Business owners in a cash crunch make the same decision every day. Payroll is due, rent is due, a supplier is threatening to cut them off, and there is a pile of withheld tax sitting in the operating account. The IRS can wait, they think.
Usually, the result is a civil problem: a large balance on Form 941 periods and the Trust Fund Recovery Penalty. Sometimes it is a criminal one. IRC 7202 makes willful failure to collect or pay over tax a felony, and the IRS manual calls nonpayment of trust fund taxes the most common form of employment tax fraud.
This guide is general information about the statute and how the IRS approaches it. It is not advice about any business or any person.
The statute
IRC 7202: "Any person required under this title to collect, account for, and pay over any tax imposed by this title who willfully fails to collect or truthfully account for and pay over such tax shall, in addition to other penalties provided by law, be guilty of a felony and, upon conviction thereof, shall be fined not more than $10,000, or imprisoned not more than 5 years, or both, together with the costs of prosecution."
The $10,000 figure is the amount in the statute, but it is not the ceiling in practice. Under 18 U.S.C. 3571, an individual convicted of a felony may be fined up to the greatest of the amount in the offense statute, $250,000, or an alternative fine based on gain or loss.
The elements
The IRS summary in Exhibit 25.1.1-1 lists three elements for section 7202:
- Willfulness.
- A requirement to collect, truthfully account for, and pay over employment taxes.
- Either a failure to collect any tax, or a failure to truthfully account for and pay over any tax, or both.
Notice that the statute covers two different failures. One is not collecting the tax in the first place, for example by not withholding. The other is collecting it and then not truthfully accounting for it and paying it over.
Who is "required" to collect and pay over
The statute applies to "any person required under this title to collect, account for, and pay over" the tax. In a business, that question usually focuses on who had authority over the company's finances and payments. The same practical question drives the civil Trust Fund Recovery Penalty under IRC 6672, which applies to a person required to collect, truthfully account for, and pay over tax who willfully fails to do so. The two provisions use parallel language, and the facts that matter in one usually matter in the other.
Willfulness in the payroll context
Section 7202 requires willfulness, and the general criminal tax definition applies: a voluntary, intentional violation of a known legal duty, as described in IRM 25.1.1.5 and applied by the Supreme Court in Cheek v. United States, 498 U.S. 192 (1991). Good-faith misunderstanding of the law negates it. See willfulness in criminal tax cases.
The facts that tend to show willfulness in payroll cases are the ones the IRS fraud manual describes. IRM 25.1.2.7, on employment tax fraud, says "the most common employment tax fraud ... is not remitting trust fund taxes to the government," and describes the pattern the IRS calls pyramiding.
Pyramiding
The IRS defines pyramiding in IRM 25.1.2.7 as a practice "where a business collects and withholds taxes from its employees and intentionally fails to remit those funds held in trust to the IRS." The manual explains that a lack of operating capital often leads the owner to use the trust funds for other liabilities, the unpaid quarters accumulate, and pyramiding businesses "frequently shut down or file for bankruptcy, and then start a new business under a different name."
The Criminal Investigation manual describes the same scheme in IRM 9.5.3.2.1.2.1 and notes that indications of employment tax fraud are typically discovered by other IRS divisions and referred to CI. The same section flags employee leasing companies, also called professional employer organizations, that fail to pay over taxes withheld from employees as an area of concern.
Not collecting at all
The "failure to collect" branch of section 7202 matters in cases where no tax was withheld in the first place. IRM 25.1.2.7 notes that taxpayers frequently fail to treat as employees people who are misclassified as "self-employed" or "casual labor," while identifying nonpayment of trust fund taxes as the most common employment tax fraud.
Misclassification by itself is usually a civil dispute about employment status. It becomes a criminal question only when the government can prove willfulness, a voluntary, intentional violation of a known legal duty. The CI manual's discussion of section 7215 gives an example of the kind of reasonable doubt that matters: doubt about whether a person was an employer or was dealing with an independent contractor.
Other statutes in employment tax cases
Section 7202 is not the only tool. IRM 25.1.2.7 lists criminal violations associated with employment tax fraud: sections 7202, 7203, 7206, 7212, and 7215.
Section 7215 deserves a mention because it works differently. According to the IRS summary in Exhibit 25.1.1-1, it is a misdemeanor that applies when a person required to collect and pay over withheld income tax and FICA was notified of the failure, and then failed to collect, account for, and pay over, while not having a reasonable doubt about whether the law required it and where the failure was not due to circumstances beyond the person's control. The CI manual, IRM 9.5.3.2.1.2.2, notes that this penalty "is not limited to the 'willful' failure investigations," and explains that a lack of funds immediately after paying wages is not treated as a circumstance beyond the person's control.
What happens to collection during a criminal case
Once a criminal employment tax investigation begins, the civil collection process slows down in specific ways. IRM 9.5.3.2.1.2.3 says the other IRS divisions will not contact the subject, the representative, or employees about collecting the amounts due under the notice, or take other enforcement action on those amounts, without the prior concurrence of the Special Agent in Charge. It also says no partial payment or installment agreements covering prior delinquencies will be entered into with the subject after the referral to CI, though voluntary payments can be accepted and liens filed where needed.
That is a significant change for a business owner used to negotiating with a revenue officer. Once CI is involved, the civil options narrow.
The civil side does not go away
Section 7202 says its penalties apply "in addition to other penalties provided by law." The Trust Fund Recovery Penalty under IRC 6672 remains available, and IRC 6672(b) requires the IRS to send a preliminary notice at least 60 days before notice and demand for that penalty. A criminal case and the civil penalty can run on the same facts. See civil vs. criminal tax fraud.
Statute of limitations
Whether a payroll case falls within the 3-year default or a 6-year exception under IRC 6531 depends on how it is charged. The 6-year list includes willfully failing to pay any tax or make any return, and evasion of tax or its payment. See the criminal tax statute of limitations.
What owners should take from this
Falling behind on payroll taxes is common, and most of those cases stay civil. What moves a case toward section 7202 is a pattern: withholding, not paying, knowing it, and continuing, especially while paying other creditors, or closing and reopening under new names.
If that describes your business, stop the bleeding and get a lawyer. Current-quarter compliance matters. So does how you talk to the revenue officer about the past.
The civil manual also routes employment tax fraud cases specifically. IRM 25.1.2.7 points examiners to employment tax civil and criminal fraud procedures in IRM 4.23.9, including guidance on assessing the Trust Fund Recovery Penalty in cases that may involve criminal proceedings.
Frequently asked questions
Is not paying payroll taxes a crime?
It can be. IRC 7202 makes it a felony for a person required to collect, account for, and pay over tax to willfully fail to do so. Most unpaid payroll tax cases are handled civilly, including through the Trust Fund Recovery Penalty.
What is the penalty under section 7202?
The statute provides a fine of not more than $10,000, imprisonment of not more than 5 years, or both, plus costs of prosecution. 18 U.S.C. 3571 can allow a higher fine for felonies.
What is pyramiding?
The IRS describes pyramiding in IRM 25.1.2.7 as withholding taxes from employees and intentionally failing to remit them, letting unpaid quarters accumulate, often followed by closing the business and starting again under a new name.
Can I set up a payment plan if CI is investigating?
IRM 9.5.3.2.1.2.3 says no partial payment or installment agreements covering prior delinquencies will be entered into with the subject after a referral to CI. Voluntary payments may still be accepted. Talk to counsel before making any payment decisions.
General information only, not legal advice. Reading this page does not create an attorney-client relationship. Laws and IRS procedures change; the sources cited were reviewed on the date shown above.