GAO

United States General Accounting Office

A

Testimony

Before the Permanent Subcommittee on Investigations, 

Committee on Governmental Affairs, U.S. Senate

For Release on Delivery 

Expected at 9:30 a.m. EST

Thursday, February 12, 2004

FINANCIAL 

MANAGEMENT 

Some DOD Contractors 

Abuse the Federal Tax 

System with Little 

Consequence 

Statement of

Gregory D. Kutz

Director, Financial Management and Assurance

Steven J. Sebastian 

Director, Financial Management and Assurance

John J. Ryan

Assistant Director, Office of Special Investigations

GAO-04-414T
DOD and IRS records showed that over 27,000 contractors owed about 

$3 billion in unpaid taxes as of September 30, 2002. DOD has not fully 

implemented provisions of the Debt Collection Improvement Act of 1996 

that would assist IRS in levying up to 15 percent of each contract payment to 

offset a DOD contractor’s federal tax debt. We estimate that DOD could 

have collected at least $100 million in fiscal year 2002 had it and IRS fully 

utilized the levy process authorized by the Taxpayer Relief Act of 1997. As 

of September 2003, DOD had collected only about $687,000 in part because 

DOD provides contractor payment information from only 1 of its 16 payment 

systems to TOP. In response to our draft report, DOD developed a schedule 

to provide payment information to TOP for all of its additional payment 

systems by March 2005. 

Furthermore, we found abusive or potentially criminal activity related to the 

federal tax system through our audit and investigation of 47 DOD contractor 

case studies. The 47 contractors provided a variety of goods and services, 

including building maintenance, catering, dentistry, funeral services, and 

parts or support for weapons and other sensitive military programs. The 

businesses in these case studies owed primarily payroll taxes with some 

dating back to the early 1990s. These payroll taxes included amounts 

withheld from employee wages for Social Security, Medicare, and individual 

income taxes. However, rather than fulfill their role as “trustees” and 

forward these amounts to IRS, these DOD contractors diverted the money 

for personal gain or to fund the business. 

For example, owners of two businesses each borrowed nearly $1 million 

from their companies and, at about the same time, did not remit millions of 

dollars in payroll taxes. One owner bought a boat, several cars, and a home 

outside the United States. The other paid over $1 million for a furnished 

home. Both contractors received DOD payments during fiscal year 2002, but 

one went out of business in 2003. The business, however, transferred its 

employees to a relative’s company (also with unpaid taxes) and recently 

received payments on a previous contract. 

IRS’s continuing challenges in collecting unpaid federal taxes also 

contributed to the problem. In several case studies, IRS was not pursuing 

DOD contractors due to resource and workload management constraints. 

For other cases, control breakdowns resulted in IRS freezing collection 

activity for reasons that were no longer applicable. Federal law does not 

prohibit contractors with unpaid federal taxes from receiving federal 

contracts. OMB is responsible for providing overall direction to 

governmentwide procurement policies, regulations, and procedures, and is 

in the best position to develop policy options for prohibiting federal 

contracts to contractors that abuse the tax system. 

GAO addressed issues related to 

three high-risk areas including the 

Department of Defense (DOD) and 

the Internal Revenue Service (IRS) 

financial management and IRS 

collection of unpaid taxes. This 

testimony provides a perspective 

on (1) the magnitude of unpaid 

federal taxes owed by DOD 

contractors, (2) whether 

indications exist of abuse or 

criminal activity by DOD 

contractors related to the federal 

tax system, (3) whether DOD and 

IRS have effective processes and 

controls in place to use the 

Treasury Offset Program (TOP) in 

collecting unpaid federal taxes 

from DOD contractors, and 

(4) whether DOD contractors with 

unpaid taxes are prohibited by law 

from receiving federal contracts. 

In a companion report issued 

today, GAO made 

recommendations to DOD for 

complying with statutory guidance 

and supporting IRS efforts in 

collecting unpaid taxes, to IRS for 

improving the effectiveness of 

collection activities, and to the 

Office of Management and Budget 

(OMB) to develop options for 

prohibiting awards to contractors 

that abuse the tax system. DOD 

and IRS partially agreed; OMB did 

not agree. DOD and OMB also did 

not agree with GAO’s matters for 

congressional consideration that 

DOD report on its collections 

through TOP, and OMB report on 

policy options developed for 

contractors that abuse the tax 

system. GAO reiterated support for

its recommendations as well as its 

suggestions to Congress. 

www.gao.gov/cgi-bin/getrpt?GAO-04-414T 

To view the full product, click on the link above. 

For more information, contact Gregory D. Kutz 

at (202) 512-9095 or kutzg@gao.gov, or 

Steven J. Sebastian at (202) 512-3406. 

Highlights of GAO-04-414T, a testimony 

before the Permanent Subcommittee on 

Investigations, Committee on 

Governmental Affairs, U.S. Senate 

February 12, 2004 

FINANCIAL MANAGEMENT 

Some DOD Contractors Abuse the 

Federal Tax System with Little 

Consequence 
Page 1 GAO-04-414T 

Mr. Chairman, Members of the Subcommittee, and Representative 

Schakowsky:

Thank you for the opportunity to discuss payments to Department of 

Defense (DOD) contractors that abuse the federal tax system. Our related 

report,1

 released today and developed at the request of this Subcommittee 

and Representative Schakowsky, addresses issues related to three high-risk 

areas: DOD and Internal Revenue Service (IRS) financial management and 

IRS collection of unpaid taxes. Since 1990, we have periodically reported 

on federal programs and operations that are high risk due to their greater 

vulnerabilities to fraud, waste, and abuse. As a result of the fraud and 

abuse identified in our series of testimonies and reports on DOD’s purchase 

card program, you requested more comprehensive audits and 

investigations of controls over payments to DOD contractors.

DOD and IRS face a variety of high-risk challenges. Of the 26 areas on our 

governmentwide “high risk” list, 6 are DOD program areas, and the 

department shares responsibility for 3 other high-risk areas that are 

governmentwide in scope. Financial management, 1 of the 6 DOD program 

high-risk areas, has weaknesses, including nonintegrated and proliferating 

financial management systems, and fundamental flaws in the overall 

control environment. As we have documented in numerous reports, DOD’s 

financial management problems leave it highly vulnerable to fraud, waste, 

and abuse. IRS high-risk areas include financial management weaknesses 

and difficulties in collecting unpaid taxes. Both areas continue to expose 

the federal government to significant losses of tax revenue and 

disproportionately increase the burden on compliant taxpayers to fund 

government activities.

Today, we will summarize our work on DOD payments to contractors that 

abuse the federal tax system. Our testimony will provide a perspective on 

(1) the magnitude of unpaid federal taxes owed by DOD contractors, 

(2) whether DOD and IRS have effective processes and controls in place to 

use the Treasury Offset Program (TOP) and Federal Payment Levy Program 

(FPLP) in collecting unpaid federal taxes from DOD contractors, 

(3) whether indications exist of abuse or criminal activity by DOD 

contractors related to the federal tax system, and (4) whether DOD 

1

 U.S. General Accounting Office, Financial Management: Some DOD Contractors Abuse 

the Federal Tax System with Little Consequence, GAO-04-95 (Washington, D.C.: Feb. 12, 

2004).
Page 2 GAO-04-414T 

contractors with unpaid federal taxes are prohibited by law from receiving 

federal contracts.

