Understanding IRS Collection Priority: What Gets Paid First

Quick overview

IRS collection priority describes how the Internal Revenue Service decides which tax liabilities get satisfied first when money or enforced collection actions are available. Knowing the hierarchy matters: if you run a business or are responsible for payroll withholding, getting the order wrong can trigger personal liability, additional penalties, or loss of access to bank accounts.

This guide explains the typical priority order, how the IRS applies payments, real-world implications, practical steps to protect yourself, and when to use relief tools such as installment agreements or penalty abatements.

(Author’s note: In my 15+ years advising taxpayers, I routinely see preventable harm when business owners or individuals misunderstand which debts the IRS treats as highest priority.)

The typical IRS collection hierarchy (what usually gets paid first)

While the IRS follows statutory and administrative rules that can vary by circumstance, a practical priority order looks like this:

1. Trust fund (payroll) taxes and associated trust-fund recovery liabilities — the portions of payroll taxes withheld from employees that an employer was required to hold and send to the IRS. These are treated as highest priority because the employer holds these funds in trust for the government. (See IRS — Trust Fund Recovery Penalty.)
2. Assessed federal income taxes — unpaid income tax balances legally assessed against an individual or business.
3. Accrued interest and statutory penalties — these arise after assessment and generally trail the principal tax in collection priority.
4. Other federal taxes (excise, estate, gift) — may be interwoven with priority depending on assessments and attachments.

This order matters in two common settings: (a) when you voluntarily send a payment or designate application of funds, and (b) when the IRS enforces collection through levies or by applying available funds.

Authority and context: The IRS treats withheld payroll taxes specially because the employer never owned those dollars — they are trust funds. The IRS enforces recovery through the Trust Fund Recovery Penalty (TFRP), which can create personal liability for responsible persons (IRS — Trust Fund Recovery Penalty). For general guidance on paying taxes and collection tools see the IRS Payments and Collection resources (irs.gov/payments; irs.gov/levies).

How the IRS applies payments (practical rules)

• Taxpayer designation: If you submit a payment and clearly designate it for a specific tax year or type of liability, the IRS will generally honor that designation. Use the payment voucher or online payment tool to specify the tax year/type.
• No designation: When a payment lacks clear designation, the IRS applies it under its internal “application of payments” rules. In many cases the payment is applied to the oldest outstanding assessed liability. That can be helpful or harmful depending on which liability you intended to address.
• Enforcement actions (levies/offsets): When the IRS levies a bank account or wages, the levy typically satisfies the legally enforceable assessed liabilities rather than discretionary items. The IRS also prioritizes trust-fund amounts when pursuing responsible persons.

Because application rules can materially affect outcomes, always mark payments precisely and confirm with a tax professional if you have multiple outstanding liabilities.

Real-world implications and examples

Example 1 — Small business payroll: A small employer fell behind on payroll deposits and other federal taxes. They paid a portion of the business’ general income tax thinking that would stop enforcement. The IRS proceeded to assess the Trust Fund Recovery Penalty against the owner and levied the business account to satisfy the unpaid withholding. The withheld wages are treated as trust funds — the IRS enforces them vigorously.

Example 2 — Individual with multiple years due: A taxpayer mailed a lump-sum check without indicating the tax year. The IRS applied the payment to the oldest assessed year, which still had penalties and interest; a more recent assessed balance (with smaller trust-fund exposure) remained unpaid and later faced a levy. Clear designation would likely have avoided the unexpected levy.

(These examples reflect situations I’ve handled in practice.)

Practical steps to manage collection priority and reduce risk

1. Identify all outstanding liabilities and their assessment dates. Request a tax transcript from the IRS if uncertain.
2. Designate payments carefully. Use Form 1040-V or the online payment system and include the tax year and type.
3. Prioritize trust fund taxes if your business collects payroll withholding. Treat those funds as untouchable operating capital.
4. If you can’t pay in full, consider an installment agreement — see our guide to IRS Installment Agreements: Types, Costs, and Application Tips. Choosing the right agreement can prevent aggressive collection while you pay down higher-priority balances.
5. Seek penalty relief where appropriate. First-time penalty abatement, reasonable cause arguments, and other relief options can lower the burden of penalties and interest (ask a CPA or enrolled agent to help prepare the request).
6. If you’re a responsible person for payroll, evaluate potential exposure to the Trust Fund Recovery Penalty and consult counsel before restructuring or closing payroll accounts.
7. Maintain current filing and deposit practices — most enforcement starts when deposits aren’t made or returns are delinquent.

