How a Consulting Firm Cleared Two Late Payroll Filings Under the IRS Automatic Penalty Program

How a Consulting Firm Cleared Two Late Payroll Filings Under the IRS Automatic Penalty Program

This is an illustrative composite based on patterns that recur across small service businesses. It does not describe a specific client, the figures are illustrative rather than actual, and nothing here should be read as a promise of a similar result.

IRS automatic penalty relief is the biggest change to small business penalty administration in years, and most owners have not heard of it.

On July 8, 2026, the IRS announced Automatic Exemption from Penalty, or AEP. It replaces First Time Abate, the long-standing administrative waiver, and it does something FTA never did: it applies the relief without anyone asking for it.

Which sounds like the end of a problem. For a 22-person consulting firm sitting on two quarters of late payroll filings, it was the beginning of a more useful conversation.

What Landed in the Mail

The firm had grown from nine people to twenty-two in about eighteen months. Payroll moved from monthly to semi-monthly. Nobody revisited the federal deposit schedule.

Two notices arrived roughly a month apart. Failure to deposit penalties on two quarters, plus interest, in the low five figures combined. The owner's first instinct was the normal one: this is a bookkeeping error, we will call and explain it, they will waive it.

That instinct is right about half the time and it skips the question that actually determines the outcome. Not "was this an honest mistake." The question is whether the firm's prior three years look clean to the IRS.

What Changed in 2026, and Why the Timing Was Awkward

Under First Time Abate, relief for certain failure-to-file, failure-to-pay, and failure-to-deposit penalties was available to taxpayers with a clean compliance history for the prior three years, but you generally had to request it.

AEP applies automatically. Per the IRS announcement, it covers eligible original returns beginning with tax year 2025 returns and 2026 quarterly returns, and it fully replaces First Time Abate for eligible returns with original due dates on or after January 1, 2027. The transition is being phased in through the summer of 2026.

The firm sat exactly inside that phase-in, which produced the practical finding: one quarter fell into the automatic program and one did not.

That is worth naming because it is the current reality for anyone holding a 2026 notice. Some penalties are clearing themselves. Some still need to be requested the old way. Assuming either one universally is how a deadline gets missed.

The Eligibility Test for IRS Automatic Penalty Relief

The three-year clean compliance concept sounds soft. It is not.

For failure-to-deposit penalties on employment tax, the compliance history is generally measured across the prior twelve consecutive quarters for the same return type, and it requires that the returns were filed on time and that no penalty was assessed, or that any penalty assessed was later abated for reasonable cause or IRS error.

Businesses face two additional restrictions on deposit penalties specifically. The relief is generally unavailable if the failure-to-deposit penalty was waived four or more times in the prior three years. And it is unavailable where the penalty was charged for avoidance of the Electronic Federal Tax Payment System.

The firm cleared all of it, barely. There was one late Form 941 three years back that had itself been abated, which under the rules did not break the streak. Had it not been abated, the answer would have been different and this article would have a different ending.

That is the honest version of how this works. Eligibility is mechanical. It does not care how reasonable your explanation is.

What the Firm Actually Fixed

The penalties came off. The cause did not, and the cause was not carelessness.

Federal payroll deposit frequency is not something a business chooses. It is determined by a lookback at the employment tax reported in a prior period. Cross a threshold and you move from monthly deposits to semi-weekly deposits, and the new schedule applies whether or not anyone told your payroll system.

The firm had crossed. Its payroll provider was still depositing monthly because that is how it had been configured in 2023. Every deposit was funded. Every deposit was late.

Three changes went in:

The deposit schedule got a date on it. Someone now checks the lookback determination annually, at a specific time, and documents the answer.

Payroll and the general ledger got reconciled quarterly, not annually. The reconciliation is what surfaces a timing mismatch while it is one quarter old instead of four.

Notice handling got an owner. Payroll notices were arriving at a general inbox. They now go to a named person with a rule that any IRS notice gets opened the day it arrives, because most penalty responses run on a clock that starts at issuance.

