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92–689 PDF 2004

S. Hrg. 108–493

DOD CONTRACTORS WHO CHEAT ON THEIR

TAXES AND WHAT SHOULD BE DONE ABOUT IT

HEARING

BEFORE THE

PERMANENT SUBCOMMITTEE ON INVESTIGATIONS

OF THE

COMMITTEE ON 

GOVERNMENTAL AFFAIRS 

UNITED STATES SENATE

ONE HUNDRED EIGHTH CONGRESS

SECOND SESSION

FEBRUARY 12, 2004

Printed for the use of the Committee on Governmental Affairs

(

(II)

COMMITTEE ON GOVERNMENTAL AFFAIRS 

SUSAN M. COLLINS, Maine, Chairman 

TED STEVENS, Alaska 

GEORGE V. VOINOVICH, Ohio 

NORM COLEMAN, Minnesota 

ARLEN SPECTER, Pennsylvania 

ROBERT F. BENNETT, Utah 

PETER G. FITZGERALD, Illinois 

JOHN E. SUNUNU, New Hampshire 

RICHARD C. SHELBY, Alabama 

JOSEPH I. LIEBERMAN, Connecticut 

CARL LEVIN, Michigan 

DANIEL K. AKAKA, Hawaii 

RICHARD J. DURBIN, Illinois 

THOMAS R. CARPER, Delaware 

MARK DAYTON, Minnesota 

FRANK LAUTENBERG, New Jersey 

MARK PRYOR, Arkansas

MICHAEL D. BOPP, Staff Director and Chief Counsel 

JOYCE A. RECHTSCHAFFEN, Minority Staff Director and Counsel 

AMY B. NEWHOUSE, Chief Clerk

PERMANENT SUBCOMMITTEE ON INVESTIGATIONS 

NORM COLEMAN, Minnesota, Chairman 

TED STEVENS, Alaska 

GEORGE V. VOINOVICH, Ohio 

ARLEN SPECTER, Pennsylvania 

ROBERT F. BENNETT, Utah 

PETER G. FITZGERALD, Illinois 

JOHN E. SUNUNU, New Hampshire 

RICHARD C. SHELBY, Alabama 

CARL LEVIN, Michigan 

DANIEL K. AKAKA, Hawaii 

RICHARD J. DURBIN, Illinois 

THOMAS R. CARPER, Delaware 

MARK DAYTON, Minnesota 

FRANK LAUTENBERG, New Jersey 

MARK PRYOR, Arkansas

RAYMOND V. SHEPHERD, III, Staff Director and Chief Counsel 

ELISE J. BEAN, Minority Staff Director and Chief Counsel 

MARY D. ROBERTSON, Chief Clerk 

(III)

C O N T E N T S 

Opening statements: Page 

Senator Coleman .............................................................................................. 1

Senator Levin .................................................................................................... 4

Senator Collins ................................................................................................. 8

Senator Lautenberg .......................................................................................... 9

Senator Fitzgerald ............................................................................................ 26

Senator Akaka .................................................................................................. 29

WITNESSES 

THURSDAY, FEBRUARY 12, 2004

Gregory D. Kutz, Director, Financial Management and Assurance, U.S. General Accounting Office .......................................................................................... 11

Steve Sebastian, Director, Financial Management and Assurance, U.S. General Accounting Office .......................................................................................... 12

John J. Ryan, Assistant Director, Office of Special Investigations, U.S. General Accounting Office .......................................................................................... 12

Hon. Mark Everson, Commissioner, Internal Revenue Service, U.S. Department of the Treasury ........................................................................................... 33

Richard L. Gregg, Commissioner, Financial Management Service, U.S. Department of the Treasury .................................................................................... 35

Lawrence J. Lanzillotta, Principal Deputy Under Secretary (Comptroller), 

U.S. Department of Defense ................................................................................ 38

ALPHABETICAL LIST OF WITNESSES

Everson, Hon. Mark: 

Testimony .......................................................................................................... 33

Prepared statement .......................................................................................... 82

Gregg, Richard L.: 

Testimony .......................................................................................................... 35

Prepared statement with an attachment ....................................................... 92

Kutz, Gregory D.: 

Testimony .......................................................................................................... 11

Combined prepared statement ........................................................................ 53

Lanzillotta, Lawrence J.: 

Testimony .......................................................................................................... 38

Prepared statement .......................................................................................... 98

Ryan, John J.: 

Testimony .......................................................................................................... 12

Combined prepared statement ........................................................................ 53

Sebastian, Steve: 

Testimony .......................................................................................................... 12

Combined prepared statement ........................................................................ 53

EXHIBITS 

1. GAO Report to Congressional Requesters [The Honorable Norm Coleman, 

Chairman, The Honorable Carl Levin, Ranking Minority Member, Permanent Subcommittee on Investigations, Committee on Governmental Affairs; 

and The Honorable Janice Schakowsky, House of Representatives], FINANCIAL MANAGEMENT: Some DOD Contractors Abuse the Federal 

Tax System with Little Consequence, February 2004, GAO–04–95 ................ 102

2a. GAO Chart: Potential Diversions of Payroll Taxes for Personal Gain .......... 174

Page

IV

2b. GAO Chart: Composition of the $246 Billion of Unpaid Assessments as 

of September 30, 2003 ....................................................................................... 175

3. IRS Chart: Increasing Tax Debts Available for Levy ....................................... 176

4. Response for the record of Steven J. Sebastian, Director, GAO’s Financial 

Management and Assurance Team regarding IRS proposed $300 million 

funding increase .................................................................................................. 177

5. Responses to supplemental questions for the record submitted to Mark 

Everson, Commissioner, Internal Revenue Service ......................................... 178

6. Responses to supplemental questions for the record submitted to Richard 

L. Gregg, Commissioner, Financial Management Service, Department of 

the Treasury ........................................................................................................ 189

7. Responses to supplemental questions for the record submitted to Lawrence 

J. Lanzillotta, Principal Deputy Under Secretary and Deputy Under Secretary for Management Reform (Comptroller), U.S. Department of Defense 192

8. SEALED EXHIBIT: List of Department of Defense contractors owing back 

taxes provided to the Permanent Subcommittee on Investigations by the 

Department of Defense ....................................................................................... *

* May be found in the fields of the Subcommittee. 

(1)

DOD CONTRACTORS WHO CHEAT ON THEIR 

TAXES AND WHAT SHOULD BE DONE ABOUT IT 

THURSDAY, FEBRUARY 12, 2004

U.S. SENATE,

PERMANENT SUBCOMMITTEE ON INVESTIGATIONS,

COMMITTEE ON GOVERNMENTAL AFFAIRS, 

Washington, DC. 

The Subcommittee met, pursuant to notice, at 9:35 a.m. in room 

SD–342, Dirksen Senate Office Building, Hon. Norm Coleman, 

Chairman of the Subcommittee, presiding. 

Present: Senators Coleman, Levin, Collins, Lautenberg, Fitzgerald, and Akaka. 

Staff Present: Raymond V. Shepherd, III, Staff Director and 

Chief Counsel; Mary D. Robertson, Chief Clerk; Jay Jennings, Investigator; Elise J. Bean, Minority Staff Director and Chief Counsel; Brian C. Plesser, Counsel to the Minority; Andrew Plehal, Intern; Brian Kowalski, Intern; Alec Rogers (Senator Collins); and 

Marianne Upton (Senator Durbin). 

OPENING STATEMENT OF SENATOR COLEMAN 

Senator COLEMAN. This hearing is called to order. I would first 

like to note the presence of the Chairman of the Governmental Affairs Committee, Chairman Collins and I am pleased to have you 

here today. 

Also I’d like to recognize the Ranking Member, Senator Levin. I 

will note that during your tenure as Chairman of this Subcommittee, you certainly shined a light on instances where individuals were bringing in millions in one pocket but then were cheating 

the system. And this hearing today, I think, really is an offshoot 

of the focus that you have brought. 

Senator LEVIN. Thank you. 

Senator COLEMAN. And so, I thank you for the work you did and 

appreciate your cooperation in the work that we are doing together 

here. 

We are holding this hearing to address a continuing and growing 

problem at the Internal Revenue Service relating to the collection 

of delinquent taxes. In particular, our focus today is on the Department of Defense contractors who receive billions of dollars in contract payments each year and who currently owe $3 billion in unpaid taxes. 

Let me, if I can sum it up just very succinctly, we are talking 

about individuals, deadbeat taxpayers, who are being paid taxpayer 

dollars while they cheat the system, and the system is not doing 

2

enough to stop it. And hopefully, what we do today will move us 

in a direction to stop it. 

Under the Taxpayer Relief Act of 1997, the Internal Revenue 

Service has the authority to levy 15 percent of these contractors’ 

payments, if the Department of Defense refers its contract 

payments to the Financial Management Service and the Internal 

Revenue Service has made these cases available for collection. 

However, the Department of Defense is not referring all of its payments and the Internal Revenue Service has not made all of these 

cases available for collection. 

These failures are costing the government over $100 million in 

lost tax revenue each year. No one likes to pay taxes. But taxes are 

a necessity because freedom is not free. Our taxes help to fulfill the 

American dream. They provide for the Nation’s defense. They promote commerce and fair trade. They protect workers, promote 

health, and provide for education. They preserve our natural resources, advance research and preserve our culture. They feed the 

hungry and house the poor. They ensure justice and provide transportation. In short, taxes are the membership dues we pay to preserve our way of life. All Americans are beneficiaries of the Federal 

tax system. 

The focus of today’s hearing is DOD’s contractors who have 

abused the Federal tax system. Some of these abuses are appalling 

in their audacity and contemptible in their abject selfishness. They 

cannot and should not be tolerated. Those who are committed to 

the service of this Nation must bear their full responsibility in that 

service. 

I am especially concerned about DOD contractors who have withheld payroll taxes in trust for their employees and have failed to 

remit those taxes, cheating not only their own employees but the 

American people as well. 

The adverse impact on taxpayers’ faith in the fairness of our tax 

system would be reason enough to remedy this problem. However, 

these employers’ betrayal of their own employees demands our attention. An investigation recently completed by the General Accounting Office found that over 27,000 Federal contractors at the 

Department of Defense owed about $3 billion in unpaid taxes. If 

properly administered, the Debt Collection Act of 1996 would have 

provided DOD with the opportunity in fiscal year 2002 to collect at 

least $100 million from these contractors. 

However, because DOD has not fully implemented the provisions 

of the act, only $332,000 was collected. This problem has been further exacerbated by the IRS’ failure to aggressively pursue collections against these contractors. Specifically, IRS’ increasing collection workload and decreasing collection resources have led IRS to 

freeze collection activity in one of every three collection cases. Further, the IRS has allowed many cases to interminably languish in 

their antiquated collection process. 

In order to improve collections, DOD and the Internal Revenue 

Service must work with the Financial Management Service to identify delinquent contractors and levy their contract payments. 

I had a chance to meet with Commissioner Everson yesterday. I 

am pleased with his vision for an increased focus on investigative 

and collection efforts and by his commitment to expeditiously adVerDate 0ct 09 2002 14:41 Jun 29, 2004 Jkt 092689 PO 00000 Frm 00006 Fmt 6633 Sfmt 6633 C:\DOCS\92689.TXT SAFFAIRS PsN: PHOGAN
3

dress the concerns raised by this Subcommittee and the GAO report. 

Let me outline some of the most egregious tax abuses that have 

occurred:

• A business that provides snow removal and landscaping 

service at a military base was awarded contracts of over $1 

million and owes over $1 million in unpaid payroll and employment taxes. During 2002, the contractor received over 

$200,000 from DOD. 

• An individual business that performs repair services on military vehicles owes over $500,000 in business and individual 

taxes. This contractor has contracts with the DOD that are 

worth over $60 million and recently received an annual payment of over $100,000. 

• IRS suspended collection activity against a contractor in 

1999 because the IRS believed the contractor lacked the 

funds to pay their debt. However, between 1999 and 2002, 

DOD paid the contractor almost $700,000. 

• IRS initiated collection against a DOD contractor who owed 

about $270,000 in unpaid taxes. Because of its workload, IRS 

suspended collection activity against the contractor for 10 

months. IRS then reinitiated collection against the contractor and placed the contractor’s case in a queue of collection cases awaiting assignment. The contractor remained in 

the queue for 19 months. During this 29-month period, DOD 

paid the contractor at least $110,000.

With the passage of the Debt Collection Improvement Act of 

1996, Congress obligated DOD to levy their contractor payments to 

ensure that individuals and businesses who receive Federal payments and have failed to pay their just tax can have a portion of 

their payments forwarded to the IRS to satisfy their tax debt. The 

Federal Payment Levy Program, administered by the Financial 

Management Service, relies on computer matching of information 

provided by IRS and DOD. If the taxpayer identification information is incorrect or not provided, then, the Financial Management 

Service cannot match the DOD and IRS information. As a result, 

the IRS cannot effectively identify nonfilers, determine their full 

tax liability and levy contractors’ payments to collect the taxes that 

are owed, and DOD will continue to fully pay tax scofflaws who are 

abusing the Federal tax system. 

When we find fraud and abuse, we must fix it and stop it from 

occurring again. As we begin this hearing, I want to reiterate my 

commitment to finding solutions to the problems in government. 

This morning, we will hear from representatives of the General 

Accounting Office on their recently completed investigation of DOD 

contractors who habitually abuse the Federal tax system. We will 

also hear from the Department of Defense, the IRS and the Financial Management Service concerning the actions that they have 

taken, or plan to take to ensure that DOD contractors pay the 

taxes that they owe. 

Senator Levin. 

4

OPENING STATEMENT OF SENATOR LEVIN 

Senator LEVIN. Thank you. 

Thank you for your leadership in this effort. You have been the 

leader in this investigation, and we have been delighted to be supportive of it. But the credit belongs to you, and the leadership has 

been very strong, and I think every taxpayer in this country is in 

your debt because of it. 

The men and women in our military are putting their lives on 

the line every day for our Nation. At the same time, the GAO is 

telling us that over 27,000 of the Department of Defense’s contractors—that is about 10 percent of the Department’s contractors—are 

dodging their tax bills and have outstanding tax debts to Uncle 

Sam totalling at least $3 billion—27,000 DOD contractors with $3 

billions in unpaid taxes; I am not sure which figure is more shocking. 

Tax dodging by any Federal contractor is unfair, not only to the 

honest taxpayers left to make up the difference but also to the honest companies that have to compete against the tax dodgers for 

government contracts. Tax dodging by contractors taking taxpayers’ 

dollars to support our military is not only unfair; it is unpatriotic. 

The General Accounting Office tells us that the vast majority of 

the 27,000 Department of Defense contractors with unpaid taxes, 

about 25,000 of them, have failed primarily to pay the payroll taxes 

which they have withheld and which they owe. That means these 

contractors have failed to send to the IRS sums that are withheld 

from employees’ wages for Federal, State, Social Security, and 

Medicare taxes. 

When the GAO took a closer look at 47 of these Department of 

Defense contractors, it found that all 47 had evidence of tax avoidance, and in some cases, they unearthed unseemly tales of individuals and companies dodging taxes for years and using the money 

meant for payroll taxes on luxuries for themselves instead: Expensive homes, cars, boats, and vacations. One contractor with $10 

million in unpaid taxes had been paid $3.5 million in taxpayers’ 

dollars in fiscal year 2002 alone to provide the custodial services 

at military bases. This contractor had already defaulted on an IRS 

installment agreement; yet, it is unclear whether one dime of the 

$3.5 million was withheld to pay down the contractor’s tax debt. 

Tax chiseling by Federal contractors is not a new story, and that 

is why Congress tackled this issue in 1996 and 1997 when they enacted the Taxpayer Relief Act, which, in part, authorized Federal 

agencies to withhold 15 percent of any Federal payment going to 

a person with an outstanding tax debt. The goal was to stop taxpayer dollars from being paid to a tax deadbeat unless 15 percent 

was withheld to reduce that person’s tax debt. 

The Taxpayer Relief Act sought to apply a commonsense principle to government operations to offset the taxpayer dollars sent 

to people who have not paid their tax bills by directing a percentage of the total to reduce their tax debt. But this commonsense 

principle is not easy to apply in a government that pays hundreds 

of thousands of contractors to work on even more contracts; in essence, it requires the Federal Government to set up financial payment systems that make sure that the left hand knows what the 

right hand is doing, to make sure, for example, that contract payVerDate 0ct 09 2002 14:41 Jun 29, 2004 Jkt 092689 PO 00000 Frm 00008 Fmt 6633 Sfmt 6633 C:\DOCS\92689.TXT SAFFAIRS PsN: PHOGAN
5

ments do not go to a contractor with an outstanding tax debt unless a portion is withheld to satisfy a part of that debt. 

The first agency to begin implementation of that law was the Financial Management Service or FMS in the Treasury Department. 

That agency took until July 2000 to establish an automated tax 

levy program under a larger Treasury offset program, which handles offsets for a variety of reasons. Since then, FMS has sent 

about $76 million in tax levy money to the IRS. It took another 2 

years, until December 2002, for the Department of Defense to follow suit. It set up its first automated tax levy program for its largest contractor payment system, MOCAS, which handles payments 

on the Department of Defense’s major long-term contracts. 

Fifteen other payment systems, however, have not yet been automated. And so, we have a joint effort involving the Department of 

Defense, FMS, and the IRS which have to work together to match 

the people who are delinquent with the people who are being made 

payments by the Department of Defense. It is a very straightforward piece of technology. It just depends on willpower to be implemented; a decision made to implement this. So many much more 

miraculous technological feats are being performed within seconds 

on our computers these days—take a look at Google—that there is 

no excuse conceivably for not making this match. It is just simply 

a default on the part of our agencies, as far as I am concerned, to 

do what technology now allows them to do and the technology 

which is now in place. 

Senator Coleman, let me ask you if I could then put the balance 

of my statement in the record at this point. 

Senator COLEMAN. Without objection. 