When the IRS enforces: levies, liens, and the order of collection

• Liens: A Notice of Federal Tax Lien (NFTL) protects the government’s interest in property. It does not itself seize assets but can block transfers and subordinate other creditors depending on when the NFTL is filed.
• Levies: An IRS levy seizes property subject to levy, such as bank accounts, wages, and certain personal property. Levies are an immediate step to collect assessed unpaid taxes.

In practical terms, levies and seizures tend to be used to satisfy the most legally enforceable and highest priority assessed liabilities (including trust fund amounts). If you face an imminent levy, act fast — available remedies include an installment agreement, submitting a collection due process (CDP) appeal, or requesting a stay in limited circumstances.

For more on consequences of failing to comply with installment terms, read Defaulting on an Installment Agreement: Consequences and Fixes.

Negotiation tools and alternatives

• Installment agreements: Spread payments over time. Depending on balance and eligibility, options include streamlined agreements and partial-payment plans. See our practical guide to installment agreements linked above for details.
• Offer in Compromise (OIC): May settle the liability for less than the total if paying the full amount would create financial hardship and the offer meets IRS criteria.
• Currently Not Collectible (CNC) status: Temporary relief if you can show inability to pay living expenses. CNC leaves the liability in place but pauses active collection for a time.
• Penalty abatement and appeals: Administrative relief can remove penalties if you have reasonable cause or qualify for first-time abatement.

Choosing the right tool depends on which liabilities are highest priority and the taxpayer’s cash flow. In my practice, pairing a penalty-abatement request with an installment agreement frequently yields the best net cash outcome for taxpayers who acted before levies started.

Common mistakes and how to avoid them

• Treating withheld payroll taxes as company money. Those funds are held in trust — using them risks personal liability.
• Sending undirected lump-sum payments without specifying which liability to apply the payment toward.
• Delaying professional advice when a responsible-person assessment or levy is possible.
• Assuming penalties should be paid first — often paying principal (or trust fund amounts) is more important to stop severe enforcement.

Frequently asked questions

Q: Can I choose which IRS debt gets paid first?
A: You can designate payments for a particular tax year and type; absent designation, the IRS applies payments under its rules. Always make designations in writing and retain proof.

Q: Are payroll withholdings dischargeable in bankruptcy?
A: Generally no; trust fund portions of payroll taxes and certain payroll-related penalties are not dischargeable. Consult bankruptcy counsel for specifics to your case.

Q: If I enter an installment agreement, will the IRS still prioritize trust fund taxes?
A: Yes — trust fund obligations and assessed balances remain enforceable. An installment agreement reduces immediate enforcement but must be carefully structured if trust fund exposure exists.

Bottom line and action checklist

• Treat payroll withholding as the highest operational priority.
• Request a tax transcript to list exact liabilities and assessment dates.
• Designate payments clearly and keep proof.
• If you cannot pay, contact a tax professional and consider an installment agreement or other relief (see our guide to installment agreements).

This article is educational and does not replace tailored tax or legal advice. Tax penalties and collection rules change; consult a CPA, enrolled agent, or tax attorney for assistance specific to your facts.

Authoritative sources

• IRS — Trust Fund Recovery Penalty: https://www.irs.gov/businesses/small-businesses-self-employed/trust-fund-recovery-penalty
• IRS — Payments: https://www.irs.gov/payments
• IRS — Levies: https://www.irs.gov/businesses/small-businesses-self-employed/levies

Additional FinHelp resources

• IRS Installment Agreements: Types, Costs, and Application Tips (FinHelp): https://finhelp.io/glossary/irs-installment-agreements-types-costs-and-application-tips/
• Defaulting on an Installment Agreement: Consequences and Fixes (FinHelp): https://finhelp.io/glossary/defaulting-on-an-installment-agreement-consequences-and-fixes/
• How Penalties Accrue During an Installment Agreement (FinHelp): https://finhelp.io/glossary/how-penalties-accrue-during-an-installment-agreement/

Professional disclaimer: This content is for informational purposes only and does not constitute legal, tax, or financial advice. Always consult a qualified professional about your situation.