The One Creditor You Always Pay First

[IMAGE: An IRS notice envelope on a desk beside a small business checkbook, a calculator, and a cup of coffee under a desk lamp]

I have had this conversation about eight hundred times in thirty-one years, and the answer has never once changed. When cash is tight and you have to choose who gets paid and who waits, there is one category of creditor that always gets paid first. Always. Not sometimes. Not usually. Always. The government.

Let me tell you about a man named Carl.

Carl owns a commercial landscaping outfit in Sarasota, Florida. Ten trucks, twenty-three employees at peak, eighteen years running. Good contracts, mostly HOAs and commercial properties, the kind of steady recurring revenue book that is a hard thing to build and an easy thing to lose. When Carl sat down across from me in May of 2025, he had what looked like a manageable amount of debt on paper — about two hundred and ten thousand total, spread across a bank line, three credit cards, a truck note, and an MCA he had taken the prior fall. On the face of it, nothing he and I could not work through in twelve months.

Then I asked the question I always ask, and Carl's face did the thing. You know the thing. The thing where the color drops a shade and the jaw tightens and he looks out the window for a second.

"Carl," I said, "tell me about the IRS."

Four years of unfiled corporate returns. Six quarters of unremitted payroll taxes — the trust fund piece, the one that comes out of employee paychecks and is supposed to be deposited with the Treasury inside a few days. Personal 1040s not filed for three years. A letter from the IRS that had been sitting in a drawer in his office for five months. And an SBA disaster loan from COVID that had not been serviced in fourteen months.

Carl's real problem was not the two hundred and ten thousand in private debt. Carl's real problem was the one hundred and fifty-eight thousand in government debt I had to drag out of him, plus penalties and interest that had been compounding on it for three years. Because the private debt we could negotiate. The government debt was going to come out of his hide one way or another, and the only question was how much hide he had left by the time we got to it.

If you have any government debt on your books — federal income tax, state income tax, sales tax, payroll tax, SBA loan, state unemployment, workers' comp — and you are even thinking about paying a private creditor ahead of it this month, you need to hold your horses and read every word of what I am about to write.

Why government debt is different

I want to start with the basic framing, because a lot of owners do not quite understand why I am so insistent on this. They see a bill from the IRS and they see a bill from a credit card company and they think of them as two versions of the same thing. They are not. They are two fundamentally different kinds of debt, with fundamentally different enforcement tools behind them, and confusing one for the other is how small businesses end up in a hole they genuinely cannot climb out of.

Here is the difference in one sentence. Private creditors are trying to collect money. The government is trying to collect money and has the power to compel payment, with or without your cooperation.

A credit card company that cannot collect from you has a sequence of options. They can call. They can send letters. They can report to the credit bureaus. Eventually, if the debt is large enough, they can sue and get a judgment. Even after they have a judgment, they have to domesticate it in your state, locate assets, and levy — and in most states, there are meaningful exemptions that protect primary residences, retirement accounts, and wages below certain thresholds. The whole process takes months to years and costs the creditor real money. That is why, on most aged private debt, the creditor eventually settles for a fraction of face value. The settlement is cheaper than the collection.

The government does not have that problem. The IRS does not need a judgment. They do not need to sue. They do not need to hire a law firm. They assess a tax, they send you a series of notices, and at the end of the notice sequence, they have the power to lien your property, levy your accounts, garnish your wages, and seize assets — all administratively, without a courtroom, without your participation, and without much of anything you can do to slow it down once it starts. The tools the government has available are tools no private creditor has. That changes the math on who gets paid first.

Penalties and interest that compound on you

The first reason the IRS is the most dangerous creditor in America is that the math of what you owe them gets worse every single day you do not pay. This is not like a credit card, where the interest rate is static and the balance grows in a predictable line. The IRS layers penalties on top of penalties on top of interest, and some of those penalties compound, and the totals get out of hand fast.

Let me walk you through the basic stack, because most owners genuinely do not know what they are looking at.

Failure-to-file penalty. If you did not file the return on time, you owe five percent of the unpaid tax per month, up to twenty-five percent. That is a penalty on top of the tax you already owe. If you are more than sixty days late, there is a minimum penalty that kicks in regardless of the balance.