Senator LEVIN. Thank you 

[The prepared opening statement of Senator Levin follows:]

PREPARED OPENING STATEMENT OF SENATOR LEVIN 

Men and women in our military are putting their lives on the line every day for 

our Nation. At the same time, GAO tells us that over 27,000 of DOD’s contractors—

more than 1 in 10—are dodging their tax bills and have outstanding tax debts to 

Uncle Sam totaling at least $3 billion. 27,000 DOD contractors with $3 billion in 

unpaid taxes. I’m not sure which figure is more shocking. 

Tax dodging by any federal contractor is unfair—not only to the honest taxpayers 

left to make up the difference, but also to the honest companies that have to compete against the tax dodgers for government contracts. Tax dodging by contractors 

taking taxpayer dollars to support our military is not only unfair, it is unpatriotic 

and unacceptable. 

GAO tells us the vast majority of the 27,000 DOD contractors with unpaid taxes, 

more than 25,600 of them, have failed primarily to pay payroll taxes. That means 

these contractors have failed to send to the IRS sums withheld from employees’ 

wages for federal, state, Social Security, and Medicare taxes. When GAO took a closer look at 47 of these DOD contractors, GAO found that all 47 had evidence of tax 

avoidance and, in some cases, unearthed unseemly tales of individuals and companies dodging taxes for years and using the money meant for payroll taxes on luxuries for themselves instead—expensive homes, cars, boats, and vacations. One contractor with $10 million in unpaid taxes had been paid $3.5 million in taxpayer dollars in FY2002 alone to provide custodial services at military bases. This contractor 

had already defaulted on an IRS installment agreement, yet it is unclear whether 

a dime of the $3.5 million was withheld to pay down the contractor’s tax debt. 

Tax chiseling by federal contractors isn’t a new story. It’s an old one. And it’s one 

that Congress has tackled in the past to recoup unpaid taxes and prevent new tax 

abuses. In 1997, Congress enacted the Taxpayer Relief Act which, in part, authorized federal agencies to withhold 15 percent of any federal payment going to a person with an outstanding tax debt. The goal was to stop taxpayer dollars from being 

6

paid to a tax deadbeat, unless 15 percent was withheld off the top to reduce that 

person’s tax debt. 

The Taxpayer Relief Act sought to apply a common sense principle to government 

operations: To offset the taxpayer dollars sent to people who haven’t paid their tax 

bills by directing a small percentage of the total to reduce their tax debt. But this 

common sense principle isn’t easy to apply in a government that pays hundreds of 

thousands of contractors to work on even more contracts. In essence, it requires the 

federal government to set up financial payment systems that make sure the left 

hand knows what the right hand is doing—to make sure, for example, that contract 

payments don’t go to a contractor with an outstanding tax debt unless a portion is 

first withheld to satisfy a part of that debt. 

The first agency to tackle the problem was the Financial Management Service or 

FMS in the Treasury Department. That agency took until July 2000 to establish an 

automated tax levy program under a larger Treasury Offset Program, which handles 

offsets for a variety of reasons. Since then, FMS has sent about $76 million in tax 

levy money to the IRS, with about $60 million in FY2002 alone. 

It took another two years—until December 2002—for DOD to follow suit. Working 

with FMS, DOD set up its first automated tax levy program for its largest contractor payment system, called MOCAS, which handles payments on DOD’s major, 

long-term contracts. In FY2002, MOCAS payments totaled about $95 billion, all of 

which is now reviewed for tax levies before the money goes out the door. DOD is 

planning to but has not yet extended its automated tax levy program to 15 other 

payment systems which, together, make contract payments totaling another $85 billion each year. 

As currently operated, the DOD tax levy program is a joint effort involving DOD, 

FMS and the IRS. It is a joint effort because, while FMS is authorized by law to 

review IRS data on unpaid taxes, DOD is not. So here’s what happens. Each Monday morning, the Defense Financial and Accounting Service at DOD sends FMS an 

electronic file listing payments expected to be made to DOD contractors over the 

next few days. FMS immediately uses a computer match program to compare the 

names and taxpayer information numbers in the DOD payment data with data in 

IRS files listing persons with unpaid taxes. FMS compiles a list of the names that 

match and sends it to the IRS. The IRS then makes sure it has mailed a 30-day 

notice of intent to levy to each of the listed tax delinquent contractors. If the contractor does not respond within 30 days by paying up, protesting the tax debt, or 

offering to settle it, the IRS notifies FMS which, in turn, tells DOD to begin withholding the 15 percent from payments to the identified contractors. DOD does so 

and forwards any levied funds to FMS which, in turn forwards the fund to the IRS. 

GAO estimates that, in light of the huge DOD contract dollars and tax dollars at 

stake, DOD’s tax levy program ought to be collecting at least $100 million each year. 

But last year, the first year of the DOD tax levy program, DOD collected less than 

$1 million, or less than 1 percent of the projected total. 

The GAO report spells out a number of reasons why. The good news is that many, 

if not all, of these problems can be fixed. 

First, there is DOD. Right now, DOD is sending FMS payment data on only one 

day per week for only one of its payment systems. It needs to send more frequent 

payment data from all 16 payment systems. Another problem is that the payment 

data DOD sends to FMS is currently tainted with thousands of incorrect or missing 

taxpayer identification numbers, which makes it nearly impossible to match many 

DOD contractors to IRS lists of tax delinquents. DOD needs to set up new procedures to get valid taxpayer identification numbers (TINs) from its contractors and 

stop sending payments to contractors with invalid or missing TINs. Finally, when 

faced with having to make a payment to a contractor without a valid TIN, DOD has 

never set up the system required by law to withhold 28% of each payment to that 

contractor until a valid TIN is supplied. DOD needs to set up that backup withholding system. 

Next is the IRS. One key problem here is that the IRS has caused DOD to miss 

imposing tax levies on numerous contract payments, because the IRS hadn’t yet 

mailed the 30-day notice to the relevant contractors warning of an upcoming levy. 

The IRS needs to revamp its levy notice procedures to eliminate delays and missed 

levies. The IRS also needs to change tax collection policies that currently prevent 

DOD from using its tax levy program on many of its contractors. For example, the 

IRS needs to end its practice of waiting a year before approving use of the levy program for contractors waiting in an IRS queue for assignment to a revenue officer. 

I understand that the IRS is willing and may have already made this change. Another problem is the IRS’ automatic bar on using tax levies on contractors who are 

negotiating to settle, reduce, or stretch out repayment of their tax debt or are in 

7

bankruptcy or experiencing financial hardship, especially in the case of contractors 

with defaults on prior repayment agreements or a history of nonpayment of tax. 

In essence, when it comes to contractors paid with federal taxpayer dollars, the 

IRS must become much less cautious in using the 15 percent tax levy authorized 

by law, and it must stop allowing tax delinquent DOD contractors to receive full 

payment in taxpayer dollars without having a dime directed toward the taxes 

they’ve dodged. The IRS also needs, for the first time, to assign full-time revenue 

officers to the tax levy programs aimed at federal contractors, so that these officers 

can develop expertise, improve the DOD and FMS programs, and cut down on the 

tax abuses committed by federal contractors. 

Senator Coleman and I have been working on developing recommendations to 

strengthen the DOD tax levy program based upon the GAO report and discussions 

our staffs have held with the three agencies. DOD and the IRS have already indicated their willingness to make reforms, have made some concrete changes, and are 

considering additional improvements as well. Here are some of my thoughts about 

key improvements to strengthen use of tax levies for federal contractors. 

Recommendations for DOD 

(1) 16 Payment Systems. DOD should meet its March 2005 deadline for 

automating tax levies in all 16 of its payment systems, thereby bringing 

$85 billion more payments under review each year in DOD’s tax levy program. 

(2) More Frequent Payment Data. DOD should send its contractor payment data to the Financial Management Service more than once week and 

as often as practical to increase IRS matches and identify more tax delinquent contractors. 

(3) TIN Consent. DOD should require all registrants in the federal Central Contractor Registration (CCR) database to provide consent during the 

registration process for DOD to obtain IRS information to validate their 

taxpayer identification numbers (TINs), and DOD should work with the IRS 

to validate all TINs in the CCR. 

(4) TIN Requirement. DOD should prevent contract payments to any contractor with an invalid or non-existent taxpayer identification number. 

(5) Backup Withholding. In FY 2004, DOD should establish systems to require automatic backup withholding from payments to any contractor with 

an invalid TIN, as required by law, and notify CCR registrants that contract payments are subject to such withholding. 

Recommendations for IRS 

(1) Using Tax Levies Sooner, Not Later. The IRS should change its tax 

levy policies to use levies as a first resort, rather than a last resort, for tax 

delinquent federal contractors. 

(2) Dedicated Revenue Officers. The IRS should assign full-time revenue 

officers to specialize in collecting unpaid taxes from levies on federal contractors, and work with DOD and FMS to improve the efficiency and effectiveness of their tax levy programs. 

(3) Levy Notices. The IRS should revamp its procedures for issuing levy 

notices to federal contractors to eliminate delays, and consider such options 

as combining levy notices with delinquency notices and sending levy notices 

to tax delinquent CCR registrants with active contracts. 

(4) Queue Reform. The IRS should eliminate the policy automatically barring initiation of a tax levy for one year on any federal contractor waiting 

in the IRS queue for assignment to a revenue officer, and instead initiate 

tax levies on federal contract payments as a routine matter. 

(5) Recidivist Tax Abusers. The IRS should work with Congress to eliminate administrative and statutory barriers to initiating a tax levy on a federal contractor in negotiation to repay a tax debt, in bankruptcy, or undergoing financial hardship, if the contractor has defaulted on a prior IRS repayment agreement or has a history of repeated misconduct involving nonpayment of tax. 

Recommendation for OMB 

Study. OMB, working with DOD, FMS, IRS and others, should conduct 

a study on whether federal contractors with unpaid taxes should be barred 

under some or all circumstances from bidding on federal contracts, and 

whether federal contracting officers should be informed of contractors who 

have engaged in longstanding or egregious tax avoidance so they can assist 

in tax collection efforts.

8

DOD contracts represent nearly two-thirds of all federal contracts and, in FY2002, 

DOD contract payments totaled about $180 billion. The recipients of DOD contracts, 

whether individuals or businesses, are given an unique opportunity to support the 

men and women in our military. Most DOD contractors provide valuable goods or 

services to DOD, and do so while paying their taxes. Other DOD contractors, however, take payment in taxpayer dollars, while dodging paying their taxes to Uncle 

Sam. This tax dodging hurts honest taxpayers, honest businesses, and our country 

as a whole. Effective use of the DOD tax levy program is necessary to help keep 

the tax dodger’s hand out of the taxpayer’s wallet. 

I commend Senator Coleman and Congresswoman Janice Schakowsky for their 

leadership on this important issue. I look forward to the testimony today.

Senator COLEMAN. Chairman Collins. 

OPENING STATEMENT OF CHAIRMAN COLLINS 

Chairman COLLINS. Thank you very much, Mr. Chairman. 

First of all, let me commend you for calling this hearing to shed 

light on what the General Accounting Office has uncovered regarding the failure of some of our Nation’s defense contractors to pay 

their taxes. The crux of the GAO’s findings that more than 27,000 

defense contractors owe the Federal Government some $3 billion in 

taxes and that the Pentagon is not doing all that it can to collect 

this money is very disturbing and raises many questions about the 

Federal procurement system. 

Federal procurement laws require contractors to demonstrate integrity in order to do business with the Federal Government. That 

obviously includes paying their taxes. That some of those who provide goods and services to our Nation’s fighting men and women 

fall woefully short of these standards is of great concern to me. 

At a time of high deficits, it is also very troubling that the Pentagon appears to have been negligent in reporting tax information 

and payment information that could have helped the IRS collect 

taxes owed but not paid. Under Federal law, the government may 

withhold part of a contractor’s payment to offset for taxes the contractor owes the government. In order to accomplish this, however, 

agencies must report contract payment information to the Financial Management Service. 

As we will hear today, the Pentagon has failed to use this tool 

in far too many cases. Adding to the problem, the Internal Revenue 

Service has sometimes failed to pursue those cases it did know 

about, according to the GAO. I am determined to learn why it has 

failed to do so, and I am interested to learn what steps the Defense 

Department and the IRS intend to take in order to ensure better 

performance in the future. 

For businesses that are inexcusably delinquent in meeting their 

tax obligations, another important question arises. That is, why is 

the Department of Defense continuing to do business with these 

companies? The names of the contractors today are being withheld 

because their tax data were an integral part of GAO’s research. Because we value taxpayer privacy so highly—and rightly so—we cannot know for certain the specific circumstances surrounding each 

contractor’s failure to pay. 

Nevertheless, the GAO has singled out 47 companies as especially egregious offenders, and the Pentagon should evaluate 

whether or not these companies should continue to do business 

with the Federal Government. The Pentagon should look at whethVerDate 0ct 09 2002 14:41 Jun 29, 2004 Jkt 092689 PO 00000 Frm 00012 Fmt 6633 Sfmt 6601 C:\DOCS\92689.TXT SAFFAIRS PsN: PHOGAN
9

er they meet the standards under Federal law to qualify as responsible bidders. 

Mr. Chairman, simply put, the 27,000 defense contractors who owe approximately $3 billion in uncollected taxes need to be held 

accountable. The Pentagon needs to be held accountable. And the 

IRS needs to be held accountable. 

I very much appreciate your holding this hearing this morning 

so that we can get to the bottom of this very disturbing problem. 

Thank you. 

[The opening prepared statement of Senator Collins follows:]

PREPARED OPENING STATEMENT OF SENATOR COLLINS 

Mr. Chairman, thank you for calling this hearing to shed light on what the General Accounting Office has uncovered regarding the failure of some of our Nation’s 

defense contractors to pay their taxes and the Department of Defense’s response. 

The crux of GAO’s findings—that over 27,000 DOD contractors owe the Federal Government some $3 billion in taxes, and that the Department may not be doing 

all that it can to collect this money—is very disturbing to me. 

As Chairman of the Governmental Affairs Committee, which has jurisdiction over 

government procurement, I have made clear my belief that there should be high ethical standards for Federal contractors. That some of those who provide goods and 

services to our Nation’s fighting men and women fall short of those standards is of 

great concern to me. 

At a time of high deficits, it is also disturbing that the Pentagon appears to have 

been negligent in reporting payment data to the Treasury that could have helped 

the IRS collect taxes owed but not paid. 

Under Federal law, the government may withhold part of a contractor’s payment 

to offset for taxes the contractor owes the government. In order to accomplish this, 

however, agencies must report contract payment information to the Financial Management System. As we will hear today, the Pentagon has failed to use this tool 

in far too many cases. Adding to the problem, the Internal Revenue Service has 

sometimes failed to pursue those cases it did know about according to GAO. I am 

determined to learn why it failed to do so, and am very interested to learn what 

steps the Defense Department and the IRS intends to take to ensure better performance in the future. 

For businesses that are inexcusably delinquent in paying their taxes, another 

question arises. Why is the Department of Defense, which is among the most sophisticated purchasers of goods and services of all Federal departments, continuing to 

do business with these companies? 

The names of the contractors today are being withheld because their tax data 

were an integral part of GAO’s research. Because we value taxpayer privacy so 

highly, and rightly so, we cannot know the exact circumstances surrounding each 

one’s failure to pay. Still, GAO has singled out 47 companies as especially egregious 

offenders, and the Pentagon should evaluate whether or not these companies meet 

the standards under Federal law to continue as government contractors. 

Mr. Chairman, simply put, the 27,000 defense contractors who owe approximately 

$3 billion in uncollected taxes need to be held accountable. I appreciate your holding 

this hearing and shining a light on this problem. Thank you.

Senator COLEMAN. Thank you very much, Senator Collins. Senator Lautenberg. 

OPENING STATEMENT OF SENATOR LAUTENBERG 

Senator LAUTENBERG. Thanks very much, Mr. Chairman. I, too, 

want to commend you for holding this hearing. 

This delinquency, in my view, is what I would describe as almost 

traitorous conduct. Much of these expenses, much of these charges 

are as a result of having our people exposed to danger fighting a 

war, and its relationship to that singles them out as particularly 

scandalous in their behavior. I am dumbfounded by GAO findings 

that the Department of Defense contractors owe the Treasury over 

$3 billion. 

10

I am equally concerned that IRS officials have not fully worked 

out payment systems so their debtors can be quickly identified and 

their payments of unpaid taxes collected. One of the things that I 

had to note as I heard about IRS’ inability to pursue these deadbeats; it reminds me of the fact that IRS was the subject of a review that said there are just too many employees there. So, while 

they have successfully reduced the number of people working at 

IRS, we have lots of evidence about IRS’ inability to pursue delinquent tax accounts. 

Although I believe that today’s topic is both worthy and pressing, 

I register my disappointment that another similarly urgent issue 

involving DOD contracting transparency and oversight has yet to 

be discussed by either our Subcommittee here or the full Governmental Affairs Committee. Three times since May, I have written 

to the Committee requesting that we hold a hearing to investigate 

the controversial contracts awarded by the Pentagon for the reconstruction of the Iraqi oil industry. No luck so far. 

The specific accounting problems and contracting ethics involved 

in these particular contracts are numerous and varied, too numerous to recite here. But they have been documented extensively by 

the press and by Members of the Congress, including this Senator. 

And just as an example, I want to call attention to three particular 

examples of potentially fraudulent accounting with respect to one 

company that is receiving billions of dollars in Pentagon contract 

assignments to rebuild Iraq. The company is Halliburton, including 

its subsidiary, KBR. 

First, Halliburton was awarded a no-bid contract last March to 

extinguish oil fires, in the worst-case scenario that were ignited by 

Saddam and his crew during the battle. The initial contract was 

slated to be $50 million. Subsequently, although the worst-case scenario never materialized, this no-bid contract mutated into a $2.2 

billion monstrosity over the course of 8 months, despite the protests of many Members of Congress. 

Second, we began learning this fall that Halliburton was dramatically overcharging taxpayers for the services it was providing. 

In December, DOD auditors found that Halliburton charged the 

government more than $61 million, too much, to bring gasoline into 

Iraq. And third, we learned that Halliburton’s employees were engaged in illegal business transactions by accepting kickbacks from 

Kuwaiti firms, amounting to $6 million. 