Summary The federal government will continue to miss opportunities to collect on 

hundreds of millions of dollars in unpaid federal taxes owed by DOD 

contractors until DOD begins to fulfill its responsibilities under the Debt 

Collection Improvement Act of 1996 (DCIA) by fully assisting IRS in its 

attempts to levy DOD contractor payments, and IRS fully utilizes its 

authority under FPLP. Based on DOD and IRS records, over 27,000 

contractors registered in DOD’s automated registration system had nearly 

$3 billion in unpaid federal taxes as of September 30, 2002. DOD 

contractors receiving fiscal year 2002 payments from five of the largest 

Defense Finance and Accounting Service (DFAS) contract and vendor 

payment systems owed at least $1.7 billion of this nearly $3 billion.

As the largest purchaser of goods and services in the federal government, 

DOD payments to contractors totaled about $183 billion in fiscal year 2002. 

We estimate that DOD, which functions as its own disbursing agent, could 

have offset payments and collected at least $100 million in unpaid taxes in 

fiscal year 2002 if it had fully assisted IRS in effectively levying contractor 

payments. However, in the 6 years since passage of the Taxpayer Relief Act 

of 1997,2

 DOD has collected only about $687,000. DOD recently 

implemented a TOP payment reporting process for its contract payment 

system, which disbursed over $86 billion to contractors in fiscal year 2002. 

However, DOD did not have formal plans or a schedule at the completion of 

our work for reporting payment information from its 15 vendor payment 

systems, which disbursed another $97 billion to contractors in fiscal year 

2002. In response to our draft report, DOD developed a schedule to provide 

payment information to TOP for all of its additional payment systems by 

March 2005. DOD did not have an organizational structure in place to 

implement a TOP reporting process at the remaining payment systems.

IRS faces a number of high-risk challenges. Due to resource and workload 

management constraints, IRS established policies that either exclude or 

delay putting a significant number of cases into the levy program. In 

addition to policy constraints, inaccurate or outdated information in IRS 

2

 The act enhanced IRS’s ability to collect unpaid federal taxes by authorizing IRS to 

continuously levy up to 15 percent of certain federal payments made to businesses and 

individuals.
Page 3 GAO-04-414T 

systems prevent cases from entering the levy program. Our review of IRS 

collection efforts against DOD contractors selected for audit and 

investigation indicated that IRS attempts to work with the businesses and 

individuals to achieve voluntary compliance, pursuing enforcement actions 

such as levies of federal contract payments later rather than earlier in the 

collection process. For many of our case study contractors, this resulted in 

businesses and individuals continuing to receive federal contract payments 

without making any payments on their unpaid federal taxes.

We also found numerous instances of abusive or potentially criminal 

activity related to the federal tax system during our audit and investigation 

of 47 DOD contractor case studies. The 34 case studies involving 

businesses3 with employees had primarily unpaid payroll taxes, some 

dating to the early 1990s and some for as many as 62 tax periods.4 These 

payroll taxes included amounts withheld from employees for Social 

Security, Medicare, and individual income taxes. However, rather than 

fulfill their role as “trustees” and forward these amounts to IRS, these DOD 

contractors diverted the money for personal gain or to fund their 

businesses. The other 13 case studies involved individuals who had unpaid 

income taxes dating as far back as the 1980s. Several contractors in our 

study provided parts or services supporting weapons and other sensitive 

military programs.

Federal law does not prohibit a contractor with unpaid federal taxes from 

receiving contracts from the federal government. DOD contract awards of 

nearly $165 billion represented nearly two-thirds of the federal 

government’s contracting activity during fiscal year 2002. The criteria 

calling for federal agencies to do business only with responsible 

contractors do not require contracting officers to consider a contractor’s 

tax noncompliance, unless the contractor has been suspended or debarred 

3

 A tax identification number (TIN) is a unique nine-digit identifier assigned to each business 

and individual that files a tax return. For businesses, the employer identification number 

(EIN) assigned by IRS serves as the TIN. For individuals, the Social Security number (SSN) 

assigned by the Social Security Administration serves as the TIN. Contractors register their 

TINs in the CCR database in either the TIN/EIN field or the SSN field. In our report, a 

contractor completing the TIN/EIN field is referred to as a business, while a contractor 

completing the SSN field is referred to as an individual.

4

 A “tax period” varies by tax type. For example, the tax period for payroll and excise taxes 

is one quarter of a year. The taxpayer is required to file quarterly returns with IRS for these 

types of taxes, although payment of the taxes occurs throughout the quarter. In contrast, for 

income, corporate, and unemployment taxes, a tax period is 1 year.
Page 4 GAO-04-414T 

for tax evasion as explained later in our statement. Presently, the federal 

government has no coordinated process for identifying and determining the 

businesses and individuals that abuse the federal tax system and for 

conveying that information to contracting officers for use before awarding 

contracts.

As discussed in the report released today, we made recommendations to 

DOD for complying with DCIA and supporting IRS efforts under the 

Taxpayer Relief Act of 1997 in collecting unpaid taxes, to IRS for improving 

the effectiveness of collection activities, and to the Office of Management 

and Budget (OMB) to develop options for prohibiting federal contract 

awards to businesses and individuals that abuse the federal tax system. 

DOD and IRS partially agreed, and OMB did not agree with our 

recommendations. DOD and OMB also did not agree with our matters for 

congressional consideration that DOD report on its collections through the 

TOP, and OMB report on policy options developed and actions taken 

against contractors that abuse the federal tax system. We reiterated 

support for our recommendations as well as our suggestions to Congress.

DOD Contractors Owe 

Billions in Unpaid 

Federal Taxes

The nearly $3 billion in unpaid federal taxes owed by over 27,000 

contractors registered in DOD’s Central Contractor Registration system 

(CCR) represented almost 14 percent of the registered contractors as of 

February 2003. In addition, DOD contractors receiving fiscal year 2002 

payments from five of the largest DFAS contract and vendor payment 

systems represented at least $1.7 billion of the nearly $3 billion in unpaid 

federal taxes shown on IRS records. Data reliability issues with respect to 

DOD and IRS records prevented us from identifying an exact amount of 

unpaid federal taxes. Consequently, the total amount of unpaid federal 

taxes owed by DOD contractors is not known.

