Payroll tax problems do not stay “accounting problems” for long when an employer withholds from employees’ wages but fails to deposit those amounts. Federal law treats certain withheld and employment taxes as “trust fund taxes” because the employer holds the employee’s money in trust for the United States until the employer makes the required federal tax deposits. When a business uses those funds to pay other expenses, the IRS can pursue aggressive civil enforcement against the business and, in the right fact pattern, criminal tax prosecution against the responsible individuals. This risk grows even faster when the payroll problems involve “off books” cash wages, intentional worker misclassification, fabricated timekeeping, falsified payroll returns, or communications that suggest the business knowingly prioritized other creditors over payroll tax deposits.
Why Payroll Taxes Create Unique Personal and Criminal Risk
Employment taxes create unique exposure because the IRS can pursue both the company and individuals. When trust fund taxes go unpaid, the IRS can assess the Trust Fund Recovery Penalty (TFRP) against any “responsible person” who willfully failed to collect, truthfully account for, and pay over the taxes. The IRS defines a responsible person broadly, and the analysis often focuses on authority over finances and disbursements rather than job titles. The IRS calculates the TFRP as the unpaid balance of the trust fund tax, equal to the withheld income tax plus the employee’s share of FICA taxes. The IRS also views “using available funds to pay other creditors when the business cannot pay employment taxes” as an indication of willfulness, and the IRS does not require “evil intent or bad motive” to find willfulness for TFRP purposes.
The IRS typically proposes the TFRP before it assesses it. Internal Revenue Code section 6672(b) generally requires the IRS to issue a preliminary written notice of proposed TFRP assessment at least 60 days before the date of notice and demand, unless the IRS determines the collection of the penalty is in jeopardy, and the IRS explains that it generally issues a proposed assessment letter and provides a window to appeal before assessment. Once the IRS assesses the TFRP, it can pursue collection against personal assets, including liens and levies, which puts owners, officers, and financial decision-makers under immediate pressure.
The Federal Criminal Toolkit in Payroll Tax Cases
Payroll tax criminal exposure often centers on 26 U.S.C. § 7202, which makes it a felony for a person required to collect, account for, and pay over tax to willfully fail to do so. Section 7202 carries a maximum of 5 years’ imprisonment, plus fines and costs of prosecution, and IRS guidance notes that 18 U.S.C. section 3571 can increase the maximum permissible fines for a 26 U.S.C. section 7202 violation to not more than $250,000 for individuals and $500,000 for corporations. The DOJ Tax Division’s Criminal Tax Manual describes § 7202 as the statute used to prosecute willful failures to comply with the legal obligation to collect, account for, and pay over taxes.
The government can also add classic tax and white-collar charges when the facts support them. Prosecutors frequently evaluate charges such as tax evasion (26 U.S.C. § 7201), fraud and false statements on returns or related documents (26 U.S.C. § 7206), conspiracy (18 U.S.C. § 371), and false statements in matters within federal jurisdiction (18 U.S.C. § 1001). Payroll tax cases also commonly raise obstruction and document-integrity issues when people “fix” payroll files, alter ledgers, backdate time records, or coach employees on what to say. Those moves can become independent criminal exposure, and they often provide prosecutors with the intent narrative they want.
Employment Tax Fraud Patterns That Trigger Criminal Tax Investigation Risk
The IRS and DOJ & California’s EDD rarely view payroll tax delinquency in isolation. They focus on what the employer did with withheld funds, what decision-makers knew, and how the employer explained the conduct once the IRS started asking questions. In practice, a few patterns repeatedly create criminal tax investigation risk in employment tax cases:
- Paying net wages and other creditors while skipping required payroll tax deposits, especially after the business knew the delinquencies existed.
- Running “off books” payroll, paying cash wages, or maintaining shadow payroll records that understate wages and employment taxes.
- Intentional worker misclassification, paired with weak documentation and communications that can suggest the business understood the payroll tax consequences.
- False payroll filings or falsified payroll support, including altered timekeeping, doctored journals, and manipulated accounting system audit trails.
- Outsourcing payroll but ignoring deposit realities, including situations where a payroll service provider or PEO relationship exists, but the responsible parties still control funding and disbursement decisions. IRS guidance recognizes that TFRP responsibility analysis can extend to third-party payers, including payroll service providers and professional employer organizations, when individuals had significant control over paying clients’ employment taxes.