Failure-to-pay penalty. If you filed but did not pay, you owe half a percent of the unpaid tax per month, up to twenty-five percent. This one stacks with the failure-to-file penalty in the months where both apply.

Interest on the tax. The IRS charges interest on the unpaid tax at the federal short-term rate plus three percent, adjusted quarterly. In 2025, that has been running around eight percent, compounded daily.

Interest on the penalties. This is the part that surprises folks. The IRS also charges interest on the penalties. So your penalty is accruing interest, which is itself a running charge. The penalty plus interest plus interest-on-the-penalty stack can, on a sufficiently aged balance, double the original tax owed inside three to four years.

This is why an owner like Carl, who "only" owed about seventy thousand in original payroll tax, had one hundred and fifty-eight thousand by the time he sat in my office. The original liability was less than half the total. The rest was penalties and interest that had been quietly compounding on him every single month he did not address it. And every month he continued not to address it, the number would grow another two to three thousand dollars. Just sitting there. Doing nothing.

Federal tax liens — the silent business killer

Once you owe the IRS enough money long enough, and you have not responded to the collection notices, the IRS files a Notice of Federal Tax Lien. This is not a lien on any specific asset. This is a lien against everything you own — your real estate, your business equipment, your vehicles, your accounts receivable, your bank accounts — present and future. One document. Filed publicly. Everything in your name encumbered in one sitting.

A tax lien does a few things that matter operationally.

Your credit is done. A federal tax lien, once filed, torches your credit score. Banks will not lend to you. Leasing companies will not lease to you. Your bonding, if you need it for public work, will not renew. Even vendors who run credit checks will tighten your terms or demand prepayment.

You cannot sell real estate cleanly. If you have a lien and you want to sell your commercial building, your home, or any real property — the title company will not issue clean title until the lien is satisfied. Which means at closing, the IRS gets paid first out of the proceeds, before you see a dollar. In a lot of cases, that wipes out the entire equity you had built in the property.

Future income is encumbered. The lien attaches to after-acquired property. Meaning any new equipment, any new real estate, any future earnings — the lien follows you. You do not get to outrun it by working harder or earning more. The harder you work, the more there is for the IRS to attach to.

Your bank relationships get weird. Commercial bankers can see the lien in standard searches. Your line of credit gets reviewed. Sometimes your line gets cut. Sometimes the bank wants additional collateral. The lien changes every conversation you have with a lender for as long as it is on file.

A federal tax lien is one of the cheapest things the IRS can do to you and one of the most destructive things that can happen to a small business. It costs them one piece of paper and it costs you, in effect, your ability to operate as a normal commercial actor. Don't beat around the bush. This is the hammer that follows the notices, and the only way to avoid it is to engage with the IRS before they get to it.

[IMAGE: Close-up of an official-looking IRS Notice of Federal Tax Lien document on a desk]

Wage garnishment and bank levies

Past the lien, the IRS has two tools that hit you in the bank account directly. Both of them operate administratively — no lawsuit required — and both of them will ruin a week.

Bank levy. The IRS serves a levy on your bank, and the bank is legally required to freeze whatever is in the account on the day the levy hits. The funds sit frozen for twenty-one days, during which you have a limited window to contest or negotiate. If you do not, on day twenty-two the bank sends the funds to the IRS. Whatever was in the account is gone. Payroll does not run. Vendor checks bounce. Your operating capacity evaporates overnight.

Wage garnishment. If you draw a W-2 salary from your business or any other employer, the IRS can issue a wage levy directly to the payer. The federal exemption table — which determines how much of your paycheck you get to keep — is meaningfully less generous than most state exemptions for private creditors. Depending on your filing status and dependents, the IRS might leave you with a few hundred a week and take everything else. Your employer has no choice in the matter. They comply with the levy or they become liable themselves.

Accounts receivable levy. This one is the silent business killer. The IRS sends levies directly to the customers who owe your business money. The customer is legally required to send the funds to the IRS instead of to you. Not only does this cost you the receivable, it also tells your customers — the people whose ongoing business you depend on — that your business is in serious tax trouble. A lot of customers do not come back after they get one of those letters. A lot of them never paid attention to whether you were in trouble before, and now they have written proof of it in their filing cabinet.

