tax year original returns, eligible 2026 quarterly original returns, and subsequent periods.
Returns filed only once or in connection with an infrequent event generally do not qualify. Examples include Form 706 estate tax returns and Form 709 gift tax returns.
The Original Return Must Be Filed Within Three Years
AEP has an important filing limitation that should not be overlooked.
An eligible original return must be filed within three years of the original return due date to receive AEP consideration.
For this rule, the IRS uses the original due date rather than an extended filing date.
For example, if an individual 2025 Form 1040 had an original due date of April 15, 2026, but the taxpayer obtained an extension until October 15, 2026, the AEP three year period is still measured from the original April 15, 2026 due date.
This limitation makes the filing date particularly important when reviewing older delinquent returns.
What Compliance History Does AEP Require?
The IRS generally looks at the prior three years for annual returns or the prior 12 consecutive quarters for quarterly returns.
The same return type generally must have been timely filed for each relevant period, or IRS records must show that there was no requirement to file for a particular period.
The prior periods generally must also show no disqualifying penalty.
A prior penalty does not necessarily destroy eligibility if the penalty was subsequently removed for reasonable cause or because of IRS error.
However, a prior AEP or First Time Abatement grant within the compliance period generally prevents another AEP grant.
For employment tax returns, additional requirements apply, including limitations involving prior failure to deposit penalty waivers and EFTPS avoidance.
AEP Is Not Available Every Year
AEP is designed to recognize a period of sustained compliance followed by a compliance lapse.
Once AEP is granted, the IRS will generally not consider the same return type eligible for another AEP until the taxpayer establishes three additional consecutive years of timely compliance, or 12 consecutive quarters for a quarterly filer.
AEP is therefore automatic administrative relief based on a qualifying compliance history, not recurring annual penalty protection.
How Can You Tell Whether AEP Was Granted?
When AEP applies, the IRS sends a separate notice explaining that the qualifying penalties were not assessed.
The IRS procedural guidance identifies CP95 and CP95(SP) for individual account modules and CP195B or CP895B for business account modules.
AEP can also be confirmed through the IRS account transcript.
When AEP is granted, the IRS posts Transaction Code 971 with Action Code 996 to the applicable tax module.
What If AEP Should Have Applied but a Penalty Was Assessed?
AEP is normally determined automatically when an eligible original return completes processing.
IRS procedural guidance permits manual AEP consideration when an IRS error prevented an otherwise eligible return from receiving the relief.
During the 2026 transition, some 2025 annual returns and 2026 quarterly returns were processed without AEP consideration. Those taxpayers may still qualify to request First Time Abatement.
The account transcript, return processing date, penalty notice, and compliance history should therefore be reviewed before assuming that the penalty must be challenged through reasonable cause.
What Is Happening to First Time Abatement?
First Time Abatement has historically provided administrative penalty relief for qualifying taxpayers with a satisfactory compliance history.
Unlike AEP, First Time Abatement normally requires the taxpayer to contact the IRS after a penalty has been assessed.
During the transition, First Time Abatement remains available for:
- Eligible 2024 tax year returns and earlier annual returns
- Eligible 2025 quarterly returns and earlier quarterly periods
- Eligible 2025 tax year original returns that were processed without AEP consideration
- Eligible 2026 quarterly original returns that were processed without AEP consideration
For eligible original returns with original due dates on or after January 1, 2027, the IRS states that First Time Abatement will no longer be available and AEP will replace it.
AEP Compared With First Time Abatement
AEP and First Time Abatement are both forms of administrative penalty relief based principally on prior compliance, but the mechanics are different.
Under First Time Abatement, the penalty generally appears on the account first and the taxpayer requests that the IRS remove it.
Under AEP, qualifying penalties generally are prevented from being assessed when the original return is processed.
First Time Abatement therefore normally requires taxpayer action. AEP generally does not.
AEP also prevents a qualifying failure to pay penalty from accruing on the module once the relief is recorded, although interest on unpaid tax continues to accrue.
What Is Reasonable Cause Penalty Relief?
Reasonable cause is different from both AEP and First Time Abatement.
For many failure to file and failure to pay penalties, IRC Section 6651 provides relief when the failure was due to reasonable cause and not due to willful neglect.
Treasury Regulation Section 301.6651-1 applies an ordinary business care and prudence standard.
The taxpayer generally must demonstrate that reasonable efforts were made to comply but circumstances nevertheless prevented timely filing or payment.
For a business, the IRS generally evaluates the circumstances affecting the person who had authority and responsibility to file the return, pay the tax, or make the deposit.
Circumstances That May Support Reasonable Cause
Depending on the applicable penalty and facts, circumstances that can support a reasonable cause argument may include:
- Fire, casualty, natural disaster, or civil disturbance
- Inability to obtain essential records
- Death or serious illness
- Unavoidable absence
- Certain documented electronic filing or payment failures
- Other circumstances outside the taxpayer's control that directly prevented compliance
The event alone does not establish reasonable cause. The taxpayer should explain the chronology, the effect on the tax obligation, the efforts made to comply, and how quickly the problem was corrected.
