Tax Talk Thursday: IRS Penalty Abatement - Updates and How to Actually Win

IRS UPDATE: July 8, 2026

On July 8, 2026, the IRS announced (News Release IR-2026-83) that it is phasing out First Time Abate and replacing it with a new Automatic Exemption from Penalty (AEP).

What this means for you: If you have a clean three-year filing and payment history, eligible late-filing, late-payment, and late-deposit penalties on 2025 returns and 2026 quarterly returns will no longer be assessed at all. No request is needed, and the IRS will mail a letter confirming the relief.

What to watch for: During the transition, some eligible taxpayers may still receive penalty notices in error. Do not pay a penalty notice for a 2025 return or 2026 quarter until it has been reviewed.

What it does not cover: international information returns (Forms 5471, 3520, 8938), estimated tax and accuracy-related penalties, interest, and California FTB penalties.

An IRS penalty notice feels final. It is not. Failure-to-file and failure-to-pay penalties are among the most frequently reduced or removed charges in the entire tax system, but only for taxpayers who ask the right way, for the right penalty, at the right time.

And as of this summer, the rules of the game shifted. On July 8, 2026, the IRS announced that First Time Abate (FTA), the administrative waiver practitioners have relied on since 2001, is being phased out and replaced by a new automatic program called the Automatic Exemption from Penalty (AEP). If you are still working from an older playbook, some of your strategy is now out of date.

This post walks through how IRS penalty abatement works today, how to build a request that actually succeeds, and the California and international wrinkles that trip up even careful filers.

What Changed on July 8, 2026: First Time Abate Becomes AEP

Under the old FTA process, the IRS assessed the penalty first, and you had to call or write to get it removed. Many eligible taxpayers never asked, so they simply paid penalties they did not owe.

AEP flips that sequence. When an eligible original return is processed, the IRS simply does not assess the penalty in the first place, then mails a letter confirming that relief was applied because of your compliance history.

Who qualifies for AEP

•     You timely filed the same return type for the prior three years (or 12 consecutive quarters for quarterly filers), and

•     No penalty was assessed in that window other than the estimated tax penalty, or any penalty assessed was later abated for reasonable cause or IRS error.

•     Businesses face two extra tests: the failure-to-deposit penalty cannot have been waived four or more times in the lookback period, and it cannot have been charged for avoiding the Electronic Federal Tax Payment System (EFTPS).

What AEP covers

•     Returns: Forms 1040, 1065, 1120, 940, 941, 943, 944, 945, and CT-1.

•     Penalties: failure to file, failure to pay, and failure to deposit, regardless of amount.

•     Periods: 2025 tax year returns and 2026 quarterly returns, and everything after.

What AEP does not cover

•     Event-based or infrequent returns, such as Form 706 (estate) and Form 709 (gift).

•     Information returns, including international information returns like Forms 5471, 5472, 3520, and 8938.

•     Accuracy-related penalties, estimated tax penalties, and the tax and interest themselves.

One improvement worth noting

Under FTA, the failure-to-pay penalty could keep accruing until the balance was paid in full, which meant a second request later to clean up the tail. Under AEP, the IRS says the failure-to-pay penalty does not accrue and is not assessed on the unpaid tax for an eligible return. Interest still runs until you pay.

The transition period: why you may still need to ask

The IRS has acknowledged that during the rollout, some qualifying taxpayers will still receive penalty notices for 2025 returns and 2026 quarterly returns. FTA also remains available for 2024 and earlier years. AEP fully replaces FTA for eligible returns with original due dates on or after January 1, 2027. Until then, if you receive a notice and believe you qualify, you can still request FTA by calling the number on the notice or by filing Form 843, Claim for Refund and Request for Abatement.

Step 1: Identify Exactly Which Penalty You Are Fighting

The single most common reason abatement requests fail is asking for the wrong kind of relief. Each penalty has its own relief rules, and some cannot be removed by reasonable cause at all.