Many taxpayers assume outsourcing payroll eliminates risk. It does not. The IRS can assess the TFRP based on responsibility and willfulness, and it recognizes that responsible parties can exist within a payroll service provider or PEO and within the common law employer. When payroll tax delinquencies arise, communications often determine whether the matter remains civil. Sloppy emails, improvised explanations to revenue officers, and unreviewed written submissions can hand the government admissions about knowledge, payment priorities, and intent.
California State Employment Tax Exposure Can Add Pressure and Criminal Risk
California adds a second enforcement channel when payroll issues affect California payroll taxes that the Employment Development Department administers, including employer-paid Unemployment Insurance and Employment Training Tax and employee-withheld State Disability Insurance and Personal Income Tax. California law includes criminal provisions that can apply in willful payroll tax cases. For example, California Unemployment Insurance Code section 2118 makes it a misdemeanor to fail to withhold required wage withholding under section 13020 or to fail to pay over withheld tax. California Unemployment Insurance Code section 2117.5 also provides that willful false or fraudulent returns or willful failure to file or supply required information with intent to evade taxes imposed by the Unemployment Insurance Code can be punishable by county jail or state prison and up to a $20,000 fine, depending on the facts. These state consequences can compound federal exposure because the same payroll facts often drive both federal trust fund analysis and state enforcement decisions. Parallel exposure also increases the number of interviews, document requests, and opportunities for damaging statements, making disciplined communications and controlled production essential.
A Recent Example
According to a Department of Justice press release, Joseth “Joe” Limon of Harris County, Texas, pleaded guilty in the U.S. District Court for the Southern District of Texas to willfully failing to report and pay over the employment taxes his company withheld from workers’ paychecks. Limon owned Platinum Employment Group Inc., a labor-staffing company serving businesses in the greater Houston area. Prosecutors allege that, from 2013 through 2018, Platinum collected federal income tax, Social Security tax, and Medicare tax from its employees but never filed the required employment-tax returns or remitted the funds to the Internal Revenue Service. In all, Platinum shorted the Treasury by more than $8.8 million, money Congress earmarks to fund Social Security and Medicare, two cornerstones of the federal safety-net system. Limon now faces up to five years in prison when he returns for sentencing on Aug. 6, in addition to supervised release, restitution in the full loss amount, and substantial monetary penalties. If you or your business have fallen behind on payroll-tax obligations, or if you have been contacted by the IRS Criminal Investigation Division, it is imperative to consult an experienced tax attorney immediately to contain potential civil and criminal employment tax exposure.
Court records reveal that Platinum Employment Group operated as a classic “labor-leasing” firm: it hired laborers, placed them with client businesses, and issued paychecks to those workers. Under federal law, an employer must withhold the employee’s share of FICA (Social Security and Medicare) and federal income tax each pay period and hold those sums in trust for the United States until the next scheduled deposit date. These withheld amounts, known as “trust-fund taxes”, never belong to the employer. The company merely serves as custodian. Failing to turn them over is viewed by courts as stealing from both workers (who nonetheless receive credit toward future benefits) and the public fisc. When an employer willfully withholds but does not remit, the IRS may pursue the Trust Fund Recovery Penalty (under 26 U.S.C. § 6672) against any “responsible person” who had authority over the company’s finances and acted willfully. If the conduct is egregious, criminal prosecution under 26 U.S.C. § 7202 (“willful failure to collect or pay over tax”) becomes a possibility, as it did here.
Platinum’s non-compliance was not merely a bookkeeping oversight. From 2013 through 2018 the company filed no quarterly Forms 941. Internal payroll ledgers, however, showed clear, ongoing withholdings that should have been reported and deposited. By the time the IRS began investigating, the unpaid trust-fund component exceeded $8.8 million, not including the employer’s matching FICA liability, penalties, or accrued interest. Such a multi-year pattern of omission almost always signals intent, which prosecutors must prove beyond a reasonable doubt to sustain a § 7202 conviction. In practice, they rely on evidence that the business continued to pay other creditors, vendors, rent, owner salaries, while ignoring payroll-tax deposits. Courts routinely see this as “willful.”