I believe that we are not fulfilling our oversight responsibilities 

as legislators if we dismiss or neglect that kind of a business practice. So I am, therefore, pleased that we are going ahead with this 

but keeping in mind all the time that the system looks like it is 

out of control, and we ought to find a way to collect taxes due this 

country from earnings that were specifically directed by DOD. 

Today’s hearing is an important one, and I look forward to hearing from both GAO and the administration witnesses about how to 

hold accountable those DOD contractors who are undermining national security by avoiding paying their fair share of the taxes. But 

I believe it is equally imperative that we also investigate how DOD 

contracts are awarded and filled, especially in Iraq and especially 

when they are being given to a company like Halliburton that has 

11

1The combined prepared statement of Mr. Kutz, Mr. Sebastian, and Mr. Ryan appears in the 

Appendix on page 53. 

such a poor business track record but such close ties to the administration. 

And I thank you, Mr. Chairman. 

Senator COLEMAN. Thank you, Senator Lautenberg. 

I would now like to welcome today’s first panel to our hearing: 

Gregory Kutz, a Director with the Financial Management and Assurance Team at the General Accounting Office; Steve Sebastian, 

a Director with the Financial Management and Assurance Team at 

GAO; and finally, John Ryan, an Assistant Director with the Office 

of Special Investigations at GAO. 

As I mentioned in my opening statement this morning, GAO is 

here to release the results of its investigation of the Department 

of Defense, whose contractors were abusing the Federal tax system 

by either failing to file tax returns or not paying their taxes. The 

purpose of the hearing is to identify the corrective actions that can 

be taken to ensure that the Department of Defense contractors pay 

the taxes they owe the Federal Government. 

I appreciate your attendance at today’s important hearing. Before we begin, pursuant to Rule 6, all witnesses who testify before 

this Subcommittee are required to be sworn. At this time, I would 

ask you all to please stand and raise your right hand. 

[Witnesses sworn.] 

Senator COLEMAN. Before we begin, Senator Levin has reminded 

me that much of the focus of this investigation was initiated at the 

behest of Congresswoman Schakowsky, who we intended to have 

testify before the Subcommittee. I believe there was a personal 

emergency that made that impossible. But I do want to make note 

of her diligence and her efforts in this regard and we are sorry that 

she cannot be with us today. 

We will be using a timing system, and I think you gentlemen understand this system. About a minute before you should wrap up 

your remarks, a yellow light will come on. Please limit your remarks to no more than 10 minutes. I will ensure that your complete statement will be entered into the record. 

Mr. Kutz, I believe you and Mr. Sebastian will be presenting the 

GAO statement this morning. Please proceed. 

TESTIMONY OF GREGORY D. KUTZ,1 DIRECTOR, FINANCIAL 

MANAGEMENT AND ASSURANCE, U.S. GENERAL ACCOUNTING OFFICE 

Mr. KUTZ. Mr. Chairman, Members of the Subcommittee and 

Chairman Collins, thank you for the opportunity to be here to discuss abuse and potential criminal activity by DOD contractors. The 

bottom line of our testimony is that DOD contractors are abusing 

the Federal tax system with little or no consequences. The end result, as you have mentioned, is that compliant American taxpayers 

must pay more. 

Our testimony has two parts. First, I will discuss DOD contractors with unpaid Federal taxes, and second, my colleague, Mr. Sebastian, will discuss why little has been done to deal with abusive 

contractors. 

12

1The combined prepared statement of Mr. Kutz, Mr. Sebastian, and Mr. Ryan appears in the 

Appendix on page 53. 

First, as mentioned, we found that over 27,000 contractors had 

nearly $3 billion in unpaid Federal taxes. Over 25,000 of these contractors were businesses that owed primarily payroll taxes. These 

taxes include amounts withheld from an employee’s wages for Federal income taxes, Social Security, and Medicare. 

For all 47 contractors that we investigated, we found abusive or 

potentially criminal activity related to the Federal tax system. The 

34 businesses had severely delinquent payroll taxes, owing up to 62 

quarters or 15 years of taxes. However, rather than fulfill their role 

as trustees of this money and pay it to the IRS, these contractors 

diverted the money for their businesses or for personal gain. 

The poster board shows several examples of potential diversion 

of payroll taxes for personal gain, including the owner of a contract 

with $10 million of unpaid taxes using corporate funds to buy a 

home in the Caribbean and a luxury boat; another owner taking $1 

million from his company to buy a large home and a Mercedes. 

Other potential diversions were for homes, airplanes, and other 

luxury cars. 

The typical diversion scheme funneled money to the owners and 

officers of the company through substantial salaries or loans that 

were never repaid. In addition to these more flagrant offenders, 

other contractors were in financial trouble and used the money to 

pay the utility bill or the rent rather than forward the money to 

the IRS. Regardless of the cause, willful failure to remit payroll 

taxes is a felony. Other interesting cases include DOD awarding over $60 million 

in contracts to an individual with delinquent payroll taxes dating 

back to 1994; DOD paying a contractor to provide motivational 

speeches that has over $130,000 of unpaid taxes dating back to 

1993; and a $400,000 contract award to a dentist who has substantial unpaid payroll and income taxes also dating back to 1993. 

Many of these contractors were also involved in other crimes of 

integrity. What was the reward for these 47 abusive contractors? 

Over $200 million of DOD contracts. These contractors are small 

and mid-sized businesses that provide basic services such as building maintenance, construction and catering; thus, DOD could get 

these services from legitimate, taxpaying contractors. 

Mr. Sebastian will now discuss why tax abusers can also be contractors and why there have been few consequences to date. 

TESTIMONY OF STEVEN J. SEBASTIAN,1 DIRECTOR, FINANCIAL 

MANAGEMENT AND ASSURANCE, U.S. GENERAL ACCOUNTING OFFICE, AND JOHN J. RYAN,1 ASSISTANT DIRECTOR, OFFICE OF SPECIAL INVESTIGATIONS, U.S. GENERL ACCOUNTING OFFICE 

Mr. SEBASTIAN. Thank you, Mr. Kutz. 

Mr. Chairman, Members of the Subcommittee and Chairman 

Collins, Federal law presently does not prohibit contractors with 

unpaid taxes from receiving government contracts. However, tools 

exist to facilitate the collection of taxes for contractors. In 1996, the 

Congress passed legislation to improve the government’s debt colVerDate 0ct 09 2002 14:41 Jun 29, 2004 Jkt 092689 PO 00000 Frm 00016 Fmt 6633 Sfmt 6601 C:\DOCS\92689.TXT SAFFAIRS PsN: PHOGAN
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1See Exhibit No. 2b. which appears in the Appendix on page 175. 

lection, and in 1997, granted IRS the authority to continuously levy 

up to 15 percent of Federal payments to collect outstanding taxes. 

Critical to the levy program is the matching of DOD disbursing 

records with Treasury’s centralized database of Federal debt, including tax debt. Thus, with no legal prohibition, the government 

is dependent on DOD and IRS to ensure contractors pay their fair 

share. However, as our work shows, both agencies have been deficient in this regard. 

In the 6 years since Congress granted continuous levy authority, 

DOD has collected less than $700,000, and prior to December 2002, 

nothing had been collected for DOD contractors. Collections to date 

relate to DOD only recently providing information to Treasury for 

one payment system which had $86 billion in fiscal year 2002 disbursements. Contractors paid through this system owed $750 million in taxes. At present, DOD is not providing data to Treasury 

for other payment systems that disbursed $97 billion in fiscal year 

2002. 

The potential benefits of an effective levy cannot be overstated. 

In reviewing disbursements for five DOD payment systems, we estimate that DOD could have levied contractors’ payments and collected at least $100 million in fiscal year 2003 alone. 

As the Nation’s tax collector, IRS plays a key role. As reflected 

on the poster board,1 with $246 billion in unpaid taxes, only 8 percent of which is deemed collectible, efficient and effective means of 

collecting taxes is critical to IRS’ mission. However, restrictive policies and procedures as well as control deficiencies at IRS hinder 

the levy program’s collection potential. 

Current IRS policies restrict which and at what stage in the collection process cases enter the levy program. For example, IRS excludes cases in the queue or holding tank from potential levy for 

at least 1 year. In one of our case studies involving a contractor 

that owed $270,000 in taxes, the account was placed in the queue, 

where it sat for 19 months with no attempts to collect the taxes. 

DOD paid this contractor over $110,000 in fiscal year 2002. 

Processing delays also prevent cases from entering the levy program. When a taxpayer offers to settle its tax debt for pennies on 

the dollar, called an offer in compromise, IRS is required to suspend any efforts to levy payments. Our work shows that IRS continues to experience significant delays in processing such offers. 

These delays, in turn, reduce potential collections. 

For example, in one case, a contractor with $400,000 in unpaid 

taxes proposed an offer in compromise. IRS took over a year before 

it finally rejected the offer and over 2 years to reject a second proposal. During this time, DOD paid the contractor over $200,000, 

$30,000 of which could have been collected. 

Additionally, inaccurate records impede IRS’ collection efforts. In 

one case, a contractor proposed to pay by installment. At that time, 

IRS entered a code in its system to block the account from levy. 

IRS formally rejected the proposal 1 year later but never reversed 

the code. The account was thus erroneously excluded from levy action for 2 years. 

14

Finally, IRS attempts to work with contractors to achieve voluntary compliance, delaying more aggressive enforcement actions 

like levies until later. This results, however, in some contractors 

continuing to receive payments while making no effort to pay their 

taxes. In one case, a business with DOD contracts that generated 

$4 million had unpaid taxes of over $10 million. As the contractor’s 

tax debt mounted, IRS continued working with the business, taking 

no enforcement action. 

During this time, as Mr. Kutz mentioned, the owner diverted 

funds for personal gain, shut the company down, and moved to the 

Caribbean, leaving the IRS with uncollectible taxes of over $10 million. 

In conclusion, allowing contractors to do business with the government while not paying their taxes creates an unfair competitive 

advantage for them at the expense of the vast majority of DOD 

contractors that fulfill their tax obligations. DOD’s failure to fully 

comply with debt collection mandates and IRS’ continuing challenges in collecting unpaid taxes have contributed to this unacceptable situation. As a result, the government has missed opportunities to collect hundreds of millions of dollars in unpaid taxes. 

We believe prompt implementation of the recommendations in 

our report, released today, will result in millions of dollars of immediate tax collections. 

Mr. Chairman, this concludes our statement. We would be 

pleased to answer any questions you or the other Senators may 

have. 

Senator COLEMAN. Thank you very much, Mr. Sebastian. 

Mr. Kutz, you have indicated—you started your testimony by 

talking about abusive and criminal activities, failure to pay these 

taxes is a crime; is that correct? 

Mr. KUTZ. Yes, that is correct. 

Senator COLEMAN. And I believe it is a felony-level crime? 

Mr. KUTZ. There is a felony-level for not remitting the taxes, and 

there is a misdemeanor for not properly segregating the taxes. 

Senator COLEMAN. We have heard that in one of the 47 cases 

that you reviewed, the individual involved is now living in the Caribbean. But do you have a sense of whether these cases are still 

prosecutable? 

Mr. KUTZ. Well, Mr. Ryan could probably answer that from a 

legal standpoint. 

Senator COLEMAN. Or certainly the other cases also. 

Mr. RYAN. I believe that the 47 cases that we looked at, we took 

12, and we dug down and looked at those cases. We believe that 

those cases have some additional elements for prosecution, and we 

have referred those to the IRS for whatever action they deem necessary. 

Senator COLEMAN. Very good, Mr. Ryan, and I will ask Commissioner Everson about those cases. 

Now, you identified 47 cases among the 27,100 contractors you 

identified as owing taxes. Are there more examples of potential 

criminal abuse among the 27,100 beyond the 47? I take it these 47 

are just a small sampling. 

Mr. KUTZ. That would be a small selection. They were not a sample. We did use some data mining techniques to get to them, but 

15

there are hundreds or potentially thousands of similar stories out 

there. 

Senator COLEMAN. Would the data mining techniques be such 

that you were looking at perhaps the worst abusers among the 47? 

Mr. KUTZ. Yes, and we were also looking for cases where the taxpayer had agreed to the assessment. In some cases, there is an 

unagreed-to assessment, but for all of the cases we looked at, the 

taxpayer had agreed that they owe the money. 

Senator COLEMAN. I find the figure stunning in the report saying 

that DOD could have collected over $100 million in back taxes this 

past year if payments had been levied. Are you confident you have 

not overstated the collection potential of these cases? 

Mr. KUTZ. Yes, in fact, I would say we probably understated it 

to be conservative. When we did a mechanical match of just what 

we had, we actually came up with a little over $300 million. But 

what we did was we assumed that certain cases would be collected 

in the normal course of business; some of these were not as delinquent as others. But we believe it is at least—that is why we said 

at least $100 million, to give an order of magnitude here. 

Also, keep in mind, we only looked at 72 percent of the DOD 

database. And so, you are talking about another $50 billion or $60 

billion of business that we did not look at. And then, with respect 

to the data quality, the taxpayer information, the only time we 

would get a match here would be is if the taxpayer identification 

numbers in IRS’ database matched those in the DOD database. So 

in some cases, we probably have other situations where there was 

erroneous information where we did not get a match. 

Senator COLEMAN. And the key here to get the match is the taxpayer identification number. 

Mr. KUTZ. Correct. 

Senator COLEMAN. If you have the match, you can follow up, and 

the IRS can follow up. If there is not a match, then, it is problematic. There is a provision in law that provides that if there is something wrong with the taxpayer information number that one can 

withhold up to 28 percent of the contract? 

Mr. KUTZ. Backup withholding; that is correct. 

Senator COLEMAN. So those provisions are in law. We do not 

need to change that. 

Mr. KUTZ. Correct. 

Senator COLEMAN. What can be done to increase the number of 

matches? Because that seems to be a critical element here. 

Mr. KUTZ. Well, I think that there are several things. There is 

the contract registry, which is now a database that DOD manages 

that includes contractors from all over the government. The data 

in that database needs to be validated. That would be step one. 

And step two would be to make sure that data is interfaced with 

all of the government’s payment systems, because the payment systems are the ones that are turned over to Treasury for the actual 

match. 

And I would say just one other thing: There needs to be human 

capital involved in this, too. This is not simply a mechanical exercise. There are going to have to be people involved to make sure 

that once someone starts getting levied, they are going to figure out 

16

a way to get a new taxpayer identification number or change it so 

that they do not get levied anymore. 

Senator COLEMAN. The key, again, though, is to get the data 

flowing into the system. Am I correct in understanding that as we 

sit here today, less than half of DOD contractor data regarding taxpayer identification numbers is flowing into the system? I mean, 

one of their management systems, which is close to 50 percent, is 

flowing into the Financial Management Service. 

Mr. KUTZ. That is correct; it is called the MOCAS system, which 

is for the large contract payments for multiyear weapons systems. 

Senator COLEMAN. But over half as we sit here today is not flowing into this system. 

Mr. KUTZ. Nearly $100 billion is not being—yes. 

Senator COLEMAN. What I find so stunning here, reflecting on 

your testimony, Mr. Sebastian, is we have the greatest fighting 

force in the world. We have the most powerful, the most advanced, 

the most technologically savvy fighting force in the world, and 

thank God we do. We respect and we support and we hold up as 

a great example our great military capability. 

And yet, as I am listening to your testimony that says we have 

record systems that do not work. We have got information not 

being compiled. And I am very perplexed by all of that. And again, 

when you provided your testimony about processing delays and inaccurate records, we are just talking about the 47 cases here; is 

that correct, that you looked at? 

Mr. SEBASTIAN. The examples that I spoke of in my oral statement came out of the 47 cases. 

Senator COLEMAN. So we have still got 27,053, at least, contractors who we have not even looked at the problems there. 

Mr. SEBASTIAN. Yes, I would also point out that some of these 

issues are not new to us. In the course of conducting the annual 

audit of IRS’ financial statements, we have identified issues such 

as inaccuracies in taxpayer records, delays in processing activities 

such as offers and installment agreements. So these are not new 

issues. We are not too surprised to see some of this in the 47 cases 

we looked at. 

Senator COLEMAN. One of the keys here is to get the Federal 

Payment Levy Program moving right away; in other words, if you 

identify a problem, you levy; you start to levy up to 15 percent. And 

then, you can work it out. The IRS can work things out. But you 

have got to initiate that as a first step. My understanding, as I review the report, that in these instances, it appeared that the levy 

was not the first step, that perhaps it was a last resort. Is that a 

correct reading of the report? 

Mr. SEBASTIAN. Yes, that is correct. When we speak of the first 

step, we need to be cognizant of the fact that the first step could 

only take place after such time as IRS has followed its own statutory requirements to provide appropriate notice to the taxpayer, 

and gives the taxpayer the opportunity to appeal the assessment 

or come into the office to try to make a workout arrangement, such 

as an offer or an installment agreement. 

But short of that, the cases that we saw sitting in the holding 

tank or queue could have been subject to levy. Cases with the revenue officers could also have been subject to levy. 

17

Senator COLEMAN. Are there specific legislative changes that you 

believe have to be enacted to make sure that this system is working and is more accountable? 

Mr. SEBASTIAN. Well, I think the only issue that creates some 

problem would be that IRS is also legally required to suspend any 

levy actions if a contractor were to come to the IRS to offer some 

type of payment arrangement, such as an offer to compromise on 

the tax debt or to enter into an installment agreement. At that 

time, IRS would have to discontinue any levy action they began. 

The intent there, ultimately, is that the taxpayer is trying to 

comply. The concern we have is that in the work we have done, not 

only on this job but in prior years, we have seen companies use this 

as a stall tactic: Enter into and then default on installment agreements on a number of occasions. 

So one possible alternative legislative area that might be pursued would be to take a look at that provision and see if there is 

some leeway such that the IRS could continue to levy during such 

time as these workout arrangements are underway and perhaps 

use the levy as the collecting mechanism for an offer in compromise 

or an installment agreement. 

Senator COLEMAN. But other than that, the system is there. 

Since 1996–97, we have got a system in place that provides for 

matching of taxpayer identification numbers, levy authority and an 

ability to be getting some payment back while you are involved in 

this process. The authority is there. 