Penalty	AEP / FTA?	Reasonable cause?	Notes
Failure to file (IRC 6651(a)(1))	Yes	Yes	Usually the largest: up to 25% of unpaid tax
Failure to pay (IRC 6651(a)(2), (a)(3))	Yes	Yes	Inability to pay can qualify only with proof of ordinary care
Failure to deposit (IRC 6656)	Yes	Yes	Payroll and other deposit taxes
Estimated tax (IRC 6654)	No	No	Narrow statutory waiver only: casualty, disaster, or retirement after 62 / disability
Accuracy-related (IRC 6662)	No	Yes, plus good faith	Defense is built under IRC 6664(c)
International info returns (5471, 3520, 8938, etc.)	No	Yes, form-specific	Penalties can apply even when no tax is owed

Step 2: Pull the Transcript Before You Call Anyone

Before requesting anything, pull the IRS account transcript for the period at issue and the three years before it. The transcript tells you whether you meet the clean-history test, which penalties were assessed, and whether a prior abatement already used your clean slate.

This matters because the IRS applies administrative relief before it considers reasonable cause. If you ask for reasonable cause relief but your records show you qualify for FTA, the IRS will apply FTA. Knowing your eligibility in advance lets you decide how to frame the request rather than leaving it to the agent on the phone.

Step 3: Understand the Hidden Trade-Off of Automatic Relief

Here is the part most articles skip. Administrative relief is valuable precisely because it is limited: it rewards a clean three-year history. Use it once, and the late year itself becomes a break in your record.

Under FTA, practitioners sometimes made a deliberate choice: if a client had a strong reasonable cause case, such as a documented hospitalization, they argued reasonable cause instead and preserved the clean history for a future year when no good excuse existed. The National Taxpayer Advocate raised exactly this concern before automation, and as recently as March 2026 the AICPA asked the IRS to let taxpayers reverse automatic relief when reasonable cause applies.

With AEP applied automatically at processing, the IRS has not published a procedure for substituting reasonable cause for AEP after the fact. The published eligibility rules also say a penalty abated for reasonable cause does not break your history, but they separately require the prior returns to have been timely filed. How those two tests interact for a late return excused by reasonable cause has not been clarified.

Where we land on this

This is genuinely unsettled. Our approach: if a client has a strong, well-documented reasonable cause case, we file the reasonable cause statement with or promptly after the late return and preserve the record, rather than assuming automatic relief is the end of the conversation. If the facts are thin, we let AEP or FTA do its job and move on.

Step 4: Build a Reasonable Cause Request That Survives Review

When administrative relief is unavailable, reasonable cause is the path. The legal standard is whether you exercised ordinary business care and prudence and were still unable to comply. The IRS reviews these requests under the Penalty Handbook in IRM 20.1.1, and the reviewer is checking facts against that standard, not weighing sympathy.

Circumstances the IRS generally recognizes

•     Death, serious illness, or unavoidable absence of the taxpayer or an immediate family member

•     Fire, casualty, natural disaster, or other disturbance

•     Inability to obtain necessary records despite reasonable efforts

•     Written advice from the IRS that turned out to be wrong

•     Reasonable reliance on a competent tax professional for a substantive question of law

Arguments that usually fail

•     "I didn't know I had to file." Ignorance of the law alone rarely qualifies, though complexity and lack of sophistication can be relevant facts, especially for international forms.

•     "My preparer was supposed to file it." Under the Supreme Court's decision in United States v. Boyle, relying on someone else to meet a filing deadline is generally not reasonable cause. Relying on a professional's substantive advice is different.

•     "I didn't have the money." For failure to pay, you must show you exercised care and would have suffered undue hardship by paying on time. Lack of funds alone is not enough.

•     "I was too busy." Business demands do not qualify.

The structure that works

1.      Name the penalty, the tax period, and the notice. Make the reviewer's job easy.

2.      Give a dated timeline. When did the obligation arise, when did the event happen, and how long did it last?

3.      Connect the event to the failure. Explain specifically why the circumstance prevented you from filing or paying, not just that it occurred.

4.      Show what you did once the obstacle cleared. Prompt correction is often the most persuasive fact in the file.

5.      Attach proof. Hospital records, death certificates, insurance claims, correspondence, or the written advice you relied on.

6.      Show your compliance pattern. A history of timely filing makes a one-time failure credible.

Example: what the numbers look like

Assume a taxpayer owes $40,000 on a 2024 Form 1040 and files three months late with no extension. The combined failure-to-file and failure-to-pay penalty runs 5% per month: roughly $5,400 for failure to file (4.5% x 3) plus $600 for failure to pay (0.5% x 3), or about $6,000 before interest.