The type of unpaid taxes owed by these DOD contractors varied and 

consisted of payroll, corporate income, excise, unemployment, individual 

income, and other types of taxes. Unpaid payroll taxes include amounts 

that a business withholds from an employee’s wages for federal income 

taxes, Social Security, Medicare, and the related matching contributions of 

the employer for Social Security and Medicare. As shown in figure 1, about 

42 percent of the total tax amount owed by DOD contractors was for 

unpaid payroll taxes.
Page 5 GAO-04-414T 

Figure 1: DOD Contractor Unpaid Taxes by Tax Type

Employers are subject to civil and criminal penalties if they do not remit 

payroll taxes to the federal government. When an employer withholds 

taxes from an employee’s wages, the employer is deemed to have a 

responsibility to hold these amounts “in trust” for the federal government 

until the employer makes a federal tax deposit in that amount. To the 

extent these withheld amounts are not forwarded to the federal 

government, the employer is liable for these amounts, as well as the 

employer’s matching Federal Insurance Contribution Act contributions for 

Social Security and Medicare. Individuals within the business (e.g., 

corporate officers) may be held personally liable for the withheld amounts 

not forwarded and assessed a civil monetary penalty known as a trust fund 

recovery penalty (TFRP). Failure to remit payroll taxes can also be a 

criminal felony offense punishable by imprisonment of more than a year, 

while the failure to properly segregate payroll taxes can be a criminal 

misdemeanor offense punishable by imprisonment of up to a year.
Page 6 GAO-04-414T 

The law imposes no penalties upon an employee for the employer’s failure 

to remit payroll taxes since the employer is responsible for submitting the 

amounts withheld. The Social Security and Medicare trust funds are 

subsidized or made whole for unpaid payroll taxes by the general fund, as 

we discussed in a previous report.5 Over time, the amount of this subsidy is 

significant. As of September 1998, the estimated cumulative amount of 

unpaid taxes and associated interest for which the Social Security and 

Medicare trust funds were subsidized by the general fund was 

approximately $38 billion.

A substantial amount of the unpaid federal taxes shown in IRS records as 

owed by DOD contractors had been outstanding for several years. As 

reflected in figure 2, 78 percent of the nearly $3 billion in unpaid taxes was 

over a year old as of September 30, 2002, and 52 percent of the unpaid taxes 

was for tax periods prior to September 30, 1999.

Figure 2: DOD Contractor Unpaid Taxes by Fiscal Year

5

 U.S. General Accounting Office, Unpaid Payroll Taxes: Billions in Delinquent Taxes and 

Penalty Assessments Are Owed, GAO/AIMD/GGD-99-211 (Washington, D.C.: Aug. 2, 1999).
Page 7 GAO-04-414T 

Our previous work6 has shown that as unpaid taxes age, the likelihood of 

collecting all or a portion of the amount owed decreases. This is due, in 

part, to the continued accrual of interest and penalties on the outstanding 

tax debt, which, over time, can dwarf the original tax obligation. 

DOD and IRS Are Not 

Collecting Millions in 

Unpaid Federal Taxes 

from Contractors 

Until DOD establishes processes to provide information from all payment 

systems to TOP, the federal government will continue missing 

opportunities to collect hundreds of millions of dollars in tax debt owed by 

DOD contractors. Additionally, IRS’s current implementation strategy 

appears to make the levy program one of the last collection tools IRS uses. 

Changing the IRS collection program to (1) remove the policies that work 

to unnecessarily exclude cases from entering the levy program and 

(2) promote the use of the levy program to make it one of the first 

collection tools could allow IRS—and the government—to reap the 

advantages of the program earlier in the collection process.

DOD Is Not Fully Assisting 

in the Collection of Unpaid 

Taxes Owed by Its 

Contractors

We estimate that DOD, which functions as its own disbursing agent, could 

have offset payments and collected at least $100 million in unpaid taxes in 

fiscal year 2002 if it and IRS had worked together to effectively levy 

contractor payments. However, in the 6 years since the passage of the 

Taxpayer Relief Act of 1997, DOD has collected only about $687,000. DOD 

collections to date relate to DFAS payment reporting associated with 

implementation of the TOP process in December 2002 for its contract 

payment system,7

 which disbursed over $86 billion to DOD contractors in 

fiscal year 2002.

6

 U.S. General Accounting Office, Internal Revenue Service: Recommendations to Improve 

Financial and Operational Management, GAO-01-42 (Washington, D.C.: Nov. 17, 2000); 

Internal Revenue Service: Composition and Collectibility of Unpaid Assessments, 

GAO/AIMD-99-12 (Washington, D.C.: Oct. 29, 1998); and GAO/AIMD/GGD-99-211.

7

 Mechanization of Contract Administration Services (MOCAS).
Page 8 GAO-04-414T 

Although it has been more than 7 years since the passage of DCIA,8 DOD 

has not fully assisted IRS in using its continuous levy authority for the 

collection of unpaid taxes by providing Treasury’s Financial Management 

Service (FMS) with all DFAS payment information. IRS’s continuous levy 

authority authorizes the agency to collect federal tax debts of businesses 

and individuals that receive federal payments by levying up to 15 percent of 

each payment until the debt is paid. Under TOP, FMS matches a database 

of debtors (including those with federal tax debt) to certain federal 

payments (including payments to DOD contractors). When a match 

occurs, the payment is intercepted, the levied amount is sent to IRS, and 

the balance of the payment is sent to the debtor. All disbursing agencies 

are to compare their payment records with the TOP database. Since DOD 

has its own disbursing authority, once DFAS is notified by FMS of the 

amount to be levied, DOD should deduct this amount from the contractor 

payment before it is made to the payee and forward the levied amount to 

the Department of the Treasury as described in figure 3.

8

 Congress passed DCIA to maximize the collection of delinquent nontax debts owed to 

federal agencies. Under the regulations implementing DCIA, disbursing agencies, including 

DOD and others that independently disburse rather than having it done on their behalf by 

FMS, are required to compare their payment records with the TOP database. If a match 

occurs, the disbursing agency must offset the payment, thereby reducing or eliminating the 

nontax debt.
Page 9 GAO-04-414T 

Figure 3: DOD Contractor Payment Levy Process

Source: GAO.

The TOP database includes federal tax and nontax debt, state tax debt, and 

child support debt. By fully participating in the TOP process, DOD will also 

aid in the collection of other debts, such as child support and federal 

nontax debt (e.g., student loans).

At the completion of our work, DOD had no formal plans or schedule to 

begin providing payment information from any of its 15 vendor payment 

systems to FMS for comparison with the TOP database. These 15 

decentralized payment systems disbursed almost $97 billion to DOD 

contractors from 22 different payment locations in fiscal year 2002. In 

response to our draft report, DOD developed a schedule to provide 

payment information to TOP for all of its additional payment systems by 

March 2005. As we have previously reported, DOD’s business systems 

environment is stovepiped and not well integrated.9

 DOD recently reported 

that its current business operations were supported by approximately 2,300 

systems in operation or under development, and requested approximately 

DOD

Contractor

payments

(TIN and $)

Tax

debt

(TIN and $)

No

Yes

Treasury FMS

TOP database

Contractors

IRS

Is there

a match?

Levy

payment

Process

payment

Full payment

100%

Partial payment

85%

Partial payment

15%

TREASURY

FINANCIAL MANAGEMENT SERVICE

9

 U.S. General Accounting Office, DOD Business Systems Modernization: Continued 

Investment in Key Accounting Systems Needs to Be Justified, GAO-03-465 (Washington, 

D.C.: Mar. 28, 2003); DOD Business Systems Modernization: Important Progress Made to 

Develop Business Enterprise Architecture, but Much Work Remains, GAO-03-1018

(Washington, D.C.: Sept. 19, 2003).
Page 10 GAO-04-414T 

$18 billion in fiscal year 2003 for the operation, maintenance, and 

modernization of DOD business systems. In addition, DFAS did not have 

an organizational structure in place to implement the TOP payment 

reporting process. DOD recently communicated a timetable for 

implementing TOP reporting for its vendor payment systems with 

completion targeted for March 2005.