Mr. SEBASTIAN. Yes, short of the legal restrictions I noted, the 

delays or the lack of levy action on some of these accounts had been 

policy decisions up to this point. 

Senator COLEMAN. And, of course, no one is forced to take a government contract. You enter into a voluntary arrangement. So I 

presume, as part of that process, you could require—for instance, 

is there any question about getting taxpayer identification numbers? I believe that they are required for service contracts but not 

for supply contracts; is that correct? 

Mr. RYAN. That is correct, sir. 

Senator COLEMAN. But we could certainly, as a condition of signing the contract, require people to provide taxpayer identification 

numbers in any kind of contract. 

Mr. SEBASTIAN. That would be true, especially if we could get the 

contractor, when they fill out in the central registry, to provide the 

correct and accurate information that could be checked with the 

IRS records. 

We have now gone to a system where all of the government contractors need to be registered in a central register. We need to expand possibly in that area so that all contractors can be checked, 

not just the DOD contractors but all contractors can be checked. It 

is important that we validate that information, because as Mr. 

Kutz says, we need to integrate that information into the pay systems. Because if the pay systems are going to provide the money 

to the contractors, it is a good means of identifying delinquent 

taxes. 

Senator COLEMAN. Again, the systems are in place since 1997. I 

believe, Mr. Kutz, was it your testimony that prior to September 

2002, nothing had been collected? 

18

Mr. KUTZ. Mr. Sebastian said it, but that is correct. Prior to 

2002, nothing had been done with DOD’s contract systems. 

Senator COLEMAN. Thank you. Senator Levin. 

Senator LEVIN. Thank you, Mr. Chairman. Let me go to the notices, those levy notices. The IRS is required by law to send out a 

notice of levy, as I understand it, before it levies. 

Mr. SEBASTIAN. That is correct. 

Senator LEVIN. Could it, in its delinquency notice, notify the delinquent taxpayer that it will be subject to a levy on any contract 

payments, so that there does not have to be a second notice sent 

out? 

Mr. SEBASTIAN. In fact, there are multiple notices that go to the 

taxpayers; depending on whether you are a business or an individual, up to four separate notices would be issued. 

Senator LEVIN. Does the delinquency notice contain that statement, that your payment is going to be subject to a levy? 

Mr. SEBASTIAN. I do not know if the first notice does. I know 

when we get to the second and third notices, there is a reference 

to a levy. And then, the notice of intent to levy is clearly——

Senator LEVIN. Is there any reason why there has to be a notice 

of intent to levy if the taxpayer has already been notified that a 

future payment is subject to a levy? Is there any reason why there 

has to be an additional, separate notice? 

Mr. SEBASTIAN. Other than legal requirements——

Senator LEVIN. No, is there a legal requirement, is there something in the law that says that? 

Mr. SEBASTIAN. Yes, the IRS is required to issue a notice of intent to levy and give the taxpayer an additional 30 days before the 

levy action occurs. 

Senator LEVIN. Could we legally, do you believe, if you can give 

us advice on this, give the notice of an intent to levy in the delinquency notice, so we do not have to send out another notice? 

Mr. SEBASTIAN. That would certainly be a policy option that the 

Congress could consider. 

Senator LEVIN. Well, I think we ought to take a look, surely, at 

that one. I mean, it seems to me that is fair notice, if somebody 

is told you are delinquent, and if you dispute this, you can come 

in and talk to us. That seems to me to be sufficient notice of an 

intent to levy if, in a delinquency notice, the taxpayer is told, hey, 

if you do not come in and work this thing out, you are subject to 

a levy on your payments. It seems to me—and I do not want to 

start giving legal advice, because I never made much money as a 

lawyer—but in any event, I do think that we ought to at least 

check with our legal counsel on that in terms of any legislation. Because if we are the ones in our law that says there has to be a separate notice of intent, then, it seems to me we probably could avoid 

that additional third notice by putting it right in the delinquency 

notice. 

If there is a proposal by the taxpayer to compromise, no matter 

how absurd the offer is, does that automatically stop a levy from 

occurring? 

Mr. SEBASTIAN. No, if the IRS——

Senator LEVIN. So it has to be a reasonable offer in the law? 

19

1See Exhibit No. 4 that appears in the Appendix on page 177. 

Mr. SEBASTIAN. If, on the surface, it appears to be fairly reasonable, and the IRS accepts it for processing, it is only at that point 

in time that you would suspend the levy action. 

Senator LEVIN. All right. So, if the IRS determines it is an unreasonable offer, they can reject it? 

Mr. SEBASTIAN. Yes, and they have the opportunity to reject at 

a later stage, once they have gone through the process of checking 

the financial records, the background of the individual. 

Senator LEVIN. All right. So, it is basically up to the IRS as to 

whether or not it stops the levy from occurring, because they are 

the ones who decide there is a good faith offer. 

Mr. SEBASTIAN. Yes. 

Senator LEVIN. Well, that seems to me to be reasonable. I mean, 

providing an unreasonable offer or an offer that is rejected does not 

stop the levy from occurring. 

Mr. SEBASTIAN. I believe the term they use is frivolous offer. 

Senator LEVIN. That sounds reasonable at that point. 

The IRS is going to tell us this morning, apparently, that the 

2005 budget of the administration includes a proposal that will 

allow the IRS to deal quickly with frivolous settlement offers and 

requests for hearings. If that already exists, as you have just testified, what more needs to be done in that area? 

Mr. SEBASTIAN. Well, it may go beyond just the point of an offer 

that appears frivolous on the surface. As you get in and actually 

begin to work with the taxpayer, requesting additional records to 

determine the validity, you may, at that point in time, find you are 

talking about a frivolous offer. 

The same with respect to installment agreements——

Senator LEVIN. OK; stop there. 

Mr. SEBASTIAN. Sure. 

Senator LEVIN. Under current practice or law, can they not at 

that point then say we are stopping these discussions; it is now 

frivolous; the levy is going to continue? Can they not do that now? 

Mr. SEBASTIAN. At the point in time that they have determined 

that the offer is frivolous, yes, they could. 

Senator LEVIN. I am trying to figure out—I have not read the 

budget request, so I am not familiar with the exact language—but 

are you familiar with this request or proposal in the 2005 budget 

that will allow the IRS to deal more quickly with frivolous settlement offers? What more is needed that is not already in their 

power? 

Mr. SEBASTIAN. Yes, I am familiar with the fact that it is in the 

proposal. I do not know to what extent it will effectively deal with 

the issue that we are talking about here. 

Senator LEVIN. Or that it is necessary. 

Mr. SEBASTIAN. Or that it is necessary with respect to reviewing 

frivolous offers. 

Senator LEVIN. If you could give us a reaction to that proposal 

for the record,1 that would be helpful. 

Now, on this queue rule, apparently, a tax levy cannot be initiated for a year if one is waiting to be assigned to a revenue officer. 

Do I have that correctly? 

20

Mr. SEBASTIAN. By IRS policy, that is correct. There is no legal 

requirement. 

Senator LEVIN. Right; by IRS policy. I understand that policy has 

now been eliminated, by the way. Is that your understanding? 

Mr. SEBASTIAN. Our understanding is that has occurred very recently. 

Senator LEVIN. OK. Perhaps as a result of the initiative of this 

Subcommittee, or of your GAO report, apparently, fairly recently, 

there has been this step taken by the IRS. And whether there is 

a cause-effect or not is not the point. It is a good step forward, I 

gather, in your view. 

Mr. SEBASTIAN. Yes. 

Senator LEVIN. There is no longer that automatic withholding of 

a levy because you are waiting in line to see a revenue officer. 

Mr. SEBASTIAN. Yes. Bear in mind, too, that the cases that are 

sitting in the queue are not being touched by anyone. But what is 

occurring is that the statutory period for the IRS to collect those 

taxes continues to run. IRS has, in general, 10 years from the time 

of the assessment to collect the taxes. After that point in time, the 

uncollected taxes come off the books. 

Senator LEVIN. On the queue, if there is a taxpayer who says 

look, I want to settle this, I want to do partial payments, or there 

is a dispute, and I want to resolve the dispute, if that person cannot see a revenue officer to discuss the settlement, why, then, 

should there be a levy? I want to now go at it from the opposite 

side, I want to go at it from the taxpayer’s perspective. If there is 

an honest effort to make the payments or an honest effort to resolve a dispute, if that person is unable to talk to the IRS, why 

should he or she be levied on? 

Mr. SEBASTIAN. Well, I believe if the taxpayer is coming forward 

with an attempt to try and make a workout arrangement, they will 

be able to contact the IRS. They have phone lines, customer service 

representatives that would assist them. 

Senator LEVIN. Well, then, what was the queue rule before it was 

eliminated? 

Mr. SEBASTIAN. The case was not being worked by anyone, nor 

was the taxpayer coming forth and making any attempt to repay 

their tax debt. 

Senator LEVIN. You are assuring us, however, that if there is an 

effort being made under new policy with no queue rule, and a good 

faith effort is being made by the taxpayer to work out a problem 

that the levy will not occur. 

Mr. SEBASTIAN. I am fairly certain of that. 

Senator LEVIN. OK. One last question, if I am not out of time, 

and that is were you surprised, Mr. Kutz, by the extent of the problem that you uncovered, by the 27,000 figure? Did that surprise 

you? 

Mr. KUTZ. Not necessarily. Mr. Sebastian and I testified on this 

several years ago, looking at all of unpaid payroll taxes, and we 

saw significant evidence there that there were government contractors that were involved in this. So it is not that surprising to us 

that this has happened. 

Senator LEVIN. Thank you. Thank you, Mr. Chairman. 

Senator COLEMAN. Thank you. Chairman Collins. 

21

Chairman COLLINS. Thank you, Mr. Chairman. 

Mr. Ryan, back in 2001, you and I worked together on an important investigation where we examined the security of the transportation of missiles and ammunition—Mr. Kutz was involved also—

to storage sites by the Department of Defense. As part of that investigation, we concluded that there were serious security lapses 

and vulnerabilities of missiles that were held at contractor facilities. 

Today, you have identified contractors that not only abuse the 

Federal tax system but are also involved in other ‘‘crimes of integrity’’. I am concerned that in addition to the problem of tax-dodging 

that some of these companies may represent a security threat. If 

they are not paying their taxes, and you have found kinds of diversions and evidence of possible crimes, this raises serious questions 

in my mind. 

I have two questions for you: First of all, did the 47 contractors 

whom you did in depth investigations of perform work on weapons 

systems or on military bases? And second, based on what you saw 

about the possible criminal activity and the lack of integrity of 

these contractors, do you think we are dealing also with a potential 

security risk in addition to tax evasion? 

Mr. RYAN. Thank you, Senator. It was good working with you 

back then. 

In this particular case, we did find that there were, in the 12 

particular contractors that we jumped into, we tried to pull back 

all the layers. Some of the things or questionable actions, from the 

background work that we did, we found that there were, with these 

12 contractors, product substitution problems, false statements to 

Federal agents, money laundering, submitting false statements to 

insurance companies, paying employees in cash to avoid payroll 

taxes, establishing shell companies to avoid the IRS getting hold of 

any government payments, the issuing of payroll checks to their 

employees where the accounts were closed. 

All of these issues add up to, as you say, crimes, I call, of integrity, based on my experience. When we talk about the security of 

our military installations, we spend an awful lot of time talking 

about ensuring who it is that is coming into the facilities. Just 

short of the biometric system, we have to try to establish something. There has to be some kind of a risk analysis done. 

We obviously do not want embarrassing situations at our military installations. We do not want government contractors coming 

in and conducting criminal activities on military installations and 

buildings. So I think it is absolutely necessary that we do something to ensure that the contractors that we are bringing into our 

installations and to our buildings, that security has to be put in 

place. There has to be backgrounds. There has to be determined 

what the minimum standard is, and then, based on the exposure 

of those type of contractors to the facility, that needs to rise. There 

needs to be a gradual increase. 

Mr. KUTZ. Some of these contracts were also dealing with weapons programs, major weapons programs. 

Chairman COLLINS. That is what concerns me. Is there any evidence that these bad actors, and they certainly appear to be bad 

actors, were referred by Federal contracting officials for possible 

22

debarment or suspension? In other words, did you come across any 

indications that Federal procurement officials were taking a look at 

the question of whether these companies should even be doing 

business with the Federal Government in the first place? 

Mr. KUTZ. There was no evidence of that. In fact, there is a concern that they do not really know who they are dealing with here. 

In one of the cases that the individual basically stole the money 

and went to the Caribbean, the business was turned over to a relative of that individual, and the Department, I think, still thought 

it was doing business with the person who was gone to the Caribbean. That is where the payments were being made to. 

Chairman COLLINS. It is extraordinary to me that Federal contracting officials are not looking at tax delinquencies when they are 

making responsibility determinations, when they are determining 

whether or not a company is a responsible bidder. We are supposed 

to have safeguards in our procurement laws to ensure that the Federal Government is only doing business with companies that demonstrate ethics and a certain level of business integrity. And I am 

at a loss to see how that is the case with the contracts that you 

investigated. 

But you have found no evidence that Federal procurement officials were even looking at this evidence? 

Mr. KUTZ. No. 

Mr. RYAN. No. 

Chairman COLLINS. In the year 2000, the GAO testified in support of legislation that would have amended the Debt Collection 

Improvement Act to prohibit delinquent Federal debtors, including 

Federal taxpayers, from being eligible to contract with Federal 

agencies. Mr. Kutz, could you tell me if that is still GAO’s position? 

Would you like to see legislation that would prohibit a company 

that has a serious tax delinquency from being eligible to do business with the Federal Government? 

Mr. KUTZ. As we noted back in 2000, it is a valid policy consideration for the Congress to look at, and it is something that—there 

are some implementation issues, such as data reliability; how 

quickly you can actually get a response from the IRS as to whether 

someone has tax debt. For example, if it would take 2 or 3 weeks, 

you would slow down the procurement process. If you could get 

one-day turnaround, it might be something feasible. 

So at that point in time, there were serious implementation 

issues related to automated systems that still exist today, to some 

extent. But from a policy perspective, that is something that could 

be very well considered, like it was back then. 

Chairman COLLINS. It occurs to me that companies that are failing to remit their payroll taxes can enjoy lower labor costs. And 

ironically, that gives these scofflaws a competitive advantage in 

bidding on Federal contracts. If you are a company that remits 

your fair share of Social Security and Medicare taxes to the Federal Government as well as the employee’s share, your costs are 

about 15 percent higher. 

If you are a company that is not remitting these payroll taxes, 

you are able to show lower labor costs. Do you think that is an 

issue as well, Mr. Kutz? 

23

Mr. KUTZ. Absolutely, and Mr. Ryan has a case that he can mention to you. But it gives you a 15.3 percent advantage on your wage 

base, and almost all the 47 that we looked at are wage-based-type 

companies providing services. So that is a substantial difference. 

Plus, many of these contractors were not paying their income taxes. 

So, on top of the payroll taxes, the income taxes give you a substantial advantage. And I think Mr. Ryan’s case is quite interesting. 

Chairman COLLINS. Mr. Ryan. 

Mr. RYAN. Yes, Senator, I met a retired contractor who is not 

part of this job; I just met a retired contractor; we were talking. 

And he was explaining to me that several years ago, he bid on government contracts. He paid his employees; paid his payroll taxes; 

and was taking care of his State responsibilities. And what he was 

finding was that other contractors were coming in, fly-by-nights, 

getting government contracts, staying in existence for a short period of time, doing away with that company, changing the name. 

In one case, he said that they had magnetic signs that they put 

on the truck. And when the contract was done, they would take it 

off and put another one on. And they were able to get away, because no one ever followed up. They got a new EIN, and they just 

kept bidding on government contracts. 

Mr. KUTZ. In 1999, we found that individuals were doing this 

with dozens of companies. We had some individuals that were involved in 40 or more companies that would run another into the 

ground; start them up; run them into the ground. And so, this is 

something that is an issue out there. 

Chairman COLLINS. Thank you very much. Thank you, Mr. 

Chairman. 

Senator COLEMAN. Thank you. Senator Lautenberg. 

Senator LAUTENBERG. Thanks, Mr. Chairman. I must say our 

friends at the witness table offered some pretty interesting testimony. Enough to kind of wonder what is happening with the review of a contractor’s ability and who they are before these contracts are issued. It sounds like it is kind of a conspiratorial thing 

to find these systems that permit you to go ahead, get a contract 

and get out of town. 

And I think one of the worst violations of all is to not remit the 

employee withholding. It is employee money that they are stealing. 

They are stealing from the government, but they are also stealing 

from those employees, who should have those amounts credited to 

their Social Security and so forth. 

I noticed your report said what GAO recommends—and thank 

you for this excellent report. Now, it says embargoed. I assume 

that embargo is off now that it is in the record. 

Mr. KUTZ. Right. 

Senator LAUTENBERG. Now, it says GAO makes recommendations 

to DOD for complying with statutory guidance supporting IRS efforts in collecting unpaid taxes. It was recommended to the office 

of OMB to develop options for prohibiting Federal contract awards 

to businesses and individuals that abuse the Federal tax system. 

DOD and IRS partially agreed. OMB did not agree that we ought 

to be able to punish these contractors who have showed this kind 

24

of an attitude about their obligations to the country and to their 

fellow citizens. 

What happened, by the way, to the guy who built the Caribbean 

home? Is he living there peacefully, or did we find a better place 

for him to live? [Laughter.] 

Mr. RYAN. Well, actually, he is still there, and, as a matter of 

fact, one of the agents who worked on this, Kenny Hill, actually 

sent him an email, and he got a reply back. We told him what we 

wanted, and after that, he decided not to email us back anymore. 

Senator LAUTENBERG. Is he out of reach? 

Mr. RYAN. In the Caribbean, he is, yes. 

Senator LAUTENBERG. We need an extradition treaty with that 

country. 

Mr. KUTZ. Senator, can I make one point on one of the things 

that you said? You talked about the employees and whether they 

are made whole. I just wanted to make the point: The way the system works is that the employees are made whole——

Senator LAUTENBERG. I figured that. 

Mr. KUTZ [continuing]. For Social Security and withholding 

taxes. And the money comes from the general fund. So the taxpayers are paying for it. 

