26 U.S.C. § 7202: Willful Failure to Pay Over Tax

Federal law under 26 U.S.C. § 7202 makes it a felony to willfully fail to collect, account for, or remit taxes held in trust for the government. The most frequent application of this law involves employment taxes, where businesses must withhold federal income tax, Social Security, and Medicare contributions from employee wages. These withheld funds are considered to be held in trust for the U.S. Treasury, and the law targets the individuals responsible for ensuring these funds are properly paid.

The Core Prohibited Act

The core of this statute is the concept of “trust fund taxes.” When an employer deducts taxes from an employee’s paycheck, that money is not the property of the business. Instead, the employer acts as a fiduciary, holding the funds in a trust for the government as mandated by the Internal Revenue Code. This obligation creates a legal duty to handle these funds with the highest level of care.

The law is violated in two primary ways. The first is failing to collect the required taxes from employee wages. The second, more common violation occurs when an employer collects the taxes but then fails to pay them to the Internal Revenue Service (IRS). In these situations, the collected funds are often diverted to cover other business expenses like rent or supplies, which constitutes a breach of trust.

This law targets the party responsible for remitting the tax, not the employee who owes it. An employee receives credit for the withheld amount regardless of whether the employer pays it to the government. This structure underscores that once withheld, the money belongs to the U.S. Treasury.

Defining Willfulness

A primary element the government must prove is “willfulness,” which is defined as a voluntary and intentional violation of a known legal duty. This standard does not require evidence of malicious intent or a desire to defraud the government. It means the individual was aware of their obligation to pay the taxes and deliberately chose not to. An accidental error, if corrected promptly, would likely not meet this threshold.

Willfulness is often demonstrated by how a business uses its funds. If a person in control of finances has enough money to pay the withheld taxes but knowingly decides to pay other creditors instead, such as suppliers or landlords, that choice is considered a willful act.

Simply being aware of the unpaid taxes and continuing to operate the business by paying other bills can be enough to establish willfulness. The focus is on the intentional decision to use funds held in trust for any purpose other than remitting them to the IRS.

Identifying the Responsible Party

Criminal liability is not confined to a company’s owner or president but applies to any “responsible person.” This term is defined by authority and control rather than by job title. A responsible person is anyone who had the status, duty, and power to direct the payment of trust fund taxes.

The IRS and courts look at several factors to determine who qualifies as a responsible person, including:

• Holding a corporate office
• Having the authority to sign checks
• Controlling corporate financial affairs
• Owning stock
• Having the ability to hire and fire employees

Liability can extend to officers, directors, partners, and employees like a bookkeeper if they had significant influence over which creditors were paid. More than one individual can be designated as a responsible person for the same unpaid taxes.

The main consideration is the individual’s functional authority over the company’s finances. A person can be held responsible if they had the power to decide which financial obligations were met, even if they did not personally handle payroll or delegated the task to a subordinate.

Criminal Penalties and Related Civil Actions

A violation of 26 U.S.C. § 7202 is a felony. Upon conviction, an individual can face imprisonment for up to five years and a fine of up to $10,000. Other federal provisions can increase this amount to $250,000 for an individual and $500,000 for a corporation. The convicted person may also be ordered to pay for the costs of prosecution.

Separate from the criminal charge, the IRS can pursue a parallel civil action under Internal Revenue Code § 6672. This action allows the agency to assess a civil penalty known as the Trust Fund Recovery Penalty (TFRP). The TFRP is a mechanism for the government to collect the unpaid trust fund taxes directly from a responsible person’s personal assets. The amount of the penalty is equal to 100% of the taxes that were not paid over.

A responsible person can face both criminal prosecution and a separate civil assessment making them personally liable for the tax debt. The government can pursue the TFRP against multiple responsible individuals, although it can only collect the total tax amount once.