None of that is sophisticated. It is the difference between a one-time event and an annual one.

What IRS Automatic Penalty Relief Did Not Do

Three things, stated plainly, because the marketing around penalty abatement tends to skip them.

The underlying tax was still owed. Penalty relief removes the penalty, not the liability.

Interest generally is not abated. Interest on the underpayment is a separate item from the penalty, and relief on one does not clear the other. The firm paid it.

And relief on one quarter consumed the firm's clean history for the near future. A business that uses first-time-style relief has, by definition, no longer got an unblemished record. The next occurrence is far less likely to be forgiven, which makes the process fix the actual value of the engagement rather than the abatement.

The Kind of Firm That Handles This Well

Payroll penalty work sits between bookkeeping and representation, which is why it often falls through the crack between two providers.

Red Bike Advisors is based in Wilmington, North Carolina and was founded in 2009, working with small business owners, high net worth individuals, and clients with partnership income and equity compensation. A practice with that much tenure has been through multiple administrative regimes at the IRS, which is directly relevant during a transition year when the rules are changing underneath the notices.

The limitations are worth naming. A firm this size is not a large national tax controversy shop, and a matter that escalates to Appeals or litigation may need different resources. More importantly, no accountant can create eligibility that is not there. If the compliance history does not qualify, the honest answer is that it does not, and the work shifts to reasonable cause or to paying the penalty and fixing the process.

The Takeaway for Any Business With a Payroll Notice

Automatic relief is a genuine improvement and it will quietly resolve a lot of small penalties for businesses with clean records.

It also does nothing about the reason the penalty happened. A firm that gets a deposit penalty waived and does not check its deposit schedule will get the same penalty next quarter, without the relief.

If you are holding a notice right now, the two things worth doing this week are confirming whether your quarter falls into the automatic program or still needs a request, and pulling your deposit schedule determination to see whether it is current.

You can compare accountants and bookkeepers and read verified client reviews in the Sam's List accountant directory or the bookkeeper directory. Every reviewer authenticates through LinkedIn, Google, or Twitter before submitting, and firms cannot delete negative reviews. A directory narrows the field. It cannot tell you whether a specific firm will get a specific penalty removed, and any firm that promises that before reviewing your compliance history is telling you something it cannot know.

Frequently Asked Questions

What is the IRS Automatic Exemption from Penalty program? It is an administrative relief program the IRS announced on July 8, 2026 that applies certain penalty relief automatically rather than on request. It replaces First Time Abate and covers eligible original returns starting with tax year 2025 returns and 2026 quarterly returns, becoming the full replacement for eligible returns with original due dates on or after January 1, 2027. Eligible taxpayers generally do not need to take action to receive it.

Does automatic relief apply to payroll deposit penalties? Failure-to-deposit penalties are within the general scope of this kind of relief, but employment tax carries extra conditions. The compliance history is generally measured over twelve consecutive quarters for the same return type, and relief is generally unavailable if the penalty was waived four or more times in the prior three years or was charged for EFTPS avoidance. Eligibility is fact-specific and worth confirming before you assume it.

If relief is automatic, do I still need to respond to the notice? Do not treat the notice as self-resolving. During the 2026 transition some penalties clear automatically and some still require a request, and every response route runs on a deadline that starts when the notice is issued. Opening the notice, identifying the tax period, and confirming which path applies is the safe sequence regardless of what you expect the outcome to be.

Will penalty relief also remove the interest? Generally no. Interest on an underpayment is computed separately from penalties, and removing a penalty does not remove the interest on the tax that was paid late. Interest attributable to a penalty that was itself abated can sometimes be adjusted, but the interest on the underlying tax typically stands, so budget for it rather than expecting a full reversal.

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About the author: Kimberly Green is the cofounder of Sam's List, where business owners and high earners find vetted CPAs, financial advisors, and fractional CFOs. She's met one-on-one with 400+ financial professionals and writes from the real data behind thousands of client-advisor matches. Ask her anything about finding an accountant - she's heard it all, including the questions people are afraid to ask.