Senator LAUTENBERG. But the fund is deprived of the receipt of 

those taxes. 

Mr. KUTZ. Right, and when we reported on this years ago, it is 

tens of billions of dollars over time that the Social Security fund 

has had to be subsidized by the general fund. So it is a substantial 

amount of money over time. 

Senator LAUTENBERG. Was there any evidence of a conspiratorial 

nature among some of these questionable contractors? Was there, 

perhaps, a connection how to deal with the government on these 

things, easy pickings, as they say? 

Mr. RYAN. I think of the contractors that we looked at, Senator, 

we did not uncover anything that would show a conspiracy, necessarily, between the contractor, the contracting officer, or the government representative. In one of the cases that my colleagues 

mentioned, about the gentleman who went to the Caribbean, he did 

have substantial contracts. He was taking the money out the back 

door and improving his lifestyle. 

At the same time, he was subcontracting his contract to family 

members, friends, or people who actually left the first company and 

went to the second one. And in response, he wanted a kickback. He 

wanted to get a substantial amount of money from these subcontractors to ensure that they would have the work. He wanted 

the money paid under the table and sent to offshore accounts. 

Mr. KUTZ. In another case, what was happening is the company 

was paying the owner and the owner’s wife’s bills for them: The 

mortgage, credit card bills, and car payments. And so, this money 

was coming out of the company. The company was using it as a deduction, probably, and these people were not reporting it as income. 

And they were calling it a loan, but the money was never paid 

back. So there were other schemes. 

And, as Mr. Ryan said earlier, a lot of the companies, there was 

evidence they were paying their employees wages in cash, which 

25

means that you have unreported payroll taxes under the table, basically. 

Senator LAUTENBERG. It sounds like these problems are initiated 

at the time of contract issue, and the notion that we cannot even 

withhold payments to them for work that they purportedly did allows that—this sounds a little bit like a sad comedy about our inability, giving out these billions of dollars worth of contracts, that 

we cannot withhold money you owe us. 

Mr. Ryan, I want to ask you a question: I wonder if you could 

update us on the progress of a report that was requested by Members of Congress last April on the Defense Department contracts 

that were awarded to Halliburton over the past couple of years. 

What has happened with it, and can we expect it to be released for 

Congressional review? 

Mr. RYAN. I have no knowledge of that work. It is not within my 

investigative responsibilities. 

Mr. KUTZ. GAO does have work underway in that area, but none 

of us are involved in that work at this point. 

Senator LAUTENBERG. I see. 

I was curious about whether or not some of the auditors found 

that—first of all, you were able to uncover this information. Why 

was this information not covered routinely by IRS or even DOD? 

There was a question asked before about DOD collecting taxes. 

Does DOD have that responsibility, tax collection? 

Mr. KUTZ. Under the Debt Collection Improvement Act, their responsibility is to refer their payment systems to the Treasury Department for offset purposes before they make the payment, and 

any items that are tagged, they are supposed to withhold and remit 

the money back to the Treasury Department. So they do have that 

responsibility. 

Senator LAUTENBERG. So what is it? Have you found any obstructionism from the other members of government agencies that prevented the review of these cases? 

Mr. KUTZ. I am not sure I understand the question. 

Senator LAUTENBERG. Well, I mean, has there been any evidence 

that these investigations were stopped, blocked in any way, as a result of friends in government or anything? 

Mr. KUTZ. No, there is no evidence of that. But there is evidence 

that these companies are doing significant business with other Federal agencies, like NASA, the Department of Energy, HHS, etc. So 

they are doing significant business with others. 

Senator LAUTENBERG. Well, the reason I asked that question, forgive me, is the Army Corps of Engineers waived an auditor’s demand for information data from Halliburton and shut off an audit 

review because DOD’s own auditing agency found that Halliburton 

has both failed to conduct adequate subcontracting price evaluations and had also overcharged U.S. taxpayers $61 million. This 

was public information, for the importation of fuel to Iraq. 

Subsequently, the Army Corps waived the auditors’ demands for 

more information and data from Halliburton, effectively shut off 

the audit. Is that a familiar——

Mr. KUTZ. No. 

Senator LAUTENBERG [continuing]. Case to any of you? 

Mr. KUTZ. We are not familiar with that. 

26

Mr. RYAN. No. 

Senator LAUTENBERG. That is why I asked the question about 

whether or not there was any attempt by one part of a government 

agency to say look, this is not really that important, and let us forget about it. 

Mr. KUTZ. But let me say something else, though: With the 47 

case studies we had, these are potential felonies, as I mentioned in 

the opening statement, as we talked about earlier. There was no 

evidence that any of these 47 were being pursued for prosecution 

under those laws that applied on failure to withhold and pay payroll taxes. 

Senator LAUTENBERG. That is pretty astounding information, 

that they rest in comfort at the expense of the taxpayers and the 

country. 

Senator COLEMAN. Senator Lautenberg, I would note that your 

time has expired. 

Senator LAUTENBERG. I am sorry. Thank you. 

Senator COLEMAN. Senator Fitzgerald. 

OPENING STATEMENT OF SENATOR FITZGERALD 

Senator FITZGERALD. Thank you, Mr. Chairman. 

Mr. Chairman, if I could have unanimous consent to submit my 

opening statement for the record, I would appreciate that. 

Senator COLEMAN. Without objection. 

[The prepared opening statement of Senator Fitzgerald follows:]

PREPARED OPENING STATEMENT OF SENATOR FITZGERALD 

Good morning. I want to join my colleagues in welcoming the distinguished witnesses who are present today. 

I would like to thank Chairman Coleman for holding this important hearing on 

Department of Defense contractors who are not paying taxes owed to the Federal 

Government. 

The spending at the Department of Defense accounts for nearly a fifth of the Federal Government’s annual budget. According to the U.S. General Accounting Office, 

over $183 billion was disbursed to contractors of the Department of Defense through 

16 different payment systems in fiscal year 2002. At the same time, 27,1000 Department of Defense contractors owed nearly $3 billion in unpaid taxes. And it’s not just 

the large contractors who are evading taxes, it’s also the small contractors like the 

dentist and the caterer. The lack of controls that allowed such payments to be made 

without first deducting delinquent axes is astounding. 

The efforts of the Department of Defense to refer contractors to the Financial 

Management Service (FMS) at the Department of the Treasury as required by the 

Debt Collection Improvement Act of 1996 are obviously inadequate. Only one payment system out of 16 separate DOD payment systems is set up to refer payment 

information to FMS to offset contractor payments. And in numerous cases—4,900 

cases—DOD contractors provided invalid taxpayer identification numbers, which 

were not validated before payment was made. For one of the Federal Government’s 

largest agencies to make billions of dollars in payments and not verify taxpayer 

identification numbers when the resources are right there is beyond me. What is 

more appalling is the fat that some of these unpaid taxes are payroll taxes deducted 

from employees’ paychecks, but never remitted to the government. 

It is the obligation of all persons, businesses and organizations in the U.S. that 

earn non-exempt income to pay their Federal taxes, particularly if those taxes have 

been withheld from an employee’s wages. When hardworking Americans comply 

with this requirement while others blatantly fail to do so, there is an injustice and 

a breakdown of the system. And when there is a failure to pay taxes, it is theft—

from the Federal Government and from the hardworking taxpayers in America. 

The Federal tax system is based on voluntary compliance and the IRS, though 

fearsome in its reputation, is essentially a very large, and not very efficient, collection agency. although the Treasury’s Financial Management Service runs the Treasury Offset Program, which matches IRS tax debtors with Federal payees to identify 

27

payments that can be levied, much more needs to be done—by both the Department 

of Defense and Treasury. 

I look forward to hearing from our witnesses from GAO today regarding their review of Department of Defense contractors’ compliance with tax laws, including the 

scope of their investigation, their findings, and their recommendations on tightening 

the system. Additionally, I look forward to hearing from our witnesses from the Internal Revenue Service, Financial Management Service and the Department of Defense about their operations, the Treasury Offset Program and the referral of the 

DOD payment systems to Treasury. 

As Members of Congress, we fail to act as stewards of taxpayer money if we allow 

these contractors to dodge taxes with impunity. 

Again, I thank the witnesses for appearing today, and I look forward to hearing 

their testimony. Thank you, Mr. Chairman.

Senator FITZGERALD. And thank you, gentlemen, for being with 

us today. 

I imagine this is far more pervasive than just the problem with 

the Defense Department. And I think you did a report back in 

April 2000 talking about how the same sort of thing is happening 

with government contracts from all agencies of the Federal Government. 

Are we talking, in general, about contracts that are so small they 

are not subject to our competitive bidding or our procurement law? 

Mr. KUTZ. No, they are not that small generally. 

Senator FITZGERALD. They are ones that may have been competitively bid? 

Mr. KUTZ. Right; most of those smaller ones would be used—the 

purchase card would actually be used to procure those. These were 

not purchase card disbursements. These were competitively-bid 

contracts generally. 

Senator FITZGERALD. OK, competitively-bid contracts. We have a 

huge procurement code that walks through what you have to do for 

a competitive bid process, but it seems to me we are really not 

checking to see that those who are bidding are even true companies. You talk about fly-by-night companies that somebody maybe 

just opened up a week before they go in to get this government contract, and all of a sudden, they are in business. Then, when they 

get their payment, they take the magnetic sign off their van, and 

they are in some other business. 

This is really pretty astonishing, the lack of controls over who is 

qualifying for these government contracts. Is that not an area, a 

fundamental threshold area, that we need to address? 

Mr. KUTZ. We did not look at that systematically, but there was 

very little evidence that the Department’s contracting officers and 

contract community really knew who they were dealing with, as 

you mentioned. Again, we would have to look at that more systematically, but there are supposed to be processes and controls in 

place to make sure these contractors are reputable before we do 

business with them, but for these 47 cases, they were not there, 

and they were not working. 

Senator FITZGERALD. They were not there, and you saw ones who 

really were not legitimate businesses, is basically what you are 

saying. 

Mr. KUTZ. Well, they were not paying their taxes in all 47 cases, 

and, as Mr. Ryan said, many of them were involved in these other 

crimes: Embezzlement, money laundering, forgery, grand theft, etc. 

28

So there were some serious background issues with many of these 

contractors. 

Senator FITZGERALD. So it looks like there had been no investigation, no background check at all on the part of the DOD before they 

did business with these entities. 

Mr. KUTZ. If there was, it would have not picked—it did not pick 

these things up, or no one did anything about it. So again, we did 

not look at that process, but we saw no evidence that anyone had 

raised any questions. 

Senator FITZGERALD. Well, it would seem to me that if we required them to do a criminal background check, required them to 

check to make sure their taxes were paid, required them to have 

been in business for a certain period of time and have a corporation 

in good standing—although I suppose some of these—are unincorporated sole proprietorships——

Mr. KUTZ. Correct, some of them were. 

Senator FITZGERALD. But we could put some requirements in the 

law before they could even enter into a contract with the company, 

could we not? 

Mr. KUTZ. Yes, we could. And I think there are some policies in 

place from a governmentwide perspective, but again, we did not see 

that they were necessarily working. I mean, these contractors could 

have been debarred if someone had been aware of what they were 

doing. So for some reason, they were not aware what they were 

doing, or they were aware, and they did nothing about it. 

Senator FITZGERALD. There is no requirement that DOD do a 

criminal background check on a prospective contractor. Is that correct? 

Mr. RYAN. I do not know, Senator. 

Senator FITZGERALD. Is there a requirement that they check to 

make sure they do not have delinquent taxes? 

Mr. KUTZ. No, not that I am aware of. 

Mr. RYAN. No. 

Senator FITZGERALD. No. Well, we could put those into the law 

before they could enter into a contract with companies. And it 

seems to me that some of these companies may be winning the 

competitive bidding, as a couple of the other Senators said, because 

they are not paying their employees’ payroll taxes. They are paying 

their employees, perhaps, under the table and so forth. They have 

less overhead expense than a legitimate company that plays by the 

rules and funds its payroll taxes. 

Were any of these 47 cases referred to prosecutors? 

Mr. RYAN. We referred them back to the agency, for the agency 

to decide what they want to do with them. I think we developed 

enough evidence to indicate that the case should be reopened. I 

think you will have to ask the next panel as to what they decide 

to do with that information. We have made our full investigative 

files available to the agents of the IRS, and we will be glad to 

share the information with them and also continue to work with 

them. 

Mr. KUTZ. We referred all 47, basically, for collection follow-up 

and several that Agent Ryan is talking about for criminal review. 

Senator FITZGERALD. I would think some high-profile prosecutions by U.S. Attorneys around the country of these bad actors 

29

would send a message out that might chill further criminal activity. 

Well, I appreciate your being here. You do agree that this is not 

just a DOD problem. This is no doubt going on with perhaps all 

our other agencies of government. 

Mr. KUTZ. It would appear so. Just these contractors alone, the 

47, had a lot of business with other government agencies. 

Senator FITZGERALD. So this is probably a governmentwide problem, and we are probably losing billions and billions of dollars in 

waste, and we are missing an easy opportunity to collect back taxes 

for the IRS. 

Mr. KUTZ. I will note that for non-DOD agencies, the actual con- tractor offset of taxes has only yielded about $6 million in 2003. 

For DOD, it was under $1 million. So even though DOD is twothirds of the government’s contracting, and the others are a third, 

the other program has not been much more successful than the 

DOD. So something is wrong with the entire levy program for payments to contractors—$7 million a year in collections. There is 

something very wrong with that. 

Senator FITZGERALD. Something is wrong. 

Well, Mr. Chairman, thank you very much, and gentlemen, 

thank you for your time. 

Senator COLEMAN. Thank you, Senator Fitzgerald. Senator 

Akaka. 

OPENING STATEMENT OF SENATOR AKAKA 

Senator AKAKA. Thank you very much, Mr. Chairman. I really 

appreciate your conducting today’s hearing and for your leadership, 

Mr. Chairman, in shedding light on tax evasion by DOD contractors. 

Mr. Chairman, I have a statement that I would like to have 

placed in the record at this point. 

Senator COLEMAN. Without objection. 

[The prepared statement of Senator Akaka follows:]

PREPARED OPENING STATEMENT OF SENATOR AKAKA 

Thank you Mr. Chairman. I appreciate your conducting today’s hearing and for 

your leadership in shedding light on tax evasion by DoD contractors. 

At a time when this country faces an unprecedented projected budget deficit of $480 billion, this year, it is wrong that 27,000 contractors owe the government $3 

billion in unpaid taxes. 

Americans incur a high cost as a result of the failure of government contractors 

to pay their taxes. The General Accounting Office report, which is the focus of today’s hearing, found that well over half of the cases of abuse involved a failure to 

submit payroll taxes. This has resulted in a $1.2 billion funding shortfall to the U.S. 

Treasury, Medicare, Social Security, and federally funded State programs. 

As the Ranking Member of the Governmental Affairs Financial Management Subcommittee and the Armed Services Readiness Subcommittee, I believe GAO’s findings raise serious concerns at a time when my constituents are calling for investigations into overcharges for Iraqi contracts and the debarment of those contractors 

who are guilty of misconduct. 

By law, government contractors must comply with ethical standards of conduct. 

Yet when contractors do break the law, they often continue to receive government 

contracts. A 2002 Project on Government Oversight report found that 16 of the top 

43 federal contractors had been convicted of criminal violations. Only one had been 

suspended from receiving federal contracts. 

Surprisingly, federal law does not prevent contractors with unpaid taxes from receiving contracts. The rate of tax payment delinquency among federal contractors 

is almost double the rate among the general public. I am disappointed that the AdVerDate 0ct 09 2002 14:41 Jun 29, 2004 Jkt 092689 PO 00000 Frm 00033 Fmt 6633 Sfmt 6621 C:\DOCS\92689.TXT SAFFAIRS PsN: PHOGAN
30

ministration chose to weaken ethical standards in the Federal Acquisition Regulation for contractors eligible to receive federal contracts. 

GAO’s findings also go to the heart of existing management challenges at DoD, 

which for the past 12 years have been on GAO’s High Risk list. Without addressing 

systemic problems in DoD’s financial systems, we will continue to see such abuses. 

Shortcomings in DoD financial management systems are a decades-old problem. 

While these challenges are not exciting or easily understood, correcting them is vitally important. As we can see from the GAO report, billions of dollars are at stake. 

DoD’s inability and unwillingness to track accurately tax levies has an impact on 

a variety of DoD functions and operations. 

I want to know why aren’t DoD and IRS working together to share relevant information and aggressively pursuing tax evading contractors? 

Prior to today’s hearing, DoD claimed that enabling all 20 of its pay systems to 

report payment information to the Treasury Offset Program (TOP) database, where 

it can be screened for discrepancies, presented too much of a hardship. This is unacceptable. Federal agencies are required to share this information under the Debt 

Collection Improvement Act of 1996. 

Mr. Chairman thank you again for holding this hearing. I look forward to learning 

from all of our witnesses on how we can prevent these abuses in the future.

Senator AKAKA. From what I have learned, I am completely 

shocked at what is happening in our country, especially when we 

think about how much tax revenue is not being collected. At a time 

our country faces an unprecedented projected budget deficit of $480 

billion this year, 27,000 contractors owe the government $3 billion 

in unpaid taxes. 

As the Ranking Member of Governmental Affairs’ Financial Management, the Budget, and the International Security Subcommittee 

and the Armed Service’s Readiness and Management Support Subcommittee, and from working with Senator Fitzgerald, I believe 

GAO’s findings raise serious concerns, especially when my constituents in Hawaii are calling for investigations into overcharges for 

Iraqi contracts and debarment of those contractors who are guilty 

of misconduct. 

And hearing from the Federal side here, I also wonder about 

what is happening to State taxes from these contractors. 

Mr. KUTZ. We can assure you that just about all 47 of them were 

deadbeat State taxpayers, too. We saw that in just about every 

case, pretty much. When you saw Federal, it was State. So all the 

States are affected by this, also. 