None of these tools require a lawsuit. None of them require you to get your day in court first. The IRS has administrative authority to do all of it, and the only thing standing between a compliant taxpayer and an IRS collection action is the fact that the taxpayer engaged with the process before the tools came out of the drawer.

The Trust Fund Recovery Penalty — the worst one

I want to spend real time on this one because it is the single most dangerous exposure a small business owner has, and most of them do not understand it until it is too late to do anything about it.

When you run payroll, you withhold federal income tax, Social Security, and Medicare from your employees' paychecks. That money, the moment you withhold it, is not yours. It belongs to the employee, and by extension to the Treasury. You are holding it in trust. You are legally required to deposit it with the IRS on a regular schedule — weekly, semi-weekly, or monthly depending on the size of your payroll.

If you do not deposit it — if you use that money to make payroll, to pay a vendor, to keep the lights on, to pay yourself — the IRS calls it a misuse of trust funds, and they have a specific tool to come after the responsible individuals for the unpaid amount. It is called the Trust Fund Recovery Penalty, and here is why it is the worst debt an owner can have.

It pierces the corporate veil. The LLC or corporation you operate through is supposed to separate your personal assets from the business. For unremitted payroll taxes, the TFRP says: not anymore. Any person deemed "willful and responsible" for the nonpayment — which almost always includes the owner, and often includes the bookkeeper, the CFO, and anyone with check-signing authority — becomes personally liable for the full amount of the unremitted trust fund portion. Your house. Your retirement accounts. Your personal savings. Your personal credit. All of it is exposed.

The business closing does not save you. This is the part that shocks owners the most. If the business fails and goes out of existence, the TFRP against you personally survives. The business is gone. The liability remains. The IRS will pursue you personally for the rest of your life or until the statute of limitations runs, whichever comes first.

Bankruptcy does not discharge it. Trust fund taxes are generally non-dischargeable in Chapter 7. You can discharge the credit card debt. You can discharge the MCA. You cannot discharge the TFRP. It follows you out of bankruptcy and into the rest of your life.

It is not negotiable the way the corporate side is. The IRS can and does negotiate on the business side of payroll tax debt — installment agreements, offers in compromise, and so on. The individual TFRP is a harder conversation. It can be negotiated, but the bar is higher, the tools are fewer, and the outcomes are worse.

An owner who uses trust fund money to float the business in a bad quarter is, in the eyes of the IRS, an owner who stole from his employees and from the Treasury. That is not my language. That is how the collections function at the IRS views it, and that is how they pursue it. You can get your feathers ruffled at the framing. The framing does not change.

If you are behind on payroll taxes right now, that is the single most urgent phone call you need to make this week. Not next week. This week. The TFRP determination is not something to be handled by the owner alone, and the downstream exposure is too severe to be handled reactively.

[IMAGE: Payroll register printout beside a folded IRS letter, with a small business owner's hand resting on the letter]

SBA loans — the government debt hiding in private clothing

The other major government creditor a lot of small business owners have — and underestimate — is the SBA. A Small Business Administration-backed loan is originated by a private bank, but the loan is guaranteed by the federal government. If you default, the bank gets paid by the SBA and the SBA then owns the debt. That shift changes everything about how the debt behaves.

Personal guarantees are standard. Nearly every SBA loan of any size requires the owner to personally guarantee the debt. If the business closes, the guarantee survives.

Treasury offset. Once the debt is owned by the federal government, it gets fed into the Treasury Offset Program. Any federal payment due to you personally — tax refunds, Social Security benefits, federal retirement benefits, contractor payments — can be intercepted and applied to the debt. You do not have to consent. The offset happens administratively.

Administrative wage garnishment. The federal government can garnish your wages for a defaulted SBA loan without suing you first, using the same administrative authority as other federal debts. Up to fifteen percent of your disposable pay can be taken.

Unlimited patience. A private lender writes off bad debt after a period and moves on. The federal government does not. The SBA will pursue a defaulted loan for the full statute of limitations, which can be years longer than any private creditor would spend on the same account.

