Builder insolvencies in Australia have roughly tripled in a few years, and commentary there focuses on insolvent trading rules that make directors pay personally. American law has no general counterpart. In Colorado, an owner’s personal risk arrives through a narrower door: progress draws owed to subs and suppliers, and payroll withholding owed to the IRS.
A diverted draw can be nondischargeable, and withheld payroll tax, once converted into a penalty against a responsible person, is a priority tax no individual discharge reaches. Knowing how those debts behave lets an owner pick a path before a supplier’s lawsuit or a revenue officer sets the timing.
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North Star Tax and Legal Briefing: Colorado Contractors Short on Cash
A five-minute audio version of this article. Trust fund draws, the Bullock intent standard, the payroll tax penalty that survives without it, and how a workout, Chapter 7, and Subchapter V compare.
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Builder failures in Australia have roughly tripled in a few years, and the commentary there is all about directors paying personally for trading while insolvent. American law has no rule like that. But if you run a construction company in Colorado and cash is getting tight, do not relax. Your personal risk arrives through two narrower doors. The first is the progress draw you spent on the wrong job. The second is the payroll tax you withheld from your crew and never sent to the I R S. One of those debts follows you out of bankruptcy only if a supplier can prove what you knew. The other follows you without anyone proving bad intent at all.
Colorado has a trust fund statute for construction money. When an owner or general contractor pays a draw to a contractor or subcontractor, that money is held in trust for the subs, laborers, and suppliers who did the work that draw paid for. A draw on a Pueblo school remodel belongs to that remodel’s suppliers. The statute does not require a separate bank account for every job. It does require separate records of account for each project. Using a Loveland draw to pay Greeley invoices is the violation. And a violation is theft under Colorado law, which opens the civil theft remedy: three times actual damages, plus attorney fees. Here is the distinction to hold onto. The supplier’s claim is a state law trust claim. The I R S claim on withheld payroll tax is a federal priority tax. They behave very differently once you file.
Start with the supplier. In a two thousand seven decision, the Colorado Supreme Court held that a trust fund claimant does not need a perfected mechanic’s lien, or even time left to file one. A supplier that let the lien deadline pass can still argue your draws were held in trust for it. The Tenth Circuit treats that statute as creating the kind of trust that lets the debt survive an individual’s discharge. The company form does not protect you either. Colorado courts hold anyone in complete control of the money personally liable.
Now the point that cuts the other way. Since the Supreme Court’s Bullock decision in two thousand thirteen, the supplier has to prove you knew the money was trust money, or were grossly reckless about it. In the Cupit case, a roofing company owner who simply paid the oldest bills first did not have that mental state, until the day another supplier served him with a trust fund complaint. Everything diverted after that date was excepted from discharge and trebled as theft. In a second Colorado case the builder won outright: every vendor was paid, the records were adequate, and no culpable state of mind was proved. Records and notice decide these cases.
Payroll tax works differently, and this is where owners get hurt. When you withhold income tax and the employee share of Social Security and Medicare, then use it to pay someone else, the I R S can assess a penalty equal to that withheld amount against every responsible person who willfully failed to pay it over. Willful does not mean evil. Paying other creditors instead is the evidence. And unlike the supplier, the I R S does not have to prove knowledge or recklessness at the discharge stage. That penalty is a priority tax that no individual discharge reaches, in Chapter seven, eleven, or thirteen. Owners pay suppliers first because the supplier is the one calling. The tax is the debt that survives anyway. The front end fix is boring: separate records for every job, and payroll deposits made before anyone else gets a check.
So what does the company do? A workout has no automatic stay, so one civil theft lawsuit can unravel it. Chapter seven gives an L L C no discharge, and the company’s case does nothing for the owner personally. Subchapter Vee, for companies under the current cap of three million four hundred twenty-four thousand dollars, lets the company pay priority taxes over up to five years, and when the plan requires it, the court can send those payments to the trust fund taxes first, which shrinks the owner’s own penalty exposure. This week, pull the draw history and vendor payments for every open job and check that the money stayed with the project. Confirm your last two quarters of payroll deposits actually went in. If either number is off, get it reviewed before a demand letter or a revenue officer sets the schedule. That’s what we do at North Star Law Firm. The initial consultation is free, and the full written analysis with citations is at c o dash legal dot net.
What does Colorado’s trust fund statute require when a contractor gets paid?
Under C.R.S. § 38-22-127(1), funds disbursed to a contractor or subcontractor on a construction project “shall be held in trust” for the subs, laborers, and suppliers with lien or bond rights for the work that draw paid for. A draw on a Pueblo school remodel belongs to that remodel’s suppliers.
