Financial Management: Thousands of Civilian Agency Contractors Abuse the Federal Tax System with Little Consequence
Published: 2005-06-16T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: Tax abuses by contractors working for the Department of Defense, on which GAO previously reported, have led to concerns about similar abuses by those hired by civilian agencies. GAO was asked to determine if similar problems exist at civilian agencies and, if so, to (1) quantify the amount of unpaid federal taxes owed by civilian agency contractors paid through the Financial Management Service (FMS), (2) identify any statutory or policy impediments and control weaknesses that impede tax collections under the Federal Payment Levy Program (FPLP), and (3) determine whether there are indications of abusive or potential criminal activity by contractors with unpaid tax debts.
section_title: What GAO Found
paragraphs: FMS and IRS records showed that about 33,000 civilian agency contractors owed over $3 billion in unpaid federal taxes as of September 30, 2004. All 50 civilian agency contractors we investigated had abusive and potentially criminal activity. For example, businesses with employees did not forward payroll taxes withheld from their employees to IRS. Willful failure to remit payroll taxes is a felony under U.S. law. Further, several individuals own multiple businesses with unpaid federal taxes--one individual owns about 20 businesses that did not fully pay taxes related to over 300 returns. Some contractors purchased or owned millions of dollars of property while they did not remit payroll taxes. These activities were identified for contractors at the Departments of Justice, Homeland Security, and Veterans Affairs; the National Aeronautics and Space Administration; and others agencies. GAO's analysis indicates that if all tax debts owed by, and all payments made to, the 33,000 contractors were included in the FPLP, FMS could have collected hundreds of millions of dollars in fiscal year 2004. However, because only a fraction of all unpaid taxes and a portion of FMS payments are subjected to the levy program, FMS actually collected only $16 million from civilian contractors. For example, about $171 billion of unpaid federal taxes were not sent to the levy program to be offset against payments because of specific statutory requirements or IRS policy exclusions, such as debtors