If the taxpayer had a timely, penalty-free 2021 through 2023, FTA can remove the full $6,000. If not, a documented reasonable cause case, for example a parent's month-long hospitalization in March, may remove all or part of it. When a penalty is removed, the interest charged on that penalty comes off automatically. Interest on the underlying tax generally does not.

Step 5: Choose the Right Channel

•     By phone: Fastest for administrative relief (FTA during the transition) and simple, small requests. Have the transcript, the notice, and your Form 2848 authorization ready if a representative is calling.

•     In writing (Form 843 or a signed letter): Best for reasonable cause, larger penalties, or anything that depends on documents. It creates a record you can rely on later in Appeals.

•     With the delinquent filing: For late international information returns, the reasonable cause statement belongs with the filing itself. Where it goes depends on the form and on whether the related income tax return was timely filed.

Step 6: If the IRS Says No, Keep Going

A denial is a first answer, not a final one. The denial letter explains your appeal rights, and the IRS Independent Office of Appeals reviews penalty cases with fresh eyes and can weigh the hazards of litigation, something a frontline reviewer cannot. Many well-documented requests that are denied initially are resolved in Appeals.

If you already paid the penalty, keep the refund statute in mind: a claim generally must be filed within three years of the return's filing date or two years of payment, whichever is later. If you have not paid, collection may continue while you appeal, so plan the timing.

The California Layer: A Separate System With Its Own Rules

A federal abatement does nothing for your Franchise Tax Board (FTB) penalties. California has its own process, and it works differently.

•     One-time, once in a lifetime. Under R&TC Section 19132.5, individuals can receive a one-time abatement of a late filing or late payment penalty for tax years beginning on or after January 1, 2022. Unlike the federal program, it does not reset.

•     Individuals only. Business entities, estates, and trusts are not eligible.

•     You must be current. All required returns must be filed.

•     How to request: Form FTB 2918, a MyFTB message, or by phone.

Because California's relief is a lifetime benefit, the trade-off above is even sharper. If a strong reasonable cause case exists, it is usually worth presenting that first and keeping the one-time abatement in reserve. The FTB allows taxpayers to request the one-time abatement even after a reasonable cause request is denied.

For Expats and Cross-Border Filers: Higher Stakes, Fewer Shortcuts

International information return penalties are where abatement strategy matters most. A missed Form 5471 starts at $10,000 per form, per year, and Form 3520 penalties can reach 35% of a foreign trust distribution, even when no U.S. tax is owed.

These penalties sit outside AEP and have never been a natural fit for FTA. Relief runs through reasonable cause, and the statement has to be tailored to the specific form, the specific penalty section, and the specific facts. Depending on the situation, the right route may be the Delinquent International Information Return Submission Procedures, the Streamlined Filing Compliance Procedures, or a reasonable cause request after assessment. Choosing the wrong route can cost you the strongest argument you had.

Penalty abatement is winnable, but it is not a form you fill out. It is a decision: which relief to use, when to use it, and how to document it. The arrival of AEP makes routine cases easier and makes strategic choices less visible, which is exactly why they deserve more attention.

1.      Read every IRS letter in 2026 and 2027 closely. An AEP confirmation letter means relief was applied. A penalty notice on an eligible 2025 return may be a transition error worth challenging.

2.      Pull transcripts before asking for anything. Know your clean-history status before the IRS decides it for you.

3.      Protect your clean history. If you have strong reasonable cause, document it and present it rather than defaulting to administrative relief.

4.      Treat California separately. Its one-time abatement is a lifetime benefit. Spend it deliberately.

5.      Address international forms on their own track. AEP will not help with Forms 5471, 3520, or 8938.

6.      File on time, even if you cannot pay. The failure-to-file penalty is ten times the monthly failure-to-pay rate. Filing on time and setting up a payment plan almost always

costs less.

MKHS Tax Group reviews IRS and FTB penalty notices, pulls your transcripts, and builds the abatement strategy that fits your facts, including reasonable cause statements for international information returns.

Email info@mkhstaxgroup.com to schedule a review. Understand more. Stress less. File with confidence.