Rather than rectify Platinum’s arrears, Limon closed the company and attempted to sidestep the growing liability by forming Rockwell Staffing LLC. Although the new entity performed the same labor-leasing function, he registered it in the name of his then-18-year-old daughter, hoping to obscure his ongoing control. When the IRS eventually assessed Rockwell’s unpaid employment taxes, Limon arranged for his daughter to submit an affidavit claiming Rockwell “had been a victim of identity theft” and bore no payroll-tax responsibility. That false statement exposed both father and daughter to potential criminal liability under federal law and demonstrated consciousness of guilt, powerful evidence in plea negotiations. The facade unraveled, and Limon ultimately admitted his role.
The maximum sentence for a single count of violating § 7202 is five years in prison, but sentencing guidelines weigh numerous factors, including the amount of loss, the duration of the scheme, acceptance of responsibility, and any obstruction. Courts also impose restitution equal to the tax loss plus interest and penalties, effectively restoring the Treasury and leaving the defendant liable for any shortfall. Given that trust-fund taxes are not dischargeable in bankruptcy, Limon’s financial exposure will likely persist well beyond any custodial term. Moreover, the IRS may still pursue civil Trust Fund Recovery Penalties against additional responsible parties at Platinum and Rockwell, including corporate officers, check signers, and financial-control personnel who acted willfully.
Takeaways for Employers
Quarterly filing is non-negotiable: Every employer must file Form 941 each quarter, even if no tax is due. Failure to file is itself a misdemeanor (§ 7203) and often the first red flag investigators notice.
Segregate Trust-Fund Monies
Best practice is to move withheld taxes into a dedicated account that is off-limits for operating expenses until deposits are transmitted electronically via EFTPS.
Document Reasonable Cause
If genuine cash-flow emergencies arise, contemporaneous records of efforts to obtain financing, defer other payments, or negotiate installment agreements can help demonstrate lack of willfulness.
Maintain Ethical Walls
Using nominees or relatives to conceal ownership rarely succeeds and typically leads to harsher penalties once uncovered.
If your company has missed payroll-tax deposits, filed late employment-tax returns, or received a notice of a trust-fund assessment, swift action is crucial. Voluntary disclosure, submission of delinquent returns, and prompt negotiation of an installment-payment agreement can dramatically reduce criminal employment tax-exposure risk. Waiting for the IRS to act limits available defenses and signals willfulness. Even where a criminal employment tax investigation has already begun, an experienced employment tax defense attorney can interface with IRS-CI and DOJ, present mitigating evidence, and negotiate plea terms that may minimize incarceration and financial penalties.
Contact the Tax Law Offices of David W. Klasing if You Face Payroll Tax Criminal Exposure or Employment Tax Fraud Risk
If you face unpaid employment taxes, trust fund exposure, or payroll practices that a revenue officer or investigator could frame as intentional, you should treat communications as evidence-in-the-making. Payroll tax cases often turn on willfulness, knowledge, and payment priorities, and the government frequently uses your own words and internal emails to prove them. At the Tax Law Offices of David W. Klasing, our dual-licensed Attorneys & CPAs focus on high-risk civil and criminal federal tax controversies, and we manage payroll tax cases the way prosecutors and IRS Criminal Investigation evaluate them: we take immediate control of communications, stabilize document integrity, and build a defense strategy designed to keep a civil payroll tax problem from escalating into a criminal tax investigation.
You should contact us if the IRS raised the Trust Fund Recovery Penalty, requested responsible-person interviews, expanded inquiries into who controlled disbursements, or questioned why the business paid other creditors while payroll tax deposits went unpaid. The IRS can assess the TFRP against responsible persons and pursue personal collection after assessment, so you need an integrated plan that addresses both liability and enforcement pressure before the IRS locks in its narrative. We step in to centralize messaging, prevent damaging admissions, and position the case for the best achievable civil resolution while we actively deter criminal referral where the facts allow.
If you need a coordinated civil and criminal tax defense approach for a payroll tax problem, call the Tax Law Offices of David W. Klasing at 800-681-1295 or use our online contact form HERE to request a confidential, reduced-rate initial consultation.