Senator AKAKA. So it is a huge problem that we are facing, and 

I am astonished that Federal law does not prevent contractors with 

unpaid taxes from receiving contracts. The rate of tax payment delinquency among Federal contractors is almost double the rate 

among the general public. I am disappointed that the administration chose to weaken ethical standards in the Federal Acquisition 

Regulations for contractors eligible to receive Federal contracts. 

And I have two questions, one difference that I cannot understand is that in his written statement, Deputy Under Secretary 

Lanzillotta states that DOD has collected $2.1 million through the 

levy program, your report states that DOD has only collected 

$332,000 through the levy program. Can you clarify the discrepancy in these numbers? 

Mr. SEBASTIAN. I have a possible explanation for you. The less 

than $700,000 that we are referring to has to do with the 15 percent continuous levy authority. In the case of the other roughly 

$1.3 million that may be referred to in the Under Secretary’s statement, that may be a direct one-time levy against that particular 

31

contractor’s payments, meaning it is not systematic. The IRS and 

DOD working in tandem would have made the levy against that 

particular payment, and it may not have been capped at 15 percent. But it was a one-time levy. And there may have been a few 

situations like that that created the additional $1.3 or $1.4 million. 

Mr. KUTZ. Right. The continuous levy would mean if 20 payments were made to a contractor in a year, you would take 15 percent of each and every payment versus a one-time hit outside of 

this program. 

Senator AKAKA. In your written statement, you stated that improving DOD’s ability to aid the IRS in its levy program may require legislative changes from Congress, and after hearing the comments that are made and responses and the questions here, this 

question becomes very important to us. Could you elaborate on 

what kind of legislation you think is necessary to deal with the 

kinds of problems we are facing? 

Mr. KUTZ. There are several that have come up here. The first 

one is the bar, the legislative bar, as you mentioned in your statement a couple of minutes ago of not letting contractors do business 

with the government that have significant or severe unpaid tax 

problems. And that was a bill that was produced in the House, I 

guess, in 1999 and 2000. And it got through the Government Reform Committee, and then, it stalled at that point in time. So, certainly, the most severe type of legislative action would be the bar. 

And again, there are some implementation issues with that, but 

conceptually, that is a policy alternative. 

One other thing is sharing of information between DOD and IRS 

to validate the contractor information. There is some restriction. 

Now, this contractor database includes not only DOD contractors 

but other agency contractors. Right now, due to the disclosure 

rules, they are not able to share all of that information for validation purposes with the Internal Revenue Service to make sure we 

validate everyone in the contract system. 

And then, Mr. Sebastian spoke earlier about possibly some legislation in the levy area. 

Mr. SEBASTIAN. Right. Such as taking a look at some of the restrictions in place with regard to a contractor that comes to the 

IRS in an attempt to make a payment arrangement through an 

offer or installment agreement; currently, the levy process would 

suspend over the period of time in which IRS is evaluating that 

proposal. And if the proposal is accepted, the contractor would be 

paying under those arrangements. 

One legislative change you could have, would be to ensure that 

the levy continues and may actually become a collecting mechanism for an agreed-to installment agreement or an offer in compromise. So you are guaranteed a stream of payments in the event 

you are dealing with a contractor who went into the arrangement 

knowing full-well they intended to default on the agreement. 

Senator AKAKA. Mr. Chairman, it is obvious that this is a much 

larger problem than just in DOD, and we need to expand what we 

are doing to all Federal contractors and try to correct this for the 

benefit of our taxpayers. 

Thank you very much, Mr. Chairman. 

32

Senator COLEMAN. Thank you, Senator Akaka, and I assure you 

that we will continue down this path. Clearly, we have a rat’s nest 

here, and my sense is that at least we have got folks in the system 

that a lot of good could happen, as it impacts not just DOD but 

other agencies; as it impacts local governments that depend on tax 

receipts; it may cut off other criminal activity. But the system has 

got to grab somebody, and obviously, that is not being done. 

Gentlemen, I want to thank you for your testimony. Your report 

was exemplary; your testimony compelling. The record will be held 

open for another 2 weeks if my colleagues have other questions for 

you, but I want to thank you for your testimony today. 

Mr. SEBASTIAN. Thank you. 

Senator COLEMAN. I would now like to welcome our final panel 

of witnesses for this morning’s hearing. 

We have a vote posted. I believe we have 12 minutes. I will begin 

the hearing, and hopefully, one of my colleagues will return and 

continue. If that does not happen, we will simply recess for a very 

short period. 

Our final panel, the Hon. Mark Everson, Commissioner of the Internal Revenue Service; Richard Gregg, the Commissioner of the 

Treasury Department’s Financial Management Service; and finally, 

from the Department of Defense, Lawrence J. Lanzillotta, the Principal Deputy Under Secretary of Defense for the Comptroller. 

Mr. Everson, it is good to see you again. As you remember, in 

November, you testified before this Subcommittee regarding the 

IRS’ response to abusive tax shelters that robbed the U.S. taxpayers of an estimated $85 billion over 6 years, according to GAO’s 

study of abusive tax shelters. In that regard, I want to acknowledge and applaud the IRS’ recent legislative proposals to curb abusive tax shelters, which would raise penalties to promoters and taxpayers alike. And I would also note before your testimony, and I 

know you have to testify other places, but I did note this morning, 

I appreciated the opportunity we had to visit yesterday and your 

commitment to followup and root out some of the abuses and particularly the cases that have come before us. I wanted to thank you 

for that. 

Mr. EVERSON. Thank you. 

Senator COLEMAN. Mr. Lanzillotta, I also want to welcome you 

back and look forward to hearing how you propose to levy your contractor payments where it is warranted. I thank all of you for your 

attendance this afternoon, and I look forward to hearing your reaction to the recent GAO examination of DOD contractors who are 

abusing the Federal tax system. And I am particularly interested 

in learning what corrective actions you would propose to ensure 

that DOD contractors pay the taxes that they owe the Federal Government. 

Before we begin, pursuant to Rule 6, all witnesses before this 

Subcommittee are required to be sworn. I would ask you to please 

stand and raise your right hand. 

[Witnesses sworn.] 

Senator COLEMAN. Thank you, gentlemen. 

We will be using a timing system. You are aware of this system: 

One minute before the red light comes on, you will see the lights 

go from green to yellow. If you can, then, limit your testimony to 

33

1The prepared statement of Mr. Everson appears in the Appendix on page 82. 

that period of time. Your written statement will be entered in its 

completeness in the record. 

Commissioner Everson, we will have you go first, followed by 

Commissioner Gregg and finally Mr. Lanzillotta. After we have 

heard all of the testimony, we will turn to questions. 

Commissioner Everson, you may proceed. 

TESTIMONY OF HON. MARK EVERSON,1 COMMISSIONER, INTERNAL REVENUE SERVICE, U.S. DEPARTMENT OF THE 

TREASURY 

Mr. EVERSON. Mr. Chairman, Senator Fitzgerald, thank you for 

inviting me here today. I am particularly pleased to be here on 

February 12, President Lincoln’s birthday. After all, he signed into 

law the first income tax and appointed the first Commissioner of 

Internal Revenue, and despite that fact, he remains one of our 

most popular and revered Presidents. [Laughter.] 

I welcome the opportunity to testify on the General Accounting 

Office’s study of the need for strengthened government procedures 

and assuring that the Department of Defense contractors meet 

their Federal tax obligations. I want to say at the outset that we 

at the IRS agree with the major conclusions of the GAO study and 

believe that many improvements can be made to our own efforts in 

this area. A number of positive steps are already underway. 

Before turning to this subject, I want to say a few things about 

our goals at the IRS and tax collection in general. I have set three 

priorities for the IRS during my 5-year term as Commissioner. 

First, we must continue to improve service, making it easier for the 

taxpayer to understand and comply with the tax laws. Through focused implementation of the IRS Restructuring and Reform Act of 

1998, the IRS has measurably improved service to taxpayers and 

practitioners. We are not backing away from this commitment to 

improve service. 

The second area of emphasis is information technology modernization. We have made a great deal of progress in increasing efiling and providing information to taxpayers and practitioners 

online and other important gains in technology. But we have struggled to update our master files and improve our financial and other 

infrastructure systems. We are addressing these challenges on an 

ongoing basis and must modernize. 

The third area of focus, a core element of which is the subject 

of your hearing today—collections—is to strengthen the integrity of 

the Nation’s tax system through enhanced enforcement activities. 

I know you are familiar with our enforcement efforts, and I remain 

appreciative of the Subcommittee’s leadership in this area, including holding a hearing last fall on abusive tax shelters and their 

promotion by professional services firms. 

I strongly support your call for more stringent penalties for promoters who violate the law and very much appreciate the fact that 

you have called for augmenting resources at the IRS. As you know, 

the President recently transmitted the 2005 budget request to Congress. It calls for a 5 percent overall increase for the IRS, including 

a 10 percent boost to our enforcement activities. The President’s 

34

budget addresses a number of areas about which the Subcommittee 

has concerns, including enhanced collections, combatting abusive 

tax shelters and confronting tax abuses within the tax-exempt sector. I hope I can count on your active support for this request. 

Turning to today’s subject, let me reiterate what I said a moment 

ago: We largely agree with the GAO report. The GAO has made 

thoughtful observations about why the IRS has not levied taxes 

from many defense contractors. The GAO observed that the IRS 

had, ‘‘a collection philosophy of continuing to work with businesses 

and individuals to achieve voluntary compliance rather than taking 

reliable enforcement actions such as levies of Federal contractor 

payments.’’

I agree with this assessment, which I believe reflects an overhang from the 1998 Reform Act. The GAO has also said that, ‘‘due 

to resource constraints, the IRS has established policies that either 

exclude or delay referral of a significant number of cases to the 

levy program.’’ I largely, but do not entirely, agree with this view. 

I believe we are making progress on both of these concerns. We are 

giving greater emphasis to enforcement, which will address some 

of the reticence our employees have had to use the levy tool. And, 

as I just noted, we are seeking more resources to boost our activities for enforcement. 

This having been said, a central conflict remains between two 

competing public policy goals: Taxpayer rights, on the one hand, 

and the expectation that those who do business with the government have a clean bill of financial health, on the other. The Taxpayer Relief Act of 1997 expanded the collection authority of the 

government by allowing the IRS to continuously levy up to 15 percent of payments to contractors. But the IRS Restructuring and Reform Act of 1998 established new procedures which limited the 

prompt collection of monies due in order to protect taxpayer rights. 

In addition, I would note that certain privacy protections significantly limit the IRS’ ability to share taxpayer information with 

other agencies for collection purposes. The chart over here shows 

the effects of these competing priorities. As GAO has noted, in 

2002, there were about a quarter of a trillion dollars of monies 

owed to the government. This is all money owed to the government. 

And as GAO also said, it stays on the books of the government for 

10 years. 

The pie wedges show that statutory and operational exclusions 

limit the amount that is available for the levy program. As examples, the statutory exclusions include the right of a taxpayer to appeal an IRS decision, which can delay the collection process for 

months or even years and prevents a matter from being considered 

for levy. This is also the case, for example, if there is already an 

installment agreement in place between the IRS and the taxpayer. 

As for operational, or as the GAO called it, policy exclusions, the 

IRS has excluded from the levy portfolio certain other categories of 

debt: Cases involving financial hardship to the taxpayer, where the 

taxpayer has died, and where the taxpayer is living in a designated 

disaster area, to mention a few. 

Responding to the GAO report and to the interests of the Subcommittee, we have already taken steps to reduce operational exclusions. Again, this is based on the 2002 audited data. As you can 

35

1The prepared statementof Mr. Gregg with an attachment appears in the Appendix on page 

92. 

see on the chart, we are making available an additional $26 billion 

for potential levy through adjustment of certain exclusion criteria. 

These steps will take effect over the next few months, as we update the programming of our systems. We are also creating a joint 

task force with Treasury, Defense, and OMB to examine the contractor collection issue. By June of this year, the task force will 

make recommendations on short-term operational improvements, 

mid- and long-term operational changes and potential statutory 

proposals that could improve the collection of taxes from Federal 

contractors. The statutory limits on tax debt collection merit a public discussion about the conflict between the need for taxpayer 

rights versus the need to make sure that government vendors have 

a clean bill of financial health. 

Defense contractors do not have to do business with the government. It can be argued that contractors should be held to a higher 

standard. 

Again, I want to thank the GAO and the Subcommittee for focusing on the issue of collections from delinquent defense contractors. 

I am happy to take any questions. 

Senator COLEMAN. Thank you, Mr. Everson. If there is anything 

else in your full statement, we will make sure that it is entered 

into the record. 

Commissioner Gregg, I think what we might do here, as I am 

told the time is winding down on the time to vote, is I am going 

to recess this hearing very briefly. Senator Levin should be on his 

way back. But let me recess, hopefully, for not more than 10 minutes, and then, we will return with your testimony. 

[Recess.] 

Senator LEVIN [presiding]. The Subcommittee will be back in 

order, and we will call upon you, Mr. Gregg. The Chairman would 

like us to proceed, so please do so. 

TESTIMONY OF RICHARD L. GREGG,1 COMMISSIONER, FINANCIAL MANAGEMENT SERVICE, U.S. DEPARTMENT OF THE 

TREASURY 

Mr. GREGG. Thank you, Senator. 

Thank you for inviting me today to discuss the role of the Financial Management Service in collecting unpaid Federal taxes that 

are owed by DOD contractors. Treasury appreciates your focusing 

attention on government financial management issues. 

FMS is a Treasury bureau charged with broad financial management responsibilities, including disbursing payments, collecting 

revenue and maintaining the government’s accounts. And I welcome the opportunity today to acquaint the Subcommittee with 

FMS’ fourth business line, which is the collection of delinquent 

debts owed to the government, both non-tax and tax. 

The Debt Collection Improvement Act of 1996 is the principal 

law under which FMS collects non-tax debts owed to Federal agencies. Our collections are accomplished through two programs: The 

Treasury Offset Program, TOP, and cross-servicing. I will just focus 

on TOP today. 

36

TOP is our largest collection program and is directly linked to 

payment disbursements. Through TOP, FMS reduces the amount of 

individuals’ or businesses’ Federal payments disbursed by Treasury 

and other agencies to satisfy delinquent debts. Types of payments 

include benefit payments paid on behalf of the Social Security Administration, Office of Personnel Management retirement payments, Federal income tax refund payments and payments to businesses, vendor payments, for goods and services provided to the 

Federal Government. 

A reduction or offset occurs if the name and taxpayer identifying 

number of a debtor included in the TOP database is matched 

against the name and the taxpayer identifying number of a Federal 

payment recipient. The TOP debtor information is supplied by the 

agencies to which the debts are owed. 

The recent GAO report notes that FMS also has a key role in the 

collection of Federal tax debts. In partnership with FMS, the IRS 

collects unpaid Federal income taxes through the continuous levy 

of certain Federal payments disbursed by FMS. Vendor, Federal 

employee salary, OPM retirement, and Social Security benefit payments are among those that are levied continuously at a rate of up 

to 15 percent until a debt is satisfied. This is accomplished through 

an automated process using the TOP system. If there is a match 

between the IRS tax debts and FMS payment records, IRS initiates 

a process by which the debtor is given a minimum of 30 days to 

make payment arrangements, appeal the proposed levy action, or 

apply for a hardship determination. The levy of a payment occurs 

only after IRS completes its due process notification and directs 

FMS to levy future payments. The Continuous Levy Program was 

authorized under the Taxpayer Relief Act of 1997. 

I spoke earlier of the link between TOP and payment disbursements. While Treasury is the primary disburser, with 85 percent 

of the government’s disbursements, nearly 1 billion payments a 

year, other agencies, including DOD and the U.S. Postal Service, 

have payment disbursement authority as well. These agencies, 

which disburse payments such as salary and vendor, began matching their payments against FMS’ TOP debtor database in 2002. 

Individuals or businesses receiving these non-Treasury disbursed 

payments may also have their payments levied if they owe tax 

debts and would be afforded the same due process as those receiving a Treasury disbursed payment. Routinely, we work with our 

partner agencies on debt collection issues by providing information 

and making recommendations for enhanced collections. As an example, we have been working with DOD and IRS for some time on 

ways that are tailored to their specific needs to improve collections. 

In the case of DOD, the existing program is designed in such a way 

that their contractors may either have their payments offset, if 

they owe non-tax debts, or levied if they owe tax debts. 

At present, payments disbursed through two of DOD’s contract 

pay systems are being matched against the TOP data for both offset and levy purposes. I have been advised that in the coming 

months, DOD expects to begin matching vendor payments it disburses through its remaining systems. For our part, FMS is working closely with DOD, and we are well-prepared to assume the additional work load. 

37

Mr. Chairman, Treasury views debt collection as an important financial management tool. Moreover, collecting money owed to the 

government is in close alignment with one of the governmentwide 

initiatives under the President’s management agenda: Improved financial performance. Along these lines, you may be interested to 

know that the President’s 2005 budget includes proposals to further improve the Federal Government’s collection of delinquent 

debts. And one of these proposals would increase the continuous 

levy on Federal vendor payments from the current 15 percent to 

100 percent. 

Unlike many Federal payments such as salary and retirement 

and benefit payments, vendor payments are not recurring, and, 

thus, fewer opportunities exist for collection. This levy increase 

would not affect the administrative processes already in place that 

give the debtor 30 days to make payment arrangements, appeal the 

levy action or apply for a hardship determination. 

We believe that devoting resources to debt collection is both wise 

and of enormous benefit to agencies in managing their budget accounts and producing accurate financial statements. As you can see 

from the chart attached to my statement, FMS’ debt programs have 

resulted in the collection of more than $18 billion since 1997. Our 

success can be attributed, in large part, to having the expertise and 

the infrastructure and cooperative working relationships with 

agencies to collect millions of dollars of outstanding debts. 

At the same time, we recognize that there are always ways to 

improve. For example, to help maximize the potential of the levy 

program, we are actively engaged with IRS in examining the feasibility of making two important improvements. First, we are discussing ways to increase the number of tax debts in TOP that can 

be actively collected following the completion of IRS due process notification, and, in fact, as the Commissioner pointed out, some of 

that has already occurred. 

