Payroll Tax Debt Is Different From Other Business Tax Debt

The whole point of the business entity is protection.

Protection from lawsuits. Protection from creditors. Protection from the worry that one bad business outcome can take everything you built outside of it. It's probably part of why most business owners incorporated in the first place.

But there's one glaring exception.

Payroll tax debt is not like other business tax debt. A Michigan federal court ruling from May 2026 is the latest reminder. The business in that case went bankrupt.

The IRS had a claim against the business for over $14 million. And at the end of the day, the business owed the taxes but two individual owners were liable for them...personally.

A personal judgment against owners whose business no longer existed

Five things about business payroll tax debt that business owners probably don't know about.

1. To understand why this gets personal, you have to understand what kind of money payroll taxes actually are.

When a business runs payroll, it withholds income tax, Social Security, and Medicare from every employee's check. That money never belonged to the business.

From the moment it leaves the employee's paycheck, it's the government's money. The business is just holding it temporarily until the next deposit deadline. The IRS calls them trust fund taxes because that's exactly what they are.

Here's why it matters.

The government is legally required to credit employees for those withholdings whether or not the employer ever sends the money in. When an employer doesn't remit, the IRS absorbs that loss directly.

That''s why Congress created Section 6672, a provision designed to reach past the business and hold individuals personally liable.

To do that, the IRS has to prove two things: that the person was a responsible party with real authority over company finances, and that they acted willfully — knowing the taxes weren't being paid while allowing money to go elsewhere.

And once the IRS makes that assessment, it's presumed correct. The burden shifts to your client to prove otherwise.

2. Hurdle one: Are they a "responsible person"?

The first question the IRS has to answer is whether your client was a responsible person — meaning someone who had the authority and control to make sure the taxes got paid.

This isn't about job title. It's about actual power inside the company. Courts look at things like: Could they sign checks? Did they have ownership? Did they have an officer role? Did they hire and fire people? Did they control how money moved?

One of the owners in this case argued he didn't really control the finances — his co-president did. The court went through the facts and wasn't persuaded. He co-founded the company. He was co-president. He owned 50% of the shares. He could sign checks. He signed tax returns. He was the liaison to the accountant.

The legal standard isn't "did you have absolute control." It's "did you have significant control." That's a much lower bar — and most owners of closely held businesses clear it without knowing it.

There's also a harder lesson buried here. This owner had previously submitted an official IRS collection form — under penalty of perjury — acknowledging he was a responsible party.

When he tried to argue the opposite in court, the judge applied what's called the sham affidavit doctrine. You can't swear one thing to the IRS and swear the opposite to a federal judge. That earlier admission stood.

What your clients say to the IRS — formally, in writing, under oath — matters years later.

3. Hurdle two: Did they "willfully" fail to pay?

Being a responsible person isn't enough on its own. The IRS also has to show the person willfully failed to pay the taxes over. And this is where a lot of business owners make things much worse without knowing it.

Willfulness doesn't mean intentional fraud. It doesn't mean your client was scheming to cheat the government. Under the law, willfulness simply means: they knew the taxes weren't being paid, and they allowed money to go somewhere else instead.

That's it.

The moment a responsible person becomes aware of an unpaid payroll tax liability, the law treats every subsequent payment decision as legally consequential.

Paying suppliers? Willful. Paying employees? Willful. Taking a salary draw? Willful. Making loans to related entities? Also willful.

The company in this case was still paying out tens of millions of dollars in operating expenses after the owners knew the taxes were delinquent.

The owner was still drawing a salary. The court treated all of it as evidence of willfulness.

There is a deeply human impulse to keep the business alive — keep employees paid, keep vendors happy, hope to catch up on taxes next quarter when things stabilize. That impulse, completely understandable, creates personal liability with every transaction after the moment of knowledge.

4. Both hurdles have to clear — but if they do, the damage is personal and lasting.

Here's why the two-part structure matters for your clients: it's not enough to be in charge. The IRS also has to show willfulness. And it's not enough to have paid something else. The IRS also has to show the person had authority.

But when both boxes are checked — and in the typical small business payroll tax situation, they usually are — the consequences follow the owner personally. Not just through the bankruptcy of the company.

Not just through the IRS lien on the business. Through to their personal finances, their personal assets, their future income.

The company in this case went bankrupt. The IRS kept going. They filed suit against the individual owners. The court entered judgment. Personal liability. The business being gone provided no shelter.

5. The IRS can come after the owner personally — even when the business has a payroll company handling taxes.

The business in this case — a telemarketing company out of Michigan — used outside payroll administrators to handle their employment taxes.

They had professional help.

And yet, when the taxes didn't get paid, the IRS went directly after the owners personally.

Using a payroll company doesn't transfer responsibility. If your client is an owner, a co-president, a check-signer, a decision-maker, it's their responsibility to make sure the payroll taxes get paid, even if an outside vendor is handling it.

TL;DR

⏩ Payroll tax debt is uniquely dangerous — the IRS can hold business owners personally liable through the Trust Fund Recovery Penalty.

⏩ To impose personal liability, the IRS must prove two things separately: (1) the person was a responsible person with significant control over company finances, and (2) they willfully failed to pay by knowingly allowing money to go elsewhere while taxes went unpaid.

⏩ Responsible person status is broader than most owners expect — equity, signing authority, and an officer title are usually enough.

⏩ Willfulness doesn't require intent to cheat — just knowledge of the delinquency combined with paying any other creditor instead.

⏩ A business going bankrupt doesn't end the IRS's pursuit of the individual owners.