Subsection (2) excuses a good faith dispute or setoff, and subsection (3) switches the statute off where the contractor posted a bond or the owner signed a written release. Subsection (4) requires “separate records of account for each project,” though not separate bank accounts. Using a Loveland draw to pay Greeley invoices is the problem. Subsection (5) makes a violation theft, which opens the civil theft remedy in C.R.S. § 18-4-405: three times actual damages plus attorney fees.
A missed lien deadline does not end the exposure. On certification from the Tenth Circuit, the Colorado Supreme Court held that a trust fund claimant need not have a perfected lien or still be able to perfect one. Fowler & Peth, Inc. v. Regan, 151 P.3d 1281 (Colo. 2007). In the follow-on opinion, Fowler & Peth, Inc. v. Regan (In re Regan), 477 F.3d 1209, 1211 n.1 (10th Cir. 2007), the panel adopted the view that the statute “creates such a trust,” meaning the express or technical trust 11 U.S.C. § 523(a)(4) requires. Colorado bankruptcy judges rely on that footnote.
Can the owner of a Colorado LLC or corporation be personally liable?
Yes, if the owner controlled the money. In Flooring Design Associates, Inc. v. Novick, 923 P.2d 216 (Colo. App. 1995), a vice-president who diverted trust funds to other corporate bills was held personally liable. Colorado bankruptcy courts apply the same rule to anyone in complete control of an entity’s finances. An LLC does not shield a member’s own handling of trust money.
One boundary helps owners. In Yale v. AC Excavating, Inc., 2013 CO 9, an LLC manager’s own “survival loan” to his company was not trust money. Draws from an owner or general contractor remain trust funds, measured job by job, and a civil theft finding can triple the exposure.
Colorado Contractor Behind on Suppliers or Payroll Tax? Contact Us Now
How did Bullock change the discharge fight in Colorado?
Before 2013, the Tenth Circuit BAP counted even a negligent failure to account as defalcation. In re Storie, 216 B.R. 283 (B.A.P. 10th Cir. 1997). Bullock v. BankChampaign, N.A., 569 U.S. 267 (2013), now requires “knowledge of, or gross recklessness in respect to, the improper nature of the fiduciary behavior.”
In In re Cupit, 514 B.R. 42 (Bankr. D. Colo. 2014), aff’d, 541 B.R. 739 (D. Colo. 2015), a roofing company owner who paid the oldest bills first lacked that mental state until August 5, 2011, when another supplier served him with a trust fund complaint. Later diversions met Bullock: $47,775.56 was excepted from discharge and trebled to $143,326.68 as theft. In Fuller v. Clasby, Adv. No. 23-01212 (Bankr. D. Colo. Nov. 26, 2024), the defense won: the builder had paid every vendor, its cost breakdown satisfied subsection (4), and no culpable state of mind was proved. Records and notice decide these cases.
Where do unpaid payroll taxes fit?
Under 26 U.S.C. § 6672, the IRS can assess a penalty equal to unpaid withheld income tax and employee FICA against any responsible person who willfully failed to pay it over. IRS guidance says “no evil intent or bad motive is required,” and paying other creditors instead is evidence of willfulness.
Unlike a supplier, the IRS need not prove knowledge or gross recklessness at the discharge stage. The penalty is a tax “required to be collected or withheld” under 11 U.S.C. § 507(a)(8)(C), and § 523(a)(1)(A) excepts it from an individual’s discharge. Owners often pay suppliers first, yet the tax is the debt that survives without proof of bad intent.
How do a workout, Chapter 7, and Subchapter V compare?
A workout has no automatic stay, so one civil theft lawsuit can unravel it. Chapter 7 gives a corporation or LLC no discharge under 11 U.S.C. § 727(a)(1); a trustee collects receivables and retainage and closes the company. Under § 524(e), the company’s case does nothing for the owner.
Subchapter V eligibility runs through the small business debtor definition in 11 U.S.C. § 101(51D), which § 1182(1) adopts. Since the April 1, 2025 adjustment (90 Fed. Reg. 8941), the cap is $3,424,000; the temporary $7,500,000 limit sunset June 21, 2024. The Senate and House each passed bills in 2026 (S. 3977 and H.R. 7730) to restore $7.5 million, but neither is law at this writing.
The plan is due within 90 days under § 1189(b) and can be confirmed without a creditor vote if it commits three to five years of disposable income under § 1191(c). Priority taxes must be paid within five years of the petition under § 1129(a)(9)(C), and United States v. Energy Resources Co., 495 U.S. 545 (1990), lets the court direct those payments to trust fund taxes first when the plan requires it, shrinking the owner’s penalty exposure.