Under this approach, IRS may consider ways to provide due process to delinquent taxpayers before, not after, the tax debts are 

transmitted to TOP. Presently, payments to DOD contractors, 

many of which are one-time, have already been disbursed by the 

time the due process is completed. Modifying the due process timing would ensure that the payments being disbursed to DOD contractors who are identified as delinquent tax debtors can be levied 

immediately. We welcome the opportunity to work with DOD and 

IRS to devise procedures that address this issue. 

Second, we are exploring with IRS ways to improve the accuracy 

of information pertaining to taxpayer identification numbers, 

names and addresses contained in DOD’s central contractor registration database. IRS advises, however, that there may be legal 

impediments under current law concerning the circumstances 

under which TIN matching may be used by IRS, the information 

the IRS may disclose as a result of that matching, and to whom 

the information is disclosed. 

If—I repeat if—these important issues can be addressed, we 

would anticipate increased matches of the delinquent tax debts 

with vendor payments to those same debtors. Increased matches 

would very likely result in greater collections. 

38

1The prepared statement of Mr. Lanzillotta appears in the Appendix on page 98. 

Once more, I appreciate the opportunity to testify today and 

would be happy to answer questions. 

Senator LEVIN. Thank you, Mr. Gregg. Mr. Lanzillotta. 

TESTIMONY OF LAWRENCE J. LANZILLOTTA,1 PRINCIPAL 

UNDER SECRETARY (COMPTROLLER), U.S. DEPARTMENT OF 

DEFENSE 

Mr. LANZILLOTTA. Thank you, Senator. 

Mr. Chairman, Members of the Subcommittee, I am pleased to 

be here today to discuss the Department of Defense program for 

offsetting payments to commercial entities that either have tax or 

non-tax debts owed to the Federal Government. Even though the 

collection of Federal debts is not a primary mission of the Department of Defense, it is an important and inherent management responsibility. 

It is part of our DOD leadership’s resolve to exercise strong stewardship over the taxpayers’ dollars. We want to thank this Subcommittee and the General Accounting Office for focusing on how 

we can improve this component of our stewardship. The Department of Defense agrees with the four GAO report recommendations 

and has taken action to address the report findings. 

Since 1991, DOD has partnered with IRS to levy offset commercial payments to collect Federal debts through a manual process involving what we call paper levies. In July 2000, IRS, in conjunction 

with the Financial Management Service, FMS, started the Federal 

Payment Levy Program. This program provides for the collection of 

Federal debts through continuous levy on commercial payments. 

In 2001, DOD began working with FMS to participate in the program. In October 2002, DOD began providing its databases on 

pending commercial payments to FMS for matching against the 

Treasury Offset Program, TOP, database, which includes both Federal tax debt and non-tax debt. In December 2002, we began taking 

offsets. 

The Department currently provides a commercial payments database only for its largest commercial payment system, the Mechanized Contract Administrative Service, MOCAS, system, and does 

this once a week. As of January 31, 2004, DOD had collected about 

$2.1 million through offsets. This $2.1 million collection is far 

below what should be achieved. Increasing this performance requires changes not only within the Department but also changes in 

partnerships with other agencies, to include possible legislative 

changes. 

The primary challenge is to better identify, through automation, 

those DOD contractors whose payments should be offset because of 

their Federal debts. When DOD receives a notification that the contractor is indebted to the U.S. Government, and its payments are 

subject to levy, we have little trouble in executing prescribed offsets. 

DOD is advancing several actions and changes to improve the 

Federal levy performance. We are refining our procedures for Federal levies to ensure they are streamlined and efficient as possible. 

We have clarified with the IRS and Treasury that the DepartVerDate 0ct 09 2002 14:41 Jun 29, 2004 Jkt 092689 PO 00000 Frm 00042 Fmt 6633 Sfmt 6601 C:\DOCS\92689.TXT SAFFAIRS PsN: PHOGAN
39

ment’s central point of contact for executing levies is the Defense 

Finance and Accounting Service, particularly the Commercial Payment Center in Columbus, Ohio. This will enable a single office to 

handle levies for all DOD commercial pay systems. Instead of oncea-week, the Department will twice weekly provide its database on 

MOCAS to FMS and evaluate whether we can even increase the 

frequency. 

Consistent with the GAO recommendation, the Department will 

continue to devote sufficient resources to implement all aspects of 

its formal plan to improve its levy performance. The Department 

is pursuing long-term changes. Some involve other agencies. We 

are expanding the DOD automated levy process beyond MOCAS to 

the rest of the Department’s commercial pay systems. We have already included another pay system and will have the additional 18 

pay systems that could be matched to the TOP database using the 

new automated system. We are currently working with Treasury to 

include these systems in the continuous offset program. This expanded automation should be completed no later than March 2005. 

We will have 90 percent of our payments completed by August 

2004, which includes all of the DFAS-owned systems, to match 

against the TOP database. 

This action meets the GAO recommendation that DOD develop 

a formal plan for providing payment information to TOP for all of 

its commercial pay systems. This full automation is the Department’s main focus for improving its levy performance. 

When our input is automated, DOD has fewer problems offsetting payments for matched vendors once we receive an automated 

file from Treasury. However, the total dollars offset is only about 

1 percent of the debts we receive from IRS. We recognize the automated process can be more effective and are working with Treasury 

and IRS to get the needed changes. With manual procedures, we 

are seldom successful because by the time we become informed of 

a match for a pending payment, we have disbursed the payments. 

Still, we are considering possible interim procedures to use until 

full automation is completed. 

The Department of Defense relies on the information in the Central Contract Registration Database for the commercial payments 

provided to FMS for matching with its TOP database. This information comes from the contractors themselves. If either the name 

or the taxpayer identification number, the TIN, provided by the 

contractor differs from the name or the TIN listed on the debt 

record, the TOP database will not identify that contractor for an 

offset or levy. 

We believe that increasing the accuracy of the CCR will increase 

the effectiveness of the TOP system’s ability to identify many contractors with Federal debt. We are working with IRS and FMS on 

how best to validate or correct the TIN and the name of the commercial activity in the CCR database. The goal is to eliminate the 

CCR inaccuracies as an obstacle to better levy collections. 

There are legal limitations. In seeking to achieve more levies, the 

Department of Defense must stay within the framework and the 

limitations of the Federal law and will honor taxpayers’ rights. For 

example, certain tax-related information cannot be released even 

40

between Federal agencies except in strict compliance with Federal 

law. 

The Department looks forward to working with the IRS, FMS 

and others in considering what legislative and legal changes might 

help achieve more successes for this program. In closing, I assure 

you that the Department of Defense will support the Federal Payment Levy Program. We have a good partnership with IRS and 

FMS, and I am sure that we will produce substantial results. I also 

want to assure this Subcommittee that the Department of Defense 

is continuing its broader challenge of transforming all of its business and financial management processes. We have made a strong 

start in our historical overhaul of DOD management processes and 

the information systems that support them. 

Once fully implemented, several years from now, our Business 

Management Modernization Program will consolidate and integrate 

our management information systems. It will enable the maximum 

permissible exchange of information that is key to ensuring all of 

our business management responsibilities. 

Thank you for this opportunity to explain how the Department 

of Defense is working to sustain sound management and strong 

stewardship of its public resources. Thank you, Mr. Chairman. 

Senator COLEMAN [presiding]. Thank you, Mr. Lanzillotta. 

A kind of micro-focus question: Here, in terms of the number of 

DOD payment systems, my notes indicate that Thomas Bloom, 

former Director of the Defense Finance and Accounting Service, 

told GAO auditors there were 16 DOD payment systems, and I 

think the report was based on that. The Director of Commercial 

Pay Systems told the investigative staff of the Permanent Subcommittee that there were 18 DOD payment systems, and I believe 

your testimony today talks about 20 DOD payment systems. 

Could you please tell me the correct number of DOD payment 

systems? 

Mr. LANZILLOTTA. Mr. Chairman, in this area, there are 20 systems. Six are owned internally by DFAS; 14 are owned by other organizations such as the military services. 

Senator COLEMAN. OK. In listening to your testimony, it is clear 

that the solution to a lot of the problems lies in expanded automation. You have got to automate your systems; get them up to capacity. Apparently, we are talking about 90 percent of the work will 

be done by 2004, but March 2005 is when you expect to have things 

in place? 

Mr. LANZILLOTTA. In August 2004, we expect to have 90 percent 

of the dollar volume automated. It will take us until March 2005 

to get that last 10 percent. But those last 10 percent represent numerous systems that are small and are more challenging. 

Senator COLEMAN. Can you help me understand or the Subcommittee understand what happened? From 1996 to 1997, when 

the Financial Management Service system was put in place; Taxpayer Offset Program, all of that, up until today, you have got a 

long period of time. I understand that collections under the system 

did not really, in any kind of significant way, take place until 

2002–2003. What happened in the interim? 

Mr. LANZILLOTTA. As I mentioned in my statement earlier, we 

have always done manual processes. But when we process 12 milVerDate 0ct 09 2002 14:41 Jun 29, 2004 Jkt 092689 PO 00000 Frm 00044 Fmt 6633 Sfmt 6601 C:\DOCS\92689.TXT SAFFAIRS PsN: PHOGAN
41

lion vouchers a year, these manual processes, because of the deliberative process, were not terribly effective. It was not until July 

2000 that FMS and IRS gave us the ability to use automation. We 

were working as part of the development of those systems to ensure that we would be able to transmit data with FMS. 

In 2001, we started our own contractor debt system, which allowed us to pull from the MOCAS system the information that 

FMS would need. In 2002, it took us from 2001 to 2002 to perfect 

our system, run test data and test files, to where we could certify 

to the system that it was accurate and that we would not be making offsets or doing things that later we would regret. 

Senator COLEMAN. One of the keys to accuracy is having correct 

taxpayer identification numbers. Can you tell me what your plan 

is to ensure that you get correct taxpayer identification numbers 

prior to being paid? 

Mr. LANZILLOTTA. Right now, we are working with both FMS and 

IRS and hope to resolve this in the task force that was announced. 

In the Department of Defense currently, the TIN number is provided by the vendor on a voluntary basis. He just writes in the 

number that he has. We have no way to validate it until we get 

a readback from FMS as to what that is. There are 270,000 contractors currently in the database. It only works effectively if we 

can do a bump and know where our mistakes are. Individual queries are somewhat time consuming. 

Senator COLEMAN. You say it is voluntary. Is there anything that 

would preclude you from requiring——

Mr. LANZILLOTTA. I stand corrected, Mr. Chairman. It is not voluntary. In the case of service contracts, it is required by law. 

Senator COLEMAN. Services, but not goods, it is not required by 

law? 

Mr. LANZILLOTTA. There are some cases where the TIN numbers 

are not required by the vendor to put in. 

Senator COLEMAN. Is there anything that would preclude you 

from requiring, as a condition of getting a contract, in all contract 

cases, the submission of a TIN number? 

Mr. LANZILLOTTA. You know, this is kind of a question outside 

my expertise. It requires a procurement official. But a lot of these 

payments are what we call miscellaneous payments. They are payments to the credit cards, airlines, utilities, some agreements that 

we have, tariff agreements, where we just do things—they provide 

a service, and we just pay them, and a contract does not exist. 

Our goal would be to get TIN numbers for as much as we possibly could, because that is the key for us to be able to identify 

where the offset should be taken. 

Senator COLEMAN. One of the penalties for not providing taxpayer identification numbers is backup withholding, I believe about 

28 percent. Do you know if you have implemented that? 

Mr. LANZILLOTTA. No, Mr. Chairman, we have not, but we will. 

Our problem that we are running into is when a vendor provides 

us a TIN, we do not know that it is a bad TIN until we bump it 

up against a payment, against the FMS. We do not know ahead of 

time. So we are having trouble ensuring that he has provided a 

valid TIN, because we have to make absolutely sure that when we 

hold up 28 percent of the payment that it is legally correct. 

42

Senator COLEMAN. I would strongly urge that you focus on what 

you need to do to make sure that you can evaluate whether somebody has a valid TIN, taxpayer identification number; and then, at 

that point in time, you can use the backup withholding. And when 

you said you will, when will you begin to use backup withholding? 

Mr. LANZILLOTTA. We have immediately told DFAS to make a 

plan for people who have not provided a TIN in areas where the 

law requires a TIN to implement the 28 percent. It will take us—

I do not know exactly how much time—to work out with FMS and 

IRS the validation of the TINs, so we will know ahead of time that 

the TIN is wrong, and we can withhold the 28 percent. 

Senator COLEMAN. I turn to the commissioners, perhaps to supplement the response there. Can you give us a better sense of what 

kinds of things have to be done so that we can ensure that you 

have that kind of very basic information of a taxpayer identification number? 

Mr. EVERSON. I guess the one point I would emphasize is what 

I said before more generally that there are two conflicting sets of 

interests here. Generally, in this area, the protection of the taxpayer rights in terms of the procedures for due process that came 

in through RRA 1998 and some that we follow that we are reviewing, as we have already said, in terms of cleaning up some of these 

operational constraints. That is one set of conflicts with prompt collection. 

The other does relate to the absolute protection of taxpayer information, and there is a part of the Internal Revenue Code, that really protects information. Now, there is a carve-out here where we 

can share information on services, as Larry was just indicating. 

The carve-out relates to active contracts. This database is broader 

than that. It includes the registration of those who would wish to 

do business with the government, and that is not a carve-out that 

qualifies—the broader population does not qualify for the data 

sharing, nor does, as was indicated, goods that are purchased. 

So there is a whole series of issues here regarding taxpayer information that we need to get to, and I know some have suggested 

maybe people could waive their protections there, and then, we 

could address it that way. I think we need to focus on these issues 

over the next few months and figure out what the best way to jump 

on this problem so that we can automate the solution. 

As Larry said, and I agree, unless we automate it, we are not 

going to get anywhere. It is too cumbersome if it is all done by 

manpower. 

Senator COLEMAN. Commissioner Gregg, anything to add? 

Mr. GREGG. Yes, I think that the basic issue is if we could take 

a slice of the CCR and look at those that are active, but then, it 

gets down to—it is one thing for us to be able to identify that a 

TIN does not match, but what is necessary—and maybe legislation 

is necessary to give IRS the authority to provide the correct information to DOD, because it does not help very much if we just tell 

them that sorry, no match, and we cannot give them the information that is a valid TIN for that particular vendor. So that is something that I think IRS is looking at, but perhaps legislation is required. I am not sure. 

43

Senator COLEMAN. Please let us know if you think you need that 

authority, because certainly, we would be inclined to move in that 

direction. 

We are going to have a second round, but before my round is 

over, just to Commissioner Everson, in the 47 cases that were identified in the GAO report, can you tell us what your plans are with 

the folks involved in those cases? 

Mr. EVERSON. Certainly, I think you know, and Senator Levin 

knows, we worked very closely with this Subcommittee, on the followup of the hearings that you had in November, and I very much 

appreciate the materials that you have provided to us in connections with those matters that you were looking at. 

It is going to be the same thing here. We are going to take these 

47 cases that happen to come from GAO. Our normal procedure 

would be that our business unit that handles these matters would 

look at them as a screen and then send potential cases into the 

Criminal Investigations Division, where they might take the case, 

investigate them. 

I am going to shortcut that process and ask our CI people to look 

at each and every one of these 47 cases to see what they think, in 

case they would conclude that they ought to look at some of them 

that maybe the business unit would not have looked at. 

Senator COLEMAN. Your CI people means criminal investigators? 

Mr. EVERSON. Criminal investigators, 1,811 law enforcement officials. 

Senator COLEMAN. Thank you very much, Commissioner. Senator 

Levin. 

Senator LEVIN. Thank you, Mr. Chairman, and thank you all for 

your testimony. 

The first question has to do with whether we should require that 

the Department of Defense contractors be paid up on their taxes 

or, at a minimum, be paid up on an installment agreement so that 

they not be on default on either their taxes or on an installment 

agreement. What is the Department of Defense’s position on that? 

In other words, in order to get a new contract, you are not going 

to get a contract if you are in default on your taxes. 

Mr. LANZILLOTTA. In concept, Senator, I do not believe the Department would oppose that at all and would welcome the opportunity to have some legislative authority, because as it was mentioned before, it is not against the law to owe back taxes and still 

have a contract with the Federal Government. 

Senator LEVIN. It is not a matter of being against the law. The 

question is whether we ought to be giving a contract to people, paying them money when they owe us money. It is not a matter of 

whether it is a crime or illegal. It is a matter of just pure business 

common sense. No business would operate that way, and we are always told we should try to be more businesslike in our operations. 

So why would the Department of Defense, if we are owed money 

from a contractor on taxes, they are delinquent on taxes, or they 

are delinquent on an installment agreement, why would we be giving that contractor another contract? 

Mr. LANZILLOTTA. I completely agree with the concept, Senator, 

that we should require full payment or give us the ability to get 

44

full payment. But we will need some legislative authority to do 

that. 

Senator LEVIN. Will you recommend it? 

Mr. LANZILLOTTA. In concept, I certainly support it. 

Senator LEVIN. Would you let the Subcommittee know whether 

you would recommend it, that the Department ask the Secretary 

as to whether or not he and the Department would support it? I 

understand OMB opposes it. Do you know if that is true? 

Mr. LANZILLOTTA. Well, it happened in 2000, and so, everybody 

who was involved with that is not here to ask as to what were their 

reasons. I would have to get the provision and take it back and 

look at it. But in concept, we are looking at ourselves, and we 

looked at our database whether we could have a certification on the 

database as to whether somebody had paid their back taxes and 

make them certify, during registration, that they were not in arrears. 

We were told that legally, that is challenging to put that certification in there, that we did not have that authority, and then, if 

we did, in some cases, it would still be meaningless, because we 

would not have a way to back it up to see if they were lying to us 

or not. I think we need to look at it. 

Senator LEVIN. But false representation to get a contract is a 

pretty serious business under law. If you make a misrepresentation 

about a fact in order to get a Federal contract, you have got problems. And so, it is a real deterrent. It is a real weapon here to try 

to collect taxes. 

But rather than pursue it further, if you would get the Department’s position on that issue, it would be helpful to us, because I 

think some of us, at least, want to seriously consider that kind of 

a requirement. 