The pandemic-era EIDL and PPP loans added hundreds of thousands of small businesses to the SBA's collections pipeline, and the backlog of those in various states of delinquency is still working its way through the system. If you took one and you are behind on it, the fact that you have not heard anything yet does not mean nothing is going to happen. It means the wheels of the federal collection machine have not gotten to your file yet. They will.

Why private creditors settle and the government does not

I want to connect the pieces here because this is the heart of the argument.

When a private creditor sits on a troubled account, they do a mental math. How much can I spend chasing this? How much am I likely to recover? What are the odds I end up with nothing? For most private creditors on aged debt, the answer is that chasing in full is more expensive than settling for a fraction. That is why a credit card company that you owe forty thousand dollars will often take fifteen to twenty thousand in a lump sum settlement — not because they like you, but because the math says that is the best they are going to do. It is the same math your personal finance instincts tell you when you are deciding whether to chase a small debt someone owes you. Some recoveries are not worth the effort.

The government does not do that math. The government has unlimited patience, unlimited staff, and collection tools that cost them almost nothing to deploy. Sending a lien is a sheet of paper. Sending a levy is a sheet of paper. Offsetting a tax refund is a database entry. The marginal cost of continued collection for the government is essentially zero, and the statute of limitations is long enough that they can sit on a file for years and still get paid in full.

That is why the settlement dynamics are completely different. The IRS does offer offers in compromise, and in the right circumstances they are a legitimate path to partial resolution. But the bar is high, the process is intrusive, and the outcomes are worse than what a private creditor would accept in a routine negotiation. The IRS is not playing the same game as the credit card company, and if you treat them the same way, you will find out the hard way that they are not the same.

Pay Uncle Sam before you pay yourself. Always. No exceptions. That is the rule.

How to prioritize when you can't pay everyone

If you are reading this and you are behind on everything and you cannot make the math work for the month, here is the prioritization order I have used for three decades of distressed-client work.

One. Current payroll. Your employees eat this week.

Two. Current payroll tax deposits. The trust fund piece deposited on schedule. Do not let a new deposit period get behind. If you are already behind on prior deposits, that is a problem we address. The new ones stop the bleed.

Three. Current sales tax remittance. Sales tax is also trust fund in most states, with many of the same personal-liability dynamics. Current period gets remitted on time.

Four. Active federal or state tax installment agreements. If you already have an agreement in place with the IRS or a state tax authority, do not default on it. Defaulting on an installment agreement makes the whole balance immediately due and closes the door on that tool going forward.

Five. Critical operating vendors. The electric, the water, the insurance, the lease. The ones who can stop the business if they are not paid.

Six. SBA loan servicing. If you can cover it, you cover it. If you cannot, you contact the servicer before the missed payment, not after.

Seven. Secured private debt with business-critical collateral. The truck note on the truck you actually drive. The equipment loan on the equipment the job depends on.

Eight. Everything else. Credit cards. Most MCAs. Unsecured lines. Personal loans from friends and family. Old vendor balances. This is the tier where deferrals, partial payments, and eventual negotiations happen.

That order keeps you alive and keeps the worst possible creditor — the government — from getting to the tools that make recovery much harder. Any other order is worse. Any owner who tells you they prioritize private creditors ahead of the government is either confused or has never actually been in a collections situation before.

What Hamilton & Merchant does — and does not — do

I want to be clear about something, because there is a whole cottage industry of "tax relief" companies on late-night TV that I do not want you to confuse us with. We are not a tax resolution firm. We do not negotiate offers in compromise directly with the IRS. We do not file back returns. We do not issue opinions on trust fund penalty assessments.

What we do, when we see a client with both private debt and significant government debt, is coordinate the whole picture. We handle the private-side negotiations — the credit cards, the MCAs, the bank lines, the vendor stretches. We work in parallel with a qualified tax attorney or CPA who handles the government-side resolution. And we make sure the two sides of the work do not step on each other, because they absolutely can if they are not coordinated.

For example — and this is a real thing that happens — if you take a settlement on a private creditor and the forgiven amount is reported as income on a 1099-C, that can create a new tax liability on top of the one you already could not pay. If your cost reduction, contract renegotiation, and private debt work is not coordinated with the government-side strategy, you can easily trade one kind of trouble for another.