For a plan confirmed over objection, § 1192(2) withholds discharge of debts “of the kind specified in section 523(a).” The Fourth Circuit applied that to an LLC in Cantwell-Cleary Co. v. Cleary Packaging, LLC, 36 F.4th 509 (4th Cir. 2022), and the Fifth and Eleventh Circuits agree. The Tenth Circuit has not ruled.
What might this look like for a Colorado Springs drywall subcontractor?
Hypothetically, Quartzcrest Wallboard LLC (fictional) in Colorado Springs has one member, Dana. It received $640,000 in draws on three jobs near Briargate but owes its board and stud supplier $162,000 on them after Dana moved $118,000 to payroll and truck notes on a losing fourth job. It missed two quarters of Form 941 deposits totaling $84,000, of which $62,000 is trust fund tax. General contractors hold $71,000 in retainage, and the bank line is $260,000 with Dana’s guarantee.
In Chapter 7, the LLC dissolves and Dana still faces $118,000 of trust fund exposure (up to $354,000 if theft is proved) and a $62,000 penalty that a personal Chapter 7 would not clear. In Subchapter V, the $84,000 runs about $1,400 a month over 60 months before interest, applied first to the $62,000 trust portion, while retainage and roughly $3,300 a month over three years retire the supplier’s $118,000.
| Debt | Company in Chapter 7 | Company in Subchapter V | Owner’s personal exposure |
|---|---|---|---|
| Diverted draws owed to supplier | No entity discharge | Paid through plan; § 1192(2) argument in a cramdown | Liable if in control; nondischargeable only with Bullock intent |
| Civil theft treble damages | No entity discharge | Plan treatment or settlement | Nondischargeable with the base debt (Cupit) |
| Withheld income tax and employee FICA | Priority claim | Paid within five years; can go to trust portion first | § 6672 penalty; nondischargeable |
| Employer share of FICA | Priority claim | Paid within five years | Not part of the § 6672 penalty |
| Bank line with guarantee | Collateral liquidated | Secured claim under the plan | Guarantee generally dischargeable personally |
| Retainage owed to company | Collected by trustee | Collected to fund the plan | Held in trust for that job’s suppliers once received |
Frequently Asked Questions
Does a Colorado supplier need a recorded mechanic’s lien to bring a trust fund claim?
No. The Colorado Supreme Court held in 2007 that a claimant under C.R.S. § 38-22-127 needs neither a perfected lien nor time remaining to file one. A supplier that let the lien deadline pass can still claim that project draws were held in trust for it.
Is putting all project money in one bank account a trust fund violation?
Not by itself. The statute does not require a separate bank account for each project, so long as trust funds are not misspent. It does require separate records of account for each project, and without them a contractor struggles to prove where the money went.
Can a trust fund claim be discharged in the owner’s personal Chapter 7?
Sometimes. After Bullock v. BankChampaign, the supplier must prove knowledge or gross recklessness. Colorado bankruptcy courts have found that standard met after an owner was put on notice of trust fund duties, and not met where the owner lacked awareness or kept adequate records.
Is the trust fund recovery penalty ever dischargeable?
Not for an individual in Chapter 7, 11, or 13. It is treated as a priority tax the debtor had to collect or withhold. An owner can still dispute responsible-person status or willfulness, and a company plan can pay down the underlying taxes.
Can an LLC in Subchapter V discharge a supplier’s trust fund claim?
With a consensual plan, ordinary Chapter 11 discharge rules apply. For a plan confirmed over objection, three federal circuits hold that section 523(a) debts survive even for an LLC; the Tenth Circuit has not decided. The LLC’s discharge never releases the owner’s own liability.
What is the Subchapter V debt limit right now?
Since April 1, 2025, it has been $3,424,000 in noncontingent, liquidated debts, at least half from business activity. Bills to restore the lapsed $7,500,000 limit passed each chamber in 2026, so a contractor near the line should confirm the figure on the filing date.
How North Star Law Firm Can Help
North Star Law Firm represents Colorado contractors and business owners in Chapter 7 and Subchapter V cases in the U.S. Bankruptcy Court for the District of Colorado. Phillip Zagotti, JD/CPA, is admitted to that court and to the U.S. Tax Court, so the firm can address the plan and the trust fund recovery penalty together. See the firm’s pages on Subchapter V reorganization, Chapter 7 bankruptcy, and discharging tax debt. Phillip Zagotti is not licensed by the Colorado Supreme Court; for Colorado state-law questions the firm works alongside Colorado-licensed counsel.
The order in which draws, suppliers, and payroll deposits are addressed affects what survives a bankruptcy. To review the numbers before a demand letter or a revenue officer sets the schedule, contact North Star Law Firm.