Obviously, people can owe back taxes. A lot of times, that is 

going to be true. But if there is not an agreement to pay back taxes 

which is being complied with, if a contractor does not even have 

that, it seems to me that we should be mighty reluctant to give 

that contractor any additional contracts, unless there is some national security reason to do it. If that is the only contractor who 

is providing us with a substance that we cannot get anywhere else, 

I guess we have got to take our licks on that one. But other than 

that, I think we should be a lot more commonsensical about handing out taxpayer dollars to contractors who owe the IRS money. 

Mr. LANZILLOTTA. I will turn this over to Commissioner Everson. 

The Department does not know or does not have a list of vendors 

who owe back taxes. We only know when we submit a vendor payment against the database at that time. 

Senator LEVIN. You can require that the person represent that 

they do not owe back taxes before they get a contract. 

Mr. LANZILLOTTA. A certification-type process. 

Senator LEVIN. A certification process, yes. 

And just give us your position on a certification process. Commissioner Everson. 

Mr. EVERSON. Yes, thank you, Senator. I think this comes back 

to what I said is a conflict of two legitimate public policy interests. 

One is taxpayer rights, on the one hand, and the other is the desire 

of the government to have its vendors have a clean bill of financial 

45

health. We do have to be careful here, because there are instances 

where there are legitimate disputes between companies or individuals and the government. And they do take time to get resolved. 

So I do not think that I would be in a position to advocate that 

one side of this trumps the other, if you will. We need to improve, 

clearly, the sharing of information. We need to look at that so that 

judgment can be brought to bear into this discussion. But I would 

be reluctant to encourage a one-sided solution. It has got to be a 

balanced solution. 

As I indicated in the statement, we have agreed, this group plus 

OMB, has agreed to look at this, and I had a meeting with OMB 

on this subject earlier this week, and as they indicated, in the information that potential vendors bring to the government to be considered for a contract, information beyond that which is normally 

required between two contracting parties in the private sector is requested and then considered. 

I do believe that the administration can look at whether, in its 

procurement policies, additional changes can be made in that regard. But again, this involves more than just the procedural rights 

of taxpayers. You also get into privacy considerations, and there 

will need to be discussion as to whether statutory modifications are 

appropriate to have information sharing. 

Senator LEVIN. I do not see that there is any privacy issue in requiring that a potential contractor certify that he or she does not 

owe any withholding taxes. That is a certification issue. 

Mr. EVERSON. That is a procurement issue, that is exactly right. 

Senator LEVIN. That is not a privacy issue. 

Mr. EVERSON. But if you want to ping the IRS database to see 

whether that is correct or not, that is a different issue. 

Senator LEVIN. That may be a different issue. 

Mr. EVERSON. Right. 

Senator LEVIN. But just requiring the certification, now 25,000 of 

the 27,000——

Mr. EVERSON. Right. 

Senator LEVIN [continuing]. Cases are withholding issues. Those 

are usually not disputed issues. That is money which was——

Mr. EVERSON. Just trying to be clear here. 

Senator LEVIN. No, I can understand that there can be legitimate 

disputes. I can understand that. And we have got major defense 

contractors who have very legitimate disputes over contract issues, 

including whether taxes are owed. 

Mr. EVERSON. Yes. 

Senator LEVIN. We can protect that legitimate right. But when 

90 percent of your cases deal with withholding taxes, over which 

there is no dispute at all, it seems to me just requiring a certification which would subject somebody who falsely certifies it to a 

criminal action could provide a real deterrent, a real collection device for back taxes. 

When the 30-day levy notice is finally sent, when is the money 

actually withheld? Is it at the same time that notice is sent, or is 

it the end of the 30 days? 

Mr. EVERSON. I would defer to my colleague. 

Mr. GREGG. Yes, it depends on the type of payment. If it is a recurring payment for a non-levy——

46

Senator LEVIN. The first one on a levy, when notice of a levy goes 

out. 

Mr. GREGG. And that depends on—what I said in my statement 

is that sometimes, because of the sending out the notice, the due 

process notice, we miss that first payment, because we get the information from DOD, and at that time, the payment may have to 

go out the door in 10 or 15 days, and by the time the due process 

notice goes out, the payment is out the door. So what we do is have 

our files ready for the subsequent payment. 

Senator LEVIN. But you do not wait for the 30 days. 

Mr. GREGG. No, we do not hold, or DOD does not hold payments 

up because of——

Senator LEVIN. Until after the 30-day period is up. 

Mr. GREGG. No. 

Senator LEVIN. Mr. Lanzillotta. 

Mr. LANZILLOTTA. The due process has to take place before I can 

make a payment offset. 

Senator LEVIN. Are payments made during that 30-day process? 

Mr. LANZILLOTTA. If FMS or the IRS has not completed their 

process, and a payment is due, a payment is made, yes. 

Senator LEVIN. Well, my question is you are sent a notice, a 30-

day notice, a so-called due process notice, that a levy is going to 

attach. My question is will payments be made during that 30-day 

period? 

Mr. LANZILLOTTA. Yes. 

Senator LEVIN. OK. So you have a situation here where this is 

the fourth step in a process, right? Frequently, there has been a 

year’s wait while somebody is in a queue. 

Mr. EVERSON. But as you indicated, Senator, this chart here—I 

want to respond to a point you made earlier. You asked if some of 

this is in response to the Subcommittee’s interest or the GAO’s interest; very much so. We have already taken some actions here to 

improve just what you are talking about. If you look over on the 

left, this pink box, it has got what we call—I have characterized 

it as operational exclusions. GAO said policy. Below that squiggly 

line are areas where we have already looked, and we are making 

changes. This queue issue is one of them. 

And we are going to do more to clean this up. 

Senator LEVIN. That is good news in terms of this queue, because 

that one seems fairly—I mean, I am glad you have cleaned that 

one up. It is pretty obvious that it needed to be cleaned up, and 

I commend you for it. 

My last question in this round, then, would be do you have officers, in the IRS, that are there full-time revenue officers that work 

in the Tax Levy Program? 

Mr. EVERSON. That is a good question. We have revenue officers, 

of course, but you are asking about the levy program for Federal 

contractors, per se, I think is the substance of what you are asking. 

Senator LEVIN. Right. That is correct. 

Mr. EVERSON. Yes, it is entirely automated is the answer, Senator. So I have seen your proposal on this, and all five of the points 

that you have made, I think that this task force that we have suggested we are going to put together ought to look at that, because 

expertise attaches to all kinds of elements of our responsibility, and 

47

collections, as you know, as we have discussed, we have drawn 

down our revenue officers by over 25 percent due to resource constraints in the last 6 or 7 years. We are bringing that back up. The 

kind of thing we do need to consider is the expertise of revenue officers as we go forward, and we will in this task force. 

Senator LEVIN. I want to commend you for not just considering 

that but for fighting for resources for tax collection. We have got 

to turn this around. We cannot have these many uncollected taxes 

out there that just go by default because we do not have the resources to go after folks. There are a lot of areas where we need 

to go after them, and I appreciate your leadership and seeking the 

resources to do that. 

Mr. EVERSON. Thank you. 

Senator COLEMAN. Thank you, Senator Levin. 

Just to follow up on that comment, I share the concerns of Senator Levin, and I appreciate in our conversations, Commissioner, 

your intent to focus those resources, focus them on folks who are 

making a lot of money and should be paying their fair share, and 

they are not. And I think that the focus piece is also an important 

piece that the average taxpayer needs to understand and appreciate. 

Commissioner, Senator Levin in his questioning had raised the 

issue of a certification process, a taxpayer contractor certifying that 

they are not in violation of any taxpaying obligation. Do you know 

if any other agencies have a certification process? 

Mr. EVERSON. It is really a procurement question, Senator, and 

I am not sure that I know the answer to that. And again, from our 

point of view, it is not a consideration unless you cure this issue 

of the data sharing because of privacy. Then, it could play for us. 

Senator COLEMAN. And certainly, the Department of Defense is 

the 800-pound gorilla when it comes to contracting. Such a substantial percentage of Federal contracts are within that Department. But the testimony from earlier witnesses gave us the very 

clear understanding that these problems exist in other agencies. 

For Mr. Gregg, I would turn to you and raise the resource issue. 

For instance, just in these cases, we are talking about 27,100 taxdelinquent contractors identified by the GAO, with the potential of 

there being many more throughout the Federal Government. Does 

the FMS have the resources to levy all contractor payments? 

Mr. GREGG. Yes, we do, Senator. We have a very highly automated system, and we are basically prepared to handle about anything—we have huge amounts of debt already in our database and 

resources, not that I say they are unlimited, but they are enough 

to handle this. 

Senator COLEMAN. That is very encouraging, Commissioner. 

At the present time, I believe, the Defense Finance and Accounting Service is sending one computer tape a week, and I think, Mr. 

Lanzillotta, you said that you were trying to increase that, to 

mechanize your MOCAS system payments, sending a tape once a 

week. Was the intent to increase, sending that tape twice a week? 

Mr. LANZILLOTTA. Yes, Mr. Chairman, what we are looking at 

now is what is the cycle time that we have right now on a tape, 

and we are going to go to two tapes a week with the hope of doing 

48

a continuous offset, where all the new contracts or new vouchers 

would just constantly be sent to FMS. 

Senator COLEMAN. And I guess, then, the same question to you, 

Commissioner: Is that a resource question? Are you prepared to 

begin accepting and processing more MOCAS tapes? 

Mr. GREGG. Yes, we are. 

Senator COLEMAN. OK; that is very helpful. 

I take it if taxpayer identification numbers in the Central Contractor Registry are validated, that will increase your ability to 

make matches for levy purposes? 

Mr. GREGG. If there is a way for IRS to validate and provide accurate information back to DOD, if there is a problem with one of 

the TINs, then, yes. And I think that is something that this task 

force can look at, to see how much flexibility they have there. 

Senator COLEMAN. OK; the last question I am going to have is 

the Department of Defense has its one major disbursement system 

now going through the FMS process, but apparently a large number of other systems are not. Is there anything that the IRS can 

do, working with the Defense Department to accelerate the process 

of getting these systems referred to the FMS? 

Mr. LANZILLOTTA. Mr. Chairman, we are accelerating the process. And this is a DOD thing that we have to do. By August, we 

hope to have 90 percent of our volume, no later than August, 90 

percent of our volume through the FMS system. The last systems, 

the remaining 10 percent, they represent a lot of smaller systems 

that we are just going to have to work on to ensure that no later 

than March 2005, we will have 100 percent of our vouchers being 

able to go through the FMS. 

Senator COLEMAN. Commissioner, perhaps on another occasion, 

we can have a broader discussion of the conflicting values issue 

that you raised, two important values: Taxpayer rights, and you 

have the value of trying to make sure that collections are done 

properly. 

Mr. EVERSON. Yes. 

Senator COLEMAN. Because taxpayers are impacted when collections are not collected properly, and I can see that here. But when 

payments are not made to Social Security, and to Medicare, taxpayers are paying for that. 

Mr. EVERSON. Yes, absolutely. I could not agree with you more. 

It is a very important subject. We need to run a balanced system 

that gives adequate consideration to both of those considerations. 

Senator COLEMAN. And as all of you gentlemen, I am sure, can 

tell by the reaction of my colleagues to this GAO report, there are 

a lot of concerns about the present state of affairs, a lot of concerns; 

certainly with DOD but beyond DOD, within the Federal Government. And I think it is quite obvious that we expect that those concerns will be addressed, that they be addressed expeditiously and 

that we do what we can to raise the level of confidence in the average taxpayer that they are paying their fair share, and they are not 

alone. 

So, with that, Senator Levin? 

Senator LEVIN. Thank you, Mr. Chairman. 

49

On this balance issue, I totally agree with you. One of the first 

things that I got involved in when I came to Washington, was a 

taxpayers’ bill of rights. 

Mr. EVERSON. Yes. 

Senator LEVIN. As a matter of fact, that taxpayers’ bill of rights 

came out of this Governmental Affairs Committee. Senator Pryor 

was involved; a number of other people were involved. It was a bipartisan effort, and it was very important, because there are 

abuses not just by taxpayers but by the IRS. 

Mr. EVERSON. Yes. 

Senator LEVIN. We do not want abuses on either side. But this 

issue, it seems to me and I think all of us, is an issue where we 

are handing out money. I mean, the Chairman is really focused on 

this aspect of it, and he is so right. I do not think this is the same 

thing as having a normal tax dispute about how much money does 

a taxpayer owe the government. 

We are handing out money to taxpayers. Ninety percent of the 

delinquent taxpayers here are people who have not paid their withholding, which I think is a crime. 

Mr. EVERSON. I agree with that entirely. The only cautionary 

note I am suggesting is that if you make things automatic, there 

are always exceptions, and I believe, however, the sharing of information that allows people to exercise judgment, that is where you 

get to a good answer. 

Senator LEVIN. I agree. You can get into areas where there are 

going to be disputes, but where you have got 25,000 of the 27,000 

are withholding issues——

Mr. EVERSON. Yes, that is pretty clear cut. 

Senator LEVIN. Now, on the due process issue, if you send out a 

delinquency notice to somebody, that you are delinquent, can the 

IRS not give notice in that delinquency notice that you can be levied, in fact, any payment from the government to you can be levied 

for this delinquency unless you come in and work out something? 

Can’t the levy due process notice be right in the delinquency notice? 

Mr. EVERSON. There are a series of steps that are in the laws 

from RRA 1998, and then, there are some other procedural things 

that the IRS does. And if you look at the whole time line—I considered doing a blow-up of this chart but declined to do it. 

Senator LEVIN. You took pity on us. 

Mr. EVERSON. Because you still could not see it. [Laughter.] 

The whole process and the dozen or more steps runs up to 21⁄2

years. Someone who has a potential problem of $5,000 at the end 

goes all the way through the process, and has sustained penalties 

and interest, might owe $30,000 but not until 21⁄2 years later. 

Someone can keep this moving if they want to. Some of this is 

at our discretion. I am not suggesting it is all in RRA 1998. And 

we have got to look at that. But some of the notices that we will 

send are actually very effective, because they do not require a great 

deal of investment of manpower, and they draw a certain response. 

So with the shortage of the revenue agents that we have had that 

we have all discussed, there has been more reliance on a barebones, automated system here. 

50

We need to attack that. As I have indicated, we have over 1,000 

collection personnel who will come in if the Congress provides the 

monies we have asked for. This can help us, and perhaps as we 

look at these procedures, we can, as we are doing here, improve our 

times. And then, we will also look at legislative remedies. I do believe the Congress is open to considering whether there need to be 

some modifications. I am not suggesting throwing out RRA 1998. 

I do not want to be misinterpreted at all on that. But perhaps 

there are some modifications in order. One was mentioned earlier 

about frivolous offers to settle something, where you say I will settle a $1 million debt with $1. That can keep the process alive and 

provide rights. That is not a good thing, obviously. 

So we have got to look at both internal procedures and, I suggest, 

perhaps, statutory changes. 

Senator LEVIN. So you will be giving us recommendations for 

statutory changes? 

Mr. EVERSON. What we have agreed is that the three organizations represented here and OMB are going to take a look at this 

whole set of issues, both what is out there operationally; which 

largely might be in my shop; might be at DOD; could be in FMS, 

although I doubt—I mean, they are really sort of—largely a conduit 

here, a processor; we are going to look at that, and we will look 

and see what statutory considerations or processes might be warranted. 

Senator LEVIN. What kind of time line is there for that review? 

Mr. EVERSON. We will do something by June. I think that gives 

us 3 or 4 months to look at it. 

Senator LEVIN. That is great. 

Mr. Lanzillotta, why are you delivering data to FMS only twice 

a week? Why not every day? 

Mr. LANZILLOTTA. Senator, that is the goal, but what we have to 

make sure we do is when we pay a voucher, we send it over to 

FMS. They have to process it and come back and tell us where the 

offset should take place. 

Senator LEVIN. But is this not all automated? 

Mr. LANZILLOTTA. It still takes about a day for us to send a file 

over to FMS; for them to bump the file and send it back to us. 

Senator LEVIN. I know that, but can the list not be sent over 

automatically every day instead of twice a week? 

Mr. LANZILLOTTA. We are trying to get to that point where 

we——

Senator LEVIN. What is the problem, if it is automated, in getting 

to that point? 

Mr. LANZILLOTTA. Our systems. We have to redo the system a little bit, modify the system. Because what we do not want to do is 

get caught up where we have a transaction in transit somewhere, 

and we make a payment or fail to make a payment or collect twice 

or not collect at all. 

Senator LEVIN. Final question, then, would be whether or not 

you can share with us the DOD contractor list that you have imposed tax levies on? 

Mr. LANZILLOTTA. Senator, I can give you the same reference my 

fiscal lawyers gave me that says no. 

Senator LEVIN. And that is because of a privacy concern? 

51

1See Exhibit No. 7 (question No. 1) which appears in the Appendix on page 192. 

Mr. LANZILLOTTA. That is because their interpretation of the 

statute says that we cannot release that information. I understand 

that there is some differing of opinion. 

Senator LEVIN. The question is this: Under Section 6103 of the 

Tax Code, you are not allowed access to confidential taxpayer information? 

Mr. LANZILLOTTA. Senator——

Senator LEVIN. You have it. You have a list of contractors that 

are in default and that have been levied upon. So if you got that 

list, why can we not have that list? 

Mr. LANZILLOTTA. Senator, I am just going to have to——

Senator LEVIN. Can you get us the legal opinion from your shop 

that says that you cannot share it with us? That is, would you get 

your lawyers to send a letter to the Subcommittee here explaining 

why it is that you can have it, despite Section 6103, but we cannot? 

That is the question. I am not asking you for the answer today. 

Mr. LANZILLOTTA. Certainly, Senator. 

Senator LEVIN. Would you get that from your lawyer to the Subcommittee? 1

Thank you, Mr. Chairman. 

Senator COLEMAN. Thank you very much, Senator Levin. 

Gentlemen, thank you for your testimony; again, to the GAO, 

thank you for your work. 

This hearing will be closed. The record, however, will be left open 

for 14 days. 

[Whereupon, at 12:15 p.m., the Subcommittee adjourned.] 

(53)

A P P E N D I X 


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