When we bring in our tax partners, we are bringing in people who have negotiated hundreds of installment agreements and offers in compromise with the IRS, who understand the state tax authorities in Florida and the jurisdictions we serve, and who know how to structure a Trust Fund Recovery Penalty conversation so that the owner's personal exposure is as small as the facts allow. That is a specialty. It is not a DIY situation, and it is not something a debt negotiator without tax experience should be touching.

What happened with Carl

Carl's resolution took about fifteen months, which is longer than most of our engagements, because the IRS side had to move through its own process on its own timeline.

Our tax partners filed all four years of back corporate returns and the three years of personal 1040s in the first six weeks. That alone reduced his total exposure by about thirty thousand dollars, because several of the assessed amounts were estimates the IRS had done based on incomplete information, and the actual returns told a more favorable story. Once he was back in compliance, an installment agreement was negotiated on the corporate side at a monthly payment Carl could actually afford. On the TFRP side — the personal liability for the unremitted payroll trust fund — we negotiated a reduced personal assessment based on the facts of who at the business had actually had check-signing authority during the unremitted periods, which limited Carl's personal exposure meaningfully.

In parallel, we handled the private side. The three credit cards settled at an average of forty-six cents on the dollar, cleared through a lump sum funded by a small home equity line Carl took out with his credit union. The MCA was restructured into a longer-tail workout at a reduced daily. The bank line was renegotiated into a term loan at a slightly higher rate but a payment Carl could carry. The truck note was current and stayed current.

The SBA loan was the longest conversation. Carl had an EIDL with a remaining balance of about ninety-six thousand and had stopped servicing it. We negotiated a modified payment plan with the SBA servicing center that brought the account current over a longer horizon.

Today Carl is eighteen months into the installment agreement with the IRS, current on all new payroll deposits, and current on his SBA servicing. His private debt is largely resolved. His business is operating again at stable cash flow, and he is on track to be completely clean inside five more years on the remaining government balances. The thing he cannot buy back is the three years of stress, the weight he lost, and the two senior employees who left him during the worst of it. That is the tuition bill. Everyone pays one. The lesson is to pay it once and not repeat the class.

The one line to remember

Pay Uncle Sam before you pay yourself. Always. No exceptions.

If you are ever in a position where you cannot pay everyone this week, the credit cards can wait. The unsecured lines can wait. The MCA is going to get its daily or it is not, but it is not going to put a lien on your house the day after tomorrow. The IRS can. The state tax authority can. The SBA can. Those three get paid first, or you engage with them proactively, or you call somebody who does this for a living before the collection tools come out of the drawer.

Private creditors eventually settle. Government creditors outlast you. That is the entire lesson in one sentence, and the fee Carl paid to learn it personally was far higher than it needed to be.

One last thing

If you have been reading this and your stomach has been tightening because some of it sounds like you — unfiled returns, unremitted payroll taxes, an SBA loan you stopped servicing, a letter from the IRS in a drawer — I am not here to scare you. I am here to tell you that every single one of those situations is fixable, provided you engage with it now instead of waiting.

The IRS is not the bogeyman it gets portrayed as in movies. The IRS is a bureaucratic collection machine. That is actually good news, because bureaucratic machines follow rules, and the rules have options in them for taxpayers who come forward. Installment agreements, offers in compromise, currently-not-collectible status, penalty abatement for reasonable cause. All of it is available, and the determining factor in whether any of it helps you is almost always whether you engaged with the process before the collection tools started coming out.

You are not stupid. You put the letter in the drawer because you were tired and scared, and you told yourself you would deal with it next month, and next month turned into next quarter and next quarter turned into next year. That is human. That is normal. What you do now, from today forward, is what matters.

The ball is in your court. Pull the letter out of the drawer this afternoon. Open it. Read it. Write down what it says. And then pick up the phone. Either your own tax professional if you have one you trust, or call us and we will connect you with one. Every day you wait the number gets bigger and the tools available get fewer. Every day you engage, the situation gets smaller and more manageable.

Keep your chin up. You are not the first person this has happened to. You will not be the last. And there is almost always a path out — a harder path than the private-side path, with less flexibility and more paperwork, but a path.

Just call us before the lien hits the courthouse. Everything gets harder after that.