I owe multiple tax debts. Which one should I pay first?
A client of mine came to me recently with a knot in his stomach. He owed the IRS twice.
One debt was income tax on his business profits, which flowed through to his personal return the way most partnership and S corp income does. The other was a trust fund recovery penalty for payroll taxes the business didn't pay.
He had saved up some money and was about to send it in. His only question was "Is this enough to make them stop?"
Before he mailed anything, I told him to write on the check which debt the payment was for.
Juggling several IRS bills is exhausting
When you owe the IRS for one thing, you worry. When you owe for two or three, every envelope feels like it could be the one that empties your bank account. People tell me they lie awake doing the math, wondering which bill to feed first, and feeling like nothing they send ever makes a dent.
Part of that feeling is real. If you send money without instructions, it may not go where it helps you most. The good news is that on a voluntary payment, you get a say.
You can tell the IRS where your payment goes
The IRS lets you designate a voluntary payment. You tell it which tax, which period, and even whether the money goes to tax, penalty or interest. The Internal Revenue Manual describes a designated payment as one the taxpayer has directed to a specific period or kind of tax, and says "Normally such direction will be followed by the IRS" (IRM 5.1.2.9).
IRS Chief Counsel has said (CCA 202129007) the designation must be:
specific,
in writing, and
made at the time of the payment.
You can't call a month later and ask to move it.
What the IRS does if you don't designate
If you send a partial payment without written instructions and owe for more than one period, the IRS applies it to periods "in the order of priority that the Service determines will serve its best interest" (Rev. Proc. 2002-26). IRS Chief Counsel put it this way: the payment is applied "in a manner serving the best interests of the government." Within a period, it generally goes to tax, then penalty, then interest. The IRS interest manual says undesignated payments are generally credited first to the earliest year with a balance (IRM 20.2.5).
In other words, the IRS picks. What is best for the government is often not what is best for you.
Why I put his payment on the trust fund penalty first
In my client's case, I had him designate the payment to the trust fund recovery penalty.
The trust fund part of payroll taxes is the income tax and the employee's share of Social Security and Medicare that the business held back from paychecks. The IRS treats that as the employees' money, held in trust, not the business's money. In my experience, that is where the IRS gives the least room and moves to a levy fastest.
The income tax on his business profits came from the same business, but there is usually more room there to work out a payment plan or other options.
That's how I saw his situation. Every case is different, so look at all of your balances before you decide on an order.
The payroll side: designate to the trust fund portion
This also matters before anyone is personally assessed. Under IRS Policy Statement 5-14, any payment on the business's payroll account is treated as paying the non-trust fund portion first (for example, the employer's share of FICA) unless the taxpayer designates otherwise. Only after that is covered does an undesignated payment go to the trust fund portion. The non-trust fund part is not what the responsible people can be personally charged with.
So if the business pays and designates the payment to the trust fund portion of a specific Form 941 quarter, it reduces the amount the owners and other responsible people can be personally liable for. The same payment sent undesignated can lower the business balance while leaving the personal exposure where it was.
Why the period matters, not just the type of tax
This is the part people skip. Writing "trust fund penalty" or "income tax" is not enough when you owe for more than one year or quarter. Here is why I always want the period on it too:
The IRS needs it to follow your instructions. A designation has to be specific. "Apply to my income tax" when you owe for 2022, 2023 and 2024 still leaves the IRS to choose the year.
Each payroll quarter is its own balance. Form 941 is filed every quarter, so a trust fund problem is usually several separate quarters. Name the quarter, for example "Form 941, quarter ending 6/30/2024, trust fund portion."
Each assessment has its own collection clock. The IRS generally has 10 years from the date a tax is assessed to collect it, including penalties and interest. The IRS calls that date the Collection Statute Expiration Date (CSED), and each assessment on your account, including a civil penalty like the TFRP, has its own. Things like an installment agreement request, an offer in compromise or bankruptcy can pause or extend it. Which period you pay down can matter, so talk it through before you choose.
The IRS tends to go oldest first. For undesignated payments, the IRS generally starts with the earliest period. That may or may not be where you need the money.
Payments can land in the wrong year. I see this often with estimated tax. Someone sends a payment in January meaning it for last year, and it posts to the new year. Then a notice comes for a balance they thought they paid. Putting the year clearly on the payment helps prevent that.
What to write on the check, voucher or cover letter
The IRS asks people to pay online when they can. If you pay by check or money order, make it payable to "U.S. Treasury" with the amount in dollars and cents. The IRS asks you to include:
Your name, address and phone number (for a business, the name exactly as the IRS has it)
Your SSN for personal debts, or the EIN for a business or payroll debt (or ITIN, if that's what you use)
The tax form or notice number: for example Form 1040, Form 941, or the notice the IRS sent about the trust fund recovery penalty
The tax year or period: for example 2024, or the quarter ending 9/30/2024
Then add your designation: what to apply it to, such as "trust fund portion" or "tax only." I put it on the check and in a short cover letter, for example: "Please apply this voluntary payment of $X to [name], [SSN or EIN], [form], [period], [portion]." Keep a copy of the letter and the check.
Mail it to the address on the notice or in the form instructions. Don't staple or clip the check to the notice or voucher. If a notice came with a payment voucher, use it and still add your written designation. The IRS says to allow about 2 weeks for a mailed check to be received and processed. If you pay online, choose the tax type and the year or period carefully.
Things designation can't do
It only works on voluntary payments. The IRS has said there is no right to designate money it takes through enforced collection, like a levy on your bank account or wages.
It has to happen when you pay. Not later.
It doesn't make the other debts go away. It just puts your money where it does the most good while you work out the rest.
A little planning on that first check can take some of the pressure off. You stop throwing money at a pile and start knocking down the bill that worries you most.
Related: Should you take a loan to pay the IRS, or set up a payment plan? · Business payroll tax debt: when it becomes your personal problem · Would you rather be right, or win? Collections while you appeal
Short FAQ
Can I choose which IRS debt my payment goes to? Yes, on a voluntary payment, if you designate it specifically and in writing at the time you pay.
What happens if I don't say where the payment goes? The IRS applies it in the way that serves the government's best interest, generally the earliest period first, then tax, penalty and interest.
Can I designate a payment the IRS took by levy? No. Designation only applies to voluntary payments.
Does a business payment on payroll taxes reduce the trust fund recovery penalty? It can, if it's designated to the trust fund portion. Undesignated payments generally go to the employer's share first.
Why do I need to write the tax year or quarter? Each year and each quarter is a separate balance with its own collection clock. Without the period, the IRS chooses where the money goes.
If you're juggling more than one IRS bill and aren't sure which to pay first, message me.
I help with IRS, New York, New Jersey, Connecticut and Pennsylvania tax problems.
General info, not advice for your specific case.