Lack of Funds Is Not Automatically Reasonable Cause
Lack of sufficient funds by itself generally does not establish reasonable cause for failing to pay tax or make a required federal tax deposit.
However, the circumstances that caused the financial problem may still matter.
Treasury Regulation Section 301.6651-1 recognizes that reasonable cause for failure to pay can exist when the taxpayer exercised ordinary business care and prudence in providing for payment but nevertheless could not pay or would have suffered undue hardship if payment had been made on the due date.
Reliance on a Tax Professional Requires a Different Analysis
Reliance on a CPA, attorney, or return preparer does not create one universal reasonable cause defense.
For late filing, the Supreme Court held in United States v. Boyle that a taxpayer generally cannot establish reasonable cause merely because the taxpayer relied on an agent to perform the ministerial act of filing a return by its known due date.
Reliance on substantive professional tax advice is different.
For certain accuracy related penalties, IRC Section 6664(c) and Treasury Regulation Section 1.6664-4 provide a reasonable cause and good faith defense.
Relevant considerations can include whether the taxpayer provided complete and accurate information to the adviser, whether the adviser had appropriate expertise, whether the advice addressed the relevant facts and law, and whether reliance on the advice was reasonable under all of the circumstances.
Reasonable Cause for Information Return Penalties
AEP generally does not cover information return penalties.
Reasonable cause therefore remains particularly important for penalties involving Forms 1099, Forms W-2, and other information reporting requirements.
Treasury Regulation Section 301.6724-1 contains a separate reasonable cause framework.
The filer generally must demonstrate significant mitigating factors or events beyond its control and must also show that it acted in a responsible manner.
How Should a Reasonable Cause Request Be Prepared?
A reasonable cause request should connect the facts directly to the legal standard for the particular penalty.
- What happened. Identify the event or circumstance that caused the failure.
- When it happened. Provide the relevant beginning and ending dates.
- Why compliance was prevented. Explain the connection between the circumstances and the filing, payment, deposit, or reporting failure.
- What efforts were made. Describe attempts to obtain records, make payments, contact advisers, correct systems, or otherwise comply.
- When the problem was corrected. Explain what happened after the obstacle ended.
- What evidence supports the explanation. Provide records that independently support the important facts.
How Is Penalty Relief Requested?
The method depends on the type of relief and the procedural status of the penalty.
AEP generally requires no taxpayer request when it is applied correctly during original return processing.
First Time Abatement generally requires the taxpayer to contact the IRS.
Some reasonable cause requests can initially be made by calling the telephone number on the IRS notice. Other circumstances require a written statement or Form 843, Claim for Refund and Request for Abatement.
If the IRS denies penalty relief, administrative appeal rights may be available. The applicable notice should be reviewed because response and appeal deadlines vary.
If the IRS reduces or removes a penalty, the IRS generally reduces or removes the interest attributable to that penalty automatically. Interest attributable to the underlying unpaid tax generally remains.
Why the IRS Account Transcript Matters
Penalty relief should not be evaluated from the notice alone.
The account transcript may help identify:
- The date the return posted
- Whether the IRS recognized an extension
- Payment posting dates
- The date and amount of a penalty assessment
- Prior penalty abatements
- Prior compliance history
- Whether AEP was granted
- Whether the account contains TC 971 with Action Code 996
- Whether a payment appears to have been applied to the wrong period
Penalty Abatement Is Different From Supervisory Approval
Reasonable cause and administrative penalty relief address whether a taxpayer qualifies for relief from a penalty.
A separate procedural issue can arise under IRC Section 6751 for certain penalties.
For a detailed discussion, see my article on IRS supervisory approval requirements under IRC Section 6751.
A penalty case can involve both issues. A taxpayer may have a substantive reasonable cause defense, a procedural Section 6751 issue, both, or neither.
Common Mistakes When Reviewing an IRS Penalty
- Requesting relief without identifying the exact penalty
- Assuming AEP applies to every IRS penalty
- Overlooking the three year original return filing requirement for AEP
- Assuming an extension moves the three year AEP deadline
- Failing to check whether AEP or First Time Abatement was previously granted
- Treating AEP and reasonable cause as the same form of relief
- Submitting a general hardship statement without dates or documentation
- Relying solely on lack of funds
- Assuming reliance on a preparer automatically excuses a late return
- Ignoring a separate response, appeal, collection, or Tax Court deadline
Key Takeaway
The IRS penalty relief framework changed significantly in 2026.
AEP is now being implemented for eligible 2025 annual returns, 2026 quarterly returns, and future periods. It can prevent qualifying penalties from being assessed when the taxpayer has the required compliance history.
During the transition, First Time Abatement remains relevant for prior periods and certain returns that did not receive AEP consideration.
Reasonable cause remains a separate and important form of relief when the taxpayer's facts satisfy the legal standard for the particular penalty.
For broader assistance reviewing the underlying IRS correspondence, deadlines, account history, and response options, see my IRS notice review and response services.
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