IRS Policies Exclude Cases 

from the Levy Program

IRS’s continuing challenges in pursuing and collecting unpaid taxes also 

hinder the government’s ability to take full advantage of the levy program. 

For example, due to resource constraints, IRS has established policies that 

either exclude or delay referral of a significant number of cases to the 

program. Also, the IRS review process for taxpayer requests, such as 

installment agreements or certain offers in compromise which IRS is 

legally required to consider, often takes many months, during which time 

IRS excludes these cases from the levy program. In addition, inaccurate or 

outdated information in IRS systems prevents cases from entering the levy 

program. Our audit and investigation of 47 case studies also showed IRS 

continuing to work with businesses and individuals to achieve voluntary 

compliance, and taking enforcement actions such as levies of federal 

contractor payments later in the collection process. We recently 

recommended that IRS study the feasibility of submitting all eligible unpaid 

federal tax accounts to FMS on an ongoing basis for matching against 

federal payment records under the levy program, and use information from 

any matches to assist IRS in determining the most efficient method of 

collecting unpaid taxes, including whether to use the levy program.10 The 

study was not completed at the time of our audit. In earlier reviews,11 we 

estimated IRS could use the levy program to potentially recover hundreds 

of millions of dollars in tax debt.

Although the levy program could provide a highly effective and efficient 

method of collecting unpaid taxes from contractors that receive federal 

payments, IRS policies restrict the number of cases that enter the program 

and the point in the collection process they enter the program. For each of 

10 U.S. General Accounting Office, Tax Administration: Federal Payment Levy Program 

Measure, Performance, and Equity Can Be Improved, GAO-03-356 (Washington, D.C.: Mar. 

6, 2003).

11 U.S. General Accounting Office, Tax Administration: IRS’ Levy of Federal Payments 

Could Generate Millions of Dollars, GAO/GGD-00-65 (Washington, D.C.: Apr. 7, 2000), GAO03-356, and GAO-01-711.
Page 11 GAO-04-414T 

the collection phases listed below, IRS policy either excludes or severely 

delays putting cases into the levy program.

• Phase 1: Notify taxpayer of unpaid taxes, including a demand for 

payment letter.

• Phase 2: Place the case into the Automated Collection System (ACS) 

process. The ACS process consists primarily of telephone calls to the 

taxpayer to arrange for payment.

• Phase 3: Move the case into a queue of cases awaiting assignment to a 

field collection revenue officer.

• Phase 4: Assign the case to field collections where a revenue officer 

attempts face-to-face contact and collection.

As of September 30, 2002, IRS listed $81 billion of cases in these four 

phases: 17 percent were in notice status, 17 percent were in ACS, 26 

percent were in field collection, and 40 percent were in the queue awaiting 

assignment to the field. At the same time these four phases take place, 

sometimes over the course of years, DOD contractors with unpaid taxes 

continue to receive billions of dollars in contract payments. IRS excludes 

cases in the notification phase from the levy program to ensure proper 

notification rules are followed. However, as we previously reported, once 

proper notification has been completed, IRS continues to delay or exclude 

from the levy program those accounts placed in the other three phases.12 

IRS policy is to exclude accounts in the ACS phase primarily because 

officials believed they lack the resources to issue levy notices and respond 

to the potential increase in telephone calls from taxpayers responding to 

the notices. Additionally, IRS excludes the majority of cases in the queue 

phase (awaiting assignment to field collection) from the levy program for 1 

year. Only after cases await assignment for over a year does IRS allow 

them to enter the levy program. Finally, IRS excludes most accounts from 

the levy program once they are assigned to field collection because revenue 

officers said that the levy action could interfere with their successfully 

contacting taxpayers and resolving the unpaid taxes.

These policy decisions, which may be justified in some cases, result in IRS 

excluding millions of cases from potential levy. IRS officials that work on 

12 GAO-03-356.
Page 12 GAO-04-414T 

ACS and field collection inventories can manually unblock individual cases 

they are working in order to put them in the levy program. However, by 

excluding cases in the ACS and field collection phases, IRS records 

indicate it excluded as much as $34 billion of cases from the levy program 

as of September 30, 2002. In January 2003, IRS unblocked and made 

available for levy those accounts identified as receiving federal salary or 

annuity payments. However, other accounts remain blocked from the levy 

program. IRS stated that it intended to unblock a portion of the remaining 

accounts sometime in 2005. Additionally, $32 billion of cases are in the 

queue, and thus under existing policy would be excluded from the levy 

program for the first year each case is in that phase. IRS policies, along 

with its inability to more actively pursue collections, both of which IRS has 

in the past attributed to resource constraints, combine to prevent many 

cases from entering the levy program. Since IRS has a statutory limitation 

on the length of time it can pursue unpaid taxes, generally limited to 10 

years from the date of the assessment, these long delays greatly decrease 

the potential for IRS to collect the unpaid taxes.

We identified specific examples of IRS not actively pursuing collection in 

our review of 47 selected cases involving DOD contractors. In one case, 

IRS cited resource and workload management considerations. IRS is not 

currently seeking collection of about $14.9 billion of unpaid taxes citing 

these considerations–about 5 percent of its overall inventory of unpaid 

assessments as of September 30, 2002. In another case, IRS cited financial 

hardship where the taxpayer was unable to pay. This puts collection 

activities on hold until the taxpayer’s adjusted gross income (per 

subsequent tax return filings) exceeds a certain threshold. Some cases 

repeatedly entered the queue awaiting assignment to a field collection 

revenue officer and remained there for long periods.

IRS Delays in Processing 

and Inaccurate Records 

Exclude Cases from the 

Levy Program

In addition to excluding cases for various operational and policy reasons as 

described above, IRS excludes cases from the levy program for particular 

taxpayer events such as bankruptcy, litigation, or financial hardship, as 

well as when taxpayers apply for an installment agreement or an offer in 

compromise. When one of these events take place, IRS enters a code in its 

automated system that excludes the case from entering the levy program. 

Although these actions are appropriate, IRS may lose opportunities to 

collect through the levy program if the processing of agreements is not 

timely or prompt action is not taken to cancel the exclusion when the 

event, such as a dismissed bankruptcy petition, is concluded.
Page 13 GAO-04-414T 

Delays in processing taxpayer documents and errors in taxpayer records 

are long-standing problems at IRS and can harm both government interests 

and the taxpayer. Our review of cases involving DOD contractors with 

unpaid federal taxes indicates that problems persist in the timeliness of 

processing taxpayer applications and in the accuracy of IRS records. For 

example, we identified a number of cases in which the processing of DOD 

contractor applications for an offer in compromise or an installment 

agreement was delayed for long periods, thus blocking the cases from the 

levy program and potentially reducing government collections. We also 

found that inaccurate coding at times prevented both IRS collection action 

and cases from entering the levy program. For example, if these blocking 

codes remain in the system for long periods, either because IRS delays 

processing taxpayer agreements or because IRS fails to input or reverse 

codes after processing is complete, cases may be needlessly excluded from 

the levy program.

IRS Subordinates Use of the 

Levy Program to Other 

Collection Efforts

Although the nation’s tax system is built upon voluntary compliance, when 

businesses and individuals fail to pay voluntarily, the government has a 

number of enforcement tools to compel compliance or elicit payment. Our 

review of DOD contractors with unpaid federal taxes indicates that 

although the levy program could be an effective, reliable collection tool, 

IRS is not using the program as a primary tool for collecting unpaid taxes 

from federal contractors. For the cases we audited and investigated, IRS 

subordinated the use of the levy program in favor of negotiating voluntary 

tax compliance with the DOD contractors, which often resulted in minimal 

or no actual collections.

DOD Contractors 

Involved in Abusive or 

Potentially Criminal 

Activity Related to the 

Federal Tax System

We selected for case study 47 businesses and individuals that had unpaid 

taxes and were receiving DOD contractor payments in fiscal year 2002. For 

all 47 cases that we audited and investigated, we found abusive or 

potentially criminal activity related to the federal tax system. Thirty-four of 

these case studies involved businesses with employees that had unpaid 

payroll taxes dating as far back as the early 1990s, some for as many as 62 

tax periods. However, rather than fulfill their role as “trustees” of this 

money and forward it to IRS, these DOD contractors diverted the money 

for other purposes. The other 13 case studies involved individuals that had 

unpaid income taxes dating as far back as the 1980s. We are referring the 

47 cases detailed in our related report to IRS for evaluation and additional 

collection action or criminal investigation.
Page 14 GAO-04-414T 

Examples of Abusive or 

Potentially Criminal Activity 

Related to the Federal Tax 

System by Businesses

Our audit and investigation of the 34 case study business contractors 

showed substantial abuse or potential criminal activity as all had unpaid 

payroll taxes and all diverted funds for personal or business use. In table 1, 

and on the following pages, we highlight 13 of these businesses and 

estimate the amounts that could have been collected through the levy 

program based on fiscal year 2002 DOD payments. For these 13 cases, the 

businesses owed unpaid taxes for a range of 6 to 30 quarters (tax periods). 

Eleven of these cases involved businesses that had unpaid taxes in excess 

of 10 tax periods, and 5 of these were in excess of 20 tax periods. The 

amount of unpaid taxes associated with these 13 cases ranged from about 

$150,000 to nearly $10 million; 7 businesses owed in excess of $1 million. 

In these 13 cases, we saw some cases where IRS filed tax liens on property 

and bank accounts of the businesses, and a few cases where IRS collected 

minor amounts through the levying of non-DOD federal payments. We also 

saw 1 case in which the business applied for an offer in compromise, which 

IRS rejected on the grounds that the business had the financial resources to 

pay the outstanding taxes in their entirety, and 2 cases in which the 

businesses entered into, and subsequently defaulted on, installment 

agreements to pay the outstanding taxes. In 5 of the 13 cases, IRS assessed 

the owners or business officers with TFRPs, yet no collections were 

received from these penalty assessments. 
Page 15 GAO-04-414T 

Table 1: DOD Contractors with Unpaid Federal Taxes—Business 

Case

study

Goods or service and 

nature of DOD work

Unpaid 

federal tax 

amounta

Estimated 

fiscal year 2002 

collections under 

effective tax levyb

Fiscal year 

2002 DOD 

paymentsc Comments

1 Base support and 

custodial services:

provides dining, trash 

removal, security, 

cleaning, and recycling 

programs on military 

bases

Nearly

$10 million

$527,000 $3.5 million State tax authorities levied the business bank 

account. The owner borrowed nearly $1 

million from the business. The owner bought 

a boat, several cars, and a home outside the 

United States. The business was dissolved 

in 2003 and transferred its employees to a 

relative’s business, where it submitted 

invoices and received payments from DOD 

on a previous contract through August 2003.

2 Engineering research 

services: conducts 

studies for DOD

Over

$1 million

$58,000 $390,000 The owner paid $1 million to purchase a 

house and furnishings in the mid-1990s. At 

around the same time, the owner borrowed 

nearly $1 million from the business, and the 

business stopped paying its taxes in full. 

DOD awarded the business contracts totaling 

over $600,000.

3 Aircraft-related goods:

manufactures structural 

parts for DOD aircraft

Nearly

$2 million

$50,000 $336,000 The business received over 30 DOD 

contracts from 1997 through 2002 totaling 

nearly $2 million.

4 Research services:

provides research for 

DOD

Over

$700,000

$13,000 $86,000 DOD awarded the business a contract in 

2002 for nearly $800,000. Owner has over 

$1 million in loans related to cars, real estate, 

and recreational activities, and owner also 

has a high-performance airplane.

5 Janitorial services:

provides custodial 

services at a DOD facility 

Over

$3 million

$108,000 $719,000 The business did not make tax payments 

after early 2001, and it made only partial 

payments prior to that dating back to the mid1990s. The business also did not file 

corporate tax returns for 8 years.

6 Private security services:

provides security guards 

at military bases

Nearly

$6 million

$3,000 $21,000 One of the business’s officers, who owns a 

large boat, paid off a recreation-related loan 

in 1999. The business paid taxes while in 

bankruptcy, but largely stopped paying after 

emerging from bankruptcy.

7 Furniture sales and 

construction services:

sells and installs office 

furniture at military 

installations

Over

$150,000

$6,000 $38,000 The owners used the business to pay 

personal expenses, such as house mortgage 

and credit cards. One owner is a retired 

military officer.

8 Custodial services:

provides janitorial and 

housekeeping services at 

military installations

Over

$800,000

$219,000 $1.5 million The business received numerous DOD 

contracts from 1998 through 2001 totaling 

nearly $12 million. The business is linked to 

potential check fraud.
Page 16 GAO-04-414T 

Source: GAO analysis of DOD, IRS, FMS, public, and other records.

Notes: Dollar amounts are rounded. The nature of unpaid taxes for businesses was primarily due to 

unpaid payroll taxes. A contractor registers in the CCR database with either an EIN or an SSN. In our 

report, any contractor registering with an EIN is referred to as a business, and any contractor 

registering with an SSN is referred to as an individual. An individual in CCR could be a business 

owner (i.e., sole proprietorship).

a

Unpaid tax amount as of September 30, 2002.

b

The estimated collections under an effective tax levy use the assumptions that all unpaid federal taxes 

are referred to TOP at Treasury FMS and all fiscal year 2002 DOD payment information is provided to 

TOP. The collection amount is calculated on 15 percent of the payment amount up to the amount of 

unpaid taxes.

c

DOD payments from MOCAS, One Bill Pay, Integrated Accounts Payable System (IAPS), 

Computerized Accounts Payable System (CAPS) Clipper, and CAPS Windows automated systems 

identified by GAO.

The following provides illustrative detailed information on several of these 

cases.

• Case # 1 - This base support contractor provided services such as trash 

removal, building cleaning, and security at U.S. military bases. The 

9 Construction services:

provides housing 

management services, 

including maintenance, 

repairs, and renovations, 

on military bases

Over

$1 million

$357,000 $2.4 million The business owes DOD tens of thousands 

of dollars for an overpayment in early 2000.

10 Base support services:

provides landscaping and 

snow removal at a military 

base

Nearly

$1 million

$33,000 $217,000 The business was awarded contracts from 

1999 through 2000 worth over $1 million. 

The business owes taxes dating back to the 

early 1990s.

11 Construction services:

provides repairs to aircraft 

hangars at a military base

Over

$700,000

$422,000 $2.8 million

12 Medical personnel 

services: provides

nursing, pharmacy, 

physical therapy, and 

other skilled medical 

personnel in DOD 

facilities

Nearly

$6 million

$698,000 $4.7 million Several federal and state tax liens have been 

placed against the owner.

13 Aircraft-related goods: 

manufactures aircraft 

components for several 

DOD and civilian 

programs 

Over

$400,000

$29,000 $194,000 The business was awarded numerous DOD 

contracts in a recent 4-year period totaling 

over $300,000.

(Continued From Previous Page)

Case

study

Goods or service and 

nature of DOD work

Unpaid 

federal tax 

amounta

Estimated 

fiscal year 2002 

collections under 

effective tax levyb

Fiscal year 

2002 DOD 

paymentsc Comments
Page 17 GAO-04-414T 

business had revenues of over $40 million in 1 year, with over 25 percent 

of this coming from federal agencies. This business’s outstanding tax 

obligations consisted of unpaid payroll taxes. In addition, the 

contractor defaulted on an IRS installment agreement. IRS assessed a 

TFRP against the owner. The business reported that it paid the owner a 

six figure income and that the owner had borrowed nearly $1 million 

from the business. The business also made a down payment for the 

owner’s boat and bought several cars and a home outside the country. 

The owner allegedly has now relocated his cars and boat outside the 

United States. This contractor went out of business in 2003 after state 

tax authorities seized its bank account. The business transferred its 

employees to a relative’s business, which also had unpaid federal taxes, 

and submitted invoices and received payments from DOD on a previous 

contract through August 2003.

• Case # 2 - This engineering research contractor received nearly 

$400,000 from DOD during 2002. At the time of our audit, the contractor 

had not remitted its payroll tax withholdings to the federal government 

since the late 1990s. In 1996, the owner bought a home and furnishings 

worth approximately $1 million and borrowed nearly $1 million from the 

business. The owner told our investigators that the payroll tax funds 

were used for other business purposes.

• Case # 3 - This aircraft parts manufacturer did not pay payroll 

withholding and unemployment taxes for 19 of 20 periods through the 

mid- to late 1990s. IRS assessed a TFRP against several corporate 

officers, and placed the business in the FPLP in 2000. This business 

claims that its payroll taxes were not paid because the business had not 

received DOD contract payments; however, DOD records show that the 

business received over $300,000 from DOD during 2002.

• Case # 5 - This janitorial services contractor reported revenues of over 

$3 million and had received over $700,000 from DOD in a recent year. 

The tax problems of this business date back to the mid-1990s. At the 

time of our audit, the business had both unpaid payroll and 

unemployment taxes of nearly $3 million. In addition, the business did 

not file its corporate tax returns for 8 years. IRS assessed a TFRP 

against the principal officer of the business in early 2002. This 

contractor employed two officers who had been previously assessed 

TFRPs related to another business.
Page 18 GAO-04-414T 

• Case # 7 - This furniture business reported gross revenues of over 

$200,000 and was paid nearly $40,000 by DOD in a recent year. The 

business had accumulated unpaid federal taxes of over $100,000 at the 

time of our audit, primarily from unpaid employee payroll taxes. The 

business also did not file tax returns for several years, even after 

repeated notices from IRS. The owners made an offer to pay IRS a 

portion of the unpaid taxes through an offer in compromise, but IRS 

rejected the offer because it concluded that the business and its owners 

had the resources to pay the entire amount. At the time of our audit, IRS 

was considering assessing a TFRP against the owners to make them 

personally liable for the taxes the business owed. The owners used the 

business to pay their personal expenses, such as their home mortgage, 

utilities, and credit cards. The owners said they considered these 

payments a loan from the business. Under this arrangement, the owners 

were not reporting this company benefit as income so they were not 

paying income taxes, and the business was reporting inflated expenses.

• Case # 9 - This family-owned and operated building contractor 

provided a variety of products and services to DOD, and DOD provided 

a substantial portion of the contractor’s revenues. At the time of our 

review, the business had unpaid payroll taxes dating back several years. 

In addition to failing to remit the payroll taxes it withheld from 

employees, the business had a history of filing tax returns late, 

sometimes only after repeated IRS contact. Additionally, DOD made an 

overpayment to the contractor for tens of thousands of dollars. 

Subsequently, DOD paid the contractor over $2 million without 

offsetting the earlier overpayment.

• Case # 10 - This base support services contractor has close to $1 

million in unpaid payroll and unemployment taxes dating back to the 

early 1990s, and the business has paid less than 50 percent of the taxes it 

owed. IRS assessed a TFRP against one of the corporate officers. This 

contractor received over $200,000 from DOD during 2002.

Examples of Abuse of the 

Federal Tax System by 

Individuals

Individuals are responsible for the payment of income taxes, and our audit 

and investigation of 13 individuals showed significant abuse of the federal 

tax system similar to what we found with our DOD business case studies. 

In table 2, and on the following pages, we highlight four of the individual 

case studies. In all four cases, the individuals had unpaid income taxes. In 

one of the four cases, the individual operated a business as a sole 

proprietorship with employees and had unpaid payroll taxes. Taxes owed 
Page 19 GAO-04-414T 

by the individuals ranged from four to nine tax periods, which equated to 

years. Each individual owed in excess of $100,000 in unpaid income taxes, 

with one owing in excess of $200,000. In two of the four cases, the 

individuals had entered into, and subsequently defaulted on, at least one 

installment agreement to pay off the tax debt.

Table 2: DOD Contractors with Unpaid Federal Taxes—Individual

Source: GAO analysis of DOD, IRS, FMS, public, and other records.

Notes: Dollar amounts are rounded. Nature of unpaid taxes for individuals was primarily due to unpaid 

income taxes. A contractor registers in the CCR database with either an EIN or an SSN. In our report, 

any contractor registering with an EIN is referred to as a business, and any contractor registering with 

an SSN is referred to as an individual. An individual in CCR could be a business owner (i.e., sole 

proprietorship). For cases selected as individuals, we reviewed both the owner and related business 

information, if it could be identified.

a

Unpaid tax amount as of September 30, 2002.

b

The estimated collections under an effective tax levy use the assumptions that all unpaid federal taxes 

are referred to TOP at Treasury FMS and all fiscal year 2002 DOD payment information is provided to 

TOP. The collection amount is calculated on 15 percent of the payment amount up to the amount of 

unpaid taxes.

c

DOD payments from MOCAS, One Bill Pay, IAPS, and CAPS automated systems identified by GAO.

Case 

study

Goods or service and

nature of DOD work

Unpaid 

federal tax 

amounta

Estimated 

fiscal year 2002 

collections under 

effective tax levyb

Fiscal year 

2002 DOD 

paymentsc Comments

14 Vehicle repair services:

provides repair and 

painting for military 

vehicles

Over

$100,000

$22,000 $147,000 The business was investigated for paying 

employee wages in cash. Despite a 

substantial tax liability, the owner recently 

purchased a home valued at over $1 million 

as well as a luxury sports car. The owner 

also owes a federal agency for child support. 

15 Dentist: provides

dental services at military 

facility

Over

$100,000

$12,000 $78,000 DOD recently increased the individual’s 

contract by over $80,000. The dentist’s 

credit history included several credit card 

accounts that were identified for collection 

action.

16 Dentist: provides 

dental services at military 

facility

Over

$200,000

$11,000 $76,000 DOD awarded the individual a multiyear 

contract for over $400,000. This individual 

paid income tax for only 1 year since 1993. 

The individual previously had a business that 

owes over $100,000 in unpaid payroll and 

unemployment taxes going back to the early 

1990s.

17 Training services:

conducts management 

and leadership courses

Over

$100,000

$2,000 $12,000 This individual has not paid income taxes for 

5 years.
Page 20 GAO-04-414T 

The following provides illustrative detailed information on these four 

cases.

• Case # 14 - This individual’s business repaired and painted military 

vehicles. The owner failed to pay personal income taxes and did not 

send employee payroll tax withholdings to IRS. The owner owed over 

$500,000 in unpaid federal business and individual taxes. Additionally, 

the TOP database showed the owner had unpaid child support. IRS 

levied the owner’s bank accounts and placed liens against the owner’s 

real property and business assets. The business received over $100,000 

in payments from DOD in a recent year, and the contractor’s current 

DOD contracts are valued at over $60 million. In addition, the business 

was investigated for paying employee wages in cash. Despite the large 

tax liability, the owner purchased a home valued at over $1 million and a 

luxury sports car.

• Case # 15 - This individual, who is an independent contractor and 

works as a dentist at a military installation, had a long history of not 

paying income taxes. The individual did not file several tax returns and 

did not pay taxes in other periods when a return was filed. The 

individual entered into an installment agreement with IRS but defaulted 

on the agreement. This individual received $78,000 from DOD during a 

recent year, and DOD recently increased the individual’s contract by 

over $80,000.

• Case # 16 - This individual is another independent contractor who also 

works as a dentist on a military installation. DOD paid this individual 

over $200,000 in recent years, and recently signed a multiyear contract 

worth over $400,000. At the time of our review, this individual had paid 

income taxes for only 1 year since the early 1990s and had accumulated 

unpaid taxes of several hundred thousand dollars. In addition, the 

individual’s prior business practice owes over $100,000 in payroll and 

unemployment taxes for multiple periods going back to the early 1990s.

• Case # 17 - DOD paid this individual nearly $90,000 for presenting 

motivational speeches on management and leadership. This individual 

has failed to file tax returns since the late 1990s and had unpaid income 

taxes for a 5-year period from the early to mid-1990s. The total amount 

of unpaid taxes owed by this individual is not known because of the 

individual’s failure to file income tax returns for a number of years. IRS 

placed this individual in the levy program in late 2000; however, DOD 
Page 21 GAO-04-414T 

payments to this individual were not levied because DFAS payment 

information was not reported to TOP as required.

See our related report13 for details on the other 30 DOD contractor case 

studies.

Contractors with 

Unpaid Taxes Are Not 

Prohibited by Law 

from Receiving 

Contracts from the 

Federal Government

Federal law does not prohibit a contractor with unpaid federal taxes from 

receiving contracts from the federal government. Existing mechanisms for 

doing business only with responsible contractors do not prevent 

businesses and individuals with unpaid federal taxes from receiving 

contracts. Further, the government has no coordinated process for 

identifying and determining the businesses and individuals with unpaid 

taxes that should be prevented from receiving contracts and for conveying 

that information to contracting officers before awarding contracts. 

In previous work, we supported the concept of barring delinquent 

taxpayers from receiving federal contracts, loans and loan guarantees, and 

insurance. In March 1992, we testified on the difficulties involved in using 

tax compliance as a prerequisite for awarding federal contracts.14 In May 

2000, we testified in support of H.R. 4181 (106th Congress), which would 

have amended DCIA to prohibit delinquent federal debtors, including 

delinquent taxpayers, from being eligible to contract with federal 

agencies.15 Safeguards in the bill would have enabled the federal 

government to procure goods or services it needed from delinquent 

taxpayers for designated disaster relief or national security. Our testimony 

also pointed out implementation issues, such as the need to first ensure 

that IRS systems provide timely and accurate data on the status of taxpayer 

accounts. However, this legislative proposal was not adopted and there is 

no existing statutory bar on delinquent taxpayers receiving federal 

contracts.

13 GAO-04-95.

14 U.S. General Accounting Office, Tax Administration: Federal Contractor Tax 

Delinquencies and Status of the 1992 Tax Return Filing Season, GAO/T-GGD-92-23

(Washington, D.C.: Mar. 17, 1992).

15 U.S. General Accounting Office, Debt Collection: Barring Delinquent Taxpayers From 

Receiving Federal Contracts and Loan Assistance, GAO/T-GGD/AIMD-00-167 (Washington, 

D.C.: May 9, 2000).
Page 22 GAO-04-414T 

Federal agencies are required by law to award contracts to responsible 

sources.16 This statutory requirement is implemented in the FAR, which 

requires that government purchases be made from, and government 

contracts awarded to, responsible contractors only.17 To effectuate this 

policy, the government has established a debarment and suspension 

process and established certain criteria for contracting officers to consider 

in determining a prospective contractor’s responsibility. Contractors 

debarred, suspended, or proposed for debarment are excluded from 

receiving contracts and agencies are prohibited from soliciting offers from, 

awarding contracts to, or consenting to subcontracts with these 

contractors, unless compelling reasons exist. Prior to award, contracting 

officers are required to check a governmentwide list of parties that have 

been debarred, suspended, or declared ineligible for government 

contracts,18 as well as to review a prospective contractor’s certification19 on 

debarment, suspension, and other responsibility matters. Among the 

causes for debarment and suspension is tax evasion.20 In determining 

whether a prospective contractor is responsible, contracting officers are 

also required to determine that the contractor meets several specified 

standards, including “a satisfactory record of integrity and business ethics.” 

Except for a brief period during 2000 through 2001, contracting officers 

have not been required to consider compliance with federal tax laws in 

making responsibility determinations.21

16 10 U.S.C. § 2305 (b) and 41 U.S.C. § 253b (2000).

17 48 C.F.R. § 9.103 (a).

18 Contractors included on the list as having been declared ineligible on the basis of 

statutory or regulatory procedures are excluded from receiving contracts under the 

conditions and for the period set forth in the statute or regulation. Agencies are prohibited 

from soliciting offers from, awarding contracts to, or consenting to subcontracts with these 

contractors under these conditions and for that period.

19 Such certification is required only for contracts exceeding the simplified acquisition 

threshold.

20 The government may suspend a contractor suspected of tax evasion, upon adequate 

evidence, and debar a contractor for a conviction or civil judgment for commission of tax 

evasion. Further, prospective contractors are required to certify in their bids or proposals 

whether they or their principals, within the preceding 3 years, were convicted or had civil 

judgments rendered against them for commission of tax evasion, and whether they or their 

principals are presently indicted or otherwise criminally or civilly charged with commission 

of tax evasion.
Page 23 GAO-04-414T 

Neither the current debarment and suspension process nor the 

requirements for considering contractor responsibility effectively prevent 

the award of government contracts to businesses and individuals that 

abuse the tax system. Since most businesses and individuals with unpaid 

taxes are not charged with tax evasion, and fewer still convicted, these 

contractors would not necessarily be subject to the debarment and 

suspension process. None of the contractors described in this report were 

charged with tax evasion for the abuses of the tax system we identified.

A prospective contractor’s tax noncompliance, other than tax evasion, is 

not considered by the federal government before deciding whether to 

award a contract to a business or individual. Further, no coordinated and 

independent mechanism exists for contracting officers to obtain accurate 

information on contractors that abuse the tax system. Such information is 

not obtainable from IRS because of a statutory restriction on disclosure of 

taxpayer information.22 As we found in November 2002,23 unless reported 

by prospective contractors themselves, contracting officers face significant 

difficulties obtaining or verifying tax compliance information on 

prospective contractors.

21 In December 2000, a controversial revision to the FAR was issued that required 

contracting officers to consider a prospective contractor’s compliance with several areas of 

law, including tax, in determining a satisfactory record of integrity and business ethics. This 

revision was revoked in December 2001 after having been effectively suspended for many 

federal agencies earlier in 2001. 

22 26 U.S.C. § 6103 (2000).

23 U.S. General Accounting Office, Government Contracting: Adjudicated Violations of 

Certain Laws by Federal Contractors, GAO-03-163 (Washington, D.C.: Nov. 15, 2002).
Page 24 GAO-04-414T 

Moreover, even if a contracting officer could obtain tax compliance 

information on prospective contractors, a determination of a prospective 

contractor’s responsibility under the FAR when a contractor abused the tax 

system is still subject to a contracting officer’s individual judgment. Thus, a 

business or individual with unpaid taxes could be determined to be 

responsible depending on the facts and circumstances of the case. Since 

the responsibility determination is largely committed to the contracting 

officer’s discretion and depends on the contracting situation involved, 

there is the risk that different determinations could be reached on the basis 

of the same tax compliance information. On the other hand, if a 

prospective contractor’s tax noncompliance results in mechanical 

determinations of nonresponsibility, de facto debarment could result.

Further, a determination that a prospective contractor is not responsible 

under the FAR could be challenged.24

Because individual responsibility determinations can be affected by a 

number of variables, any implementation of a policy designed to consider 

tax compliance in the contract award process may be more suitably 

addressed on a governmentwide basis. The formulation and 

implementation of such a policy may most appropriately be the role of 

OMB’s Office of Federal Procurement Policy. The Administrator of Federal 

Procurement Policy provides overall direction for governmentwide 

procurement policies, regulations, and procedures. In this regard, OMB’s 

Office of Federal Procurement Policy is in the best position to develop and 

pursue policy options for prohibiting federal contract awards to businesses 

and individuals that abuse the tax system.

Concluding Comments Thousands of DOD contractors that failed in their responsibility to pay 

taxes continue to get federal contracts. Allowing these contractors to do 

substantial business with the federal government while not paying their 

federal taxes creates an unfair competitive advantage for these businesses 

and individuals at the expense of the vast majority of DOD contractors that 

do pay their taxes. DOD’s failure to fully comply with DCIA and IRS’s 

continuing challenges in collecting unpaid taxes have contributed to this 

24 For example, if the prospective contractor is a small business, the nonresponsibility 

determination would be reviewed by the Small Business Administration, which could issue 

a Certificate of Competency stating that the prospective contractor is responsible for the 

purpose of receiving and performing a specific government contract. A determination of 

nonresponsibility could also be protested through the bid protest process.
Page 25 GAO-04-414T 

unacceptable situation, and have resulted in the federal government 

missing the opportunity to collect hundreds of millions of dollars in unpaid 

taxes from DOD contractors. Working closely with IRS and Treasury, DOD 

needs to take immediate action to comply with DCIA and thus assist in 

effectively implementing IRS’s legislative authority to levy contract 

payments for unpaid federal taxes. Also, IRS needs to better leverage its 

ability to levy DOD contractor payments, moving quickly to use this 

important collection tool. Beyond DOD, the federal government needs a 

coordinated process for dealing with contractors that abuse the federal tax 

system, including taking actions to prevent these businesses and 

individuals from receiving federal contracts.

Our related report on these issues released today includes nine 

recommendations to DOD, IRS, and OMB. Our DOD recommendations 

address the need to comply with the DCIA by supporting IRS efforts under 

the Taxpayer Relief Act of 1997 to collect unpaid federal taxes. Our IRS 

recommendations address improving the effectiveness of IRS collection 

activities through earlier use of the Federal Payment Levy Program and 

changing or eliminating policies that prevent businesses and individuals 

with federal contracts from entering the levy program. Our OMB 

recommendation addresses developing and pursuing policy options for 

prohibiting federal contract awards to businesses and individuals that 

abuse the federal tax system. In written comments on a draft of our report, 

DOD and IRS officials partially agreed with our recommendations. OMB 

officials did not agree with our recommendation to develop policy options 

for prohibiting federal contract awards to businesses and individuals that 

abuse the federal tax system.

Our report also suggests that Congress consider requiring DOD to 

periodically report to Congress on progress in providing its payment 

information to TOP for each of its contract and vendor payment systems, 

including details of the resulting collections by system and in total for all 

contract and vendor payment systems during the reporting period. In 

addition, our report suggests that Congress consider requiring that OMB 

report to Congress on progress in developing and pursuing options for 

prohibiting federal government contract awards to businesses and 

individuals that abuse the federal tax system, including periodic reporting 

of actions taken. DOD and OMB did not agree with our matters for 

congressional consideration.

We continue to believe all of our recommendations and matters for 

congressional consideration constitute valid and necessary courses of 
Page 26 GAO-04-414T 

action, especially in light of the identified weaknesses and the slow 

progress of DOD to fully implement the offset provisions of the DCIA since 

its passage more than 7 years ago. 

 Mr. Chairman, Members of the Subcommittee, and Ms. Schakowsky, this 

concludes our prepared statement. We would be pleased to answer any 

questions you may have.

GAO Contacts 

and Staff 

Acknowledgments

For future contacts regarding this testimony, please contact Gregory D. 

Kutz at (202) 512-9095 or kutzg@gao.gov, Steven J. Sebastian at (202) 512-

3406 or sebastians@gao.gov, or John J. Ryan at (202) 512-9587 or 

ryanj@gao.gov. Individuals making key contributions to this testimony 

included Tida Barakat, Gary Bianchi, Art Brouk, Ray Bush, William 

Cordrey, Francine DelVecchio, K. Eric Essig, Kenneth Hill, Jeff Jacobson, 

Shirley Jones, Jason Kelly, Rich Larsen, Tram Le, Malissa Livingston, 

Christie Mackie, Julie Matta, Larry Malenich, Dave Shoemaker, Wayne 

Turowski, Jim Ungvarsky, and Adam Vodraska.

(192118)
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Washington, D.C. 20548