Unpaid Payroll Taxes Are Now an IRS Criminal Investigation Priority. Here Is Why.
A slow quarter, a customer who paid late, and a payroll that had to be met on Friday. The money withheld from your employees’ paychecks sat in the operating account, so you used it to pay rent and told yourself you would catch up next quarter. Nine quarters later, a revenue officer asks you to explain where the money went. That is how an employment tax problem can develop into a criminal tax investigation, even when the owner intended to catch up later.
An intention to repay does not excuse a willful violation of the duty to pay over withheld taxes. Willfully failing to pay over withheld payroll taxes is a crime under Internal Revenue Code section 7202, punishable by up to five years in federal prison for each count, and using withheld taxes to pay other business expenses can expose a responsible person to criminal prosecution. At the Tax Law Offices of David W. Klasing, our dual-licensed Tax Attorneys and CPAs defend business owners and responsible persons before an employment tax problem becomes a criminal tax investigation, and after it already has.
Why Does the Government Take Unpaid Payroll Taxes So Seriously?
The reason is the word trust. When you withhold income tax and the employee share of Social Security and Medicare from a paycheck, the money is never yours. The Internal Revenue Code treats it as held in trust for the United States from the moment it is withheld. An owner who spends it has not underpaid his own taxes. He has spent his employees’ money, and the federal taxing authorities treat that as theft from the Treasury rather than as a debt.
The second reason is that financial hardship does not excuse a willful failure to pay over withheld taxes. In United States v. Easterday, 564 F.3d 1004 (9th Cir. 2009), the Ninth Circuit held that a defendant’s inability to pay is no defense to a section 7202 charge, and that evidence of how and why he spent the withheld money on other business expenses was irrelevant. In the court’s words, if you know that you owe the taxes and you do not pay them, you have acted willfully. That is the law in every federal courtroom in California, and it strips away the explanation nearly every defendant wants to give: that he was keeping the doors open. The government need not show lavish spending, concealment, or bad motive, only that you knew and that you paid someone else instead.
The third reason is policy. IRS Criminal Investigation has made protecting withheld payroll taxes a stated enforcement priority, and the 2026 record shows it. A bridal shop owner pleaded guilty in 2026 to willful failure to pay over trust fund taxes on a loss above $1.3 million, with the Justice Department’s new Criminal Division Tax Section prosecuting. A restaurant owner and a Camden County business owner both pleaded guilty in employment tax cases on September 8, 2026. An $89 million off-the-books payroll scheme drew a prison sentence in June. We previously analyzed the prosecution of a staffing company owner who closed his company and continued operating through another company in his daughter’s name. He pleaded guilty to an employment tax offense in May 2025.
What Does Willful Mean When You Simply Ran Out of Money?
Willfulness in a criminal tax case means a voluntary, intentional violation of a known legal duty. In an employment tax prosecution, your books and bank records can provide powerful evidence of willfulness. If the bank statements show that in the same weeks you skipped the federal tax deposit, you paid your landlord, your suppliers, your lender, and yourself, the government has its evidence of intent. In its guidance on the civil Trust Fund Recovery Penalty, the Internal Revenue Manual treats employees owed wages as other creditors and explains that preferring them over the government can establish civil willfulness. A criminal conviction requires proof beyond a reasonable doubt that the defendant voluntarily and intentionally violated a known legal duty. When funds are short, the duty is to prorate what you have between wages and the tax on those wages, not to pay the wages in full and the tax not at all.
An explanation that feels like a defense can become damaging evidence. Telling a revenue officer or special agent that you used withheld taxes to save the business and intended to repay them can support the government’s argument that you knowingly violated your payment obligations. Repeating the conduct across successive quarters, a practice the IRS calls pyramiding, can strengthen that argument. Neither pyramiding nor personal enrichment is necessary for a section 7202 conviction, but both can provide evidence prosecutors use to establish willfulness.
Who Can Be Charged? Not Only the Owner
Section 7202 reaches any person required to collect, account for, and pay over the tax, which the government reads to include anyone with the authority to decide which bills get paid. In a Southern District of California prosecution, a restaurant group manager who directed the outside payroll company to stop making federal deposits, and then paid other creditors and himself instead, pleaded guilty after causing a tax loss exceeding $1.5 million and agreed to pay more than $2.2 million in restitution, interest, and penalties. DOJ emphasized his significant control over the company’s finances and his duty to account for and pay its employment taxes. Controllers, chief financial officers, bookkeepers, and family members can face exposure when their duties and financial authority make them responsible for the taxes and they act willfully. Check-signing authority alone does not establish responsibility.
Outsourcing payroll generally does not relieve the employer of its federal employment tax obligations. If a payroll provider takes the employer’s money but fails to deposit it, the employer generally remains liable. Special rules can shift liability to a certified professional employer organization under section 3511 for qualifying wages it pays to covered worksite employees. Those rules do not provide a blanket exemption for every payroll arrangement. Owners often learn of a provider’s default only when IRS notices arrive, several quarters too late. Monitor deposits directly through EFTPS and reconcile payroll records against IRS account information so you can identify missed payments promptly.
How Does a Civil Trust Fund Case Become a Criminal One?
The path runs through people who look like collectors. A revenue officer assigned to an unpaid employment tax balance conducts trust fund recovery penalty interviews on Form 4180, asking who decided which creditors to pay and when. Revenue officers conduct those interviews under the civil rules, and business owners answer them freely, believing they are negotiating a balance. Those answers can become evidence in a later criminal tax investigation. A civil trust fund investigation does not automatically involve criminal charges, but underlying willful conduct can create an highly-risky eggshell situation that requires careful handling from the first interview.
Certain facts can prompt a revenue officer to consider a criminal referral. Employees paid partly in cash, with the cash wages never reported. Forms W-2 show withholding that never reached the Treasury, so the employee claims a tax credit the government never received. A new entity formed to run the same business under a new name once the old one’s balance became unmanageable. The owner paid personal expenses from the operating account while knowingly leaving withheld taxes unpaid. These circumstances can support a fraud referral, depending on the evidence; they do not automatically turn a collection case into a criminal investigation
The government also has time. Section 6531 gives six years to bring a section 7202 charge, so quarters the owner has stopped thinking about remain live. At sentencing, Guidelines section 2T1.6 sets the offense level from the tax loss table, which can include unpaid taxes from both charged periods and additional periods that qualify as relevant conduct, and the fine under 18 U.S.C. section 3571 reaches $250,000 for an individual regardless of the smaller figure printed in the tax statute.
Under section 6201(a)(4), the IRS can assess qualifying court-ordered tax restitution and collect it like a tax. The taxpayer cannot relitigate the underlying restitution amount through a proceeding under the Internal Revenue Code. Separate civil tax assessments may carry applicable penalties and interest, but the IRS does not automatically add a civil fraud penalty and tax interest to the restitution-based assessment itself.
What Should You Do If You Are Behind on Payroll Taxes Right Now?
Stop the pattern this quarter. Additional missed deposits increase the unpaid balance, and continued willful nonpayment can expose you to additional criminal counts for later tax periods. Keep filing Forms 941 on time even when you cannot pay in full, because an accurate return filed without payment is a very different fact from a return never filed. Do not use a new entity to conceal continued control or evade existing payroll tax liabilities; prosecutors can use that conduct as evidence of intent. And do not meet the revenue officer alone. Employment tax examinations are where owners talk themselves into indictments.
Do not take this to the accountant who runs your payroll. That person prepared the Forms 941 and may have known the deposits were not being made, which makes him a witness with an interest in placing the decision on you. No accountant-client privilege exists at federal common law, and the limited practitioner privilege in section 7525 does not apply to criminal matters. California recognizes no accountant-client privilege either. Hence, It would be wise to seek confidential legal advice from an experienced dual-licensed criminal tax defense attorney & CPA. When counsel engages an accountant to assist in providing legal advice, qualifying communications may receive attorney-client privilege protection. Counsel’s involvement does not automatically protect ordinary accounting work, tax return preparation, or preexisting records.
Where the failures were willful, and the government has not yet acted, counsel can evaluate whether the IRS Criminal Investigation Voluntary Disclosure Practice is available. Employment tax noncompliance involving legal-source income is within the practice, but timeliness is the threshold condition, and a revenue officer already assigned to the balance may mean the window has closed. The Internal Revenue Manual is explicit that a disclosure does not guarantee immunity from prosecution, but a timely, truthful, and complete disclosure remains the most reliable route away from a criminal referral, and the evaluation has to happen before anyone speaks to the government.
How the Tax Law Offices of David W. Klasing Defends Employment Tax Cases
Because our Tax Attorneys are also CPAs, we rebuild the payroll history ourselves: which quarters were deposited, which were not, who had authority over the operating account in each period, and what the bank records show was paid instead. That reconstruction helps us assess criminal exposure, identify potentially responsible persons, and determine whether the evidence supports a willfulness defense. We do it before the revenue officer asks, so that every answer given to the government is one we have already tested.
A California employer faces two governments. Withheld state income tax is held in trust for the Employment Development Department exactly as federal withholding is held for the IRS; the Unemployment Insurance Code carries its own criminal provisions for willful failure to remit, and the EDD refers cases independently. Resolving with the IRS does not close the state file. From our main office in Irvine and our satellite offices across the state, the Tax Law Offices of David W. Klasing handles the federal and California sides of an employment tax matter together, through civil and criminal tax defense in the same engagement.
If you are behind on payroll tax deposits, if a revenue officer has asked to interview you about who controlled the accounts, or if an IRS special agent has contacted you or your bookkeeper, call the Tax Law Offices of David W. Klasing at (800) 681-1295 or contact us online to schedule a reduced-rate initial consultation. The difference between a civil resolution and a felony is almost always decided in the first conversation with the government. Have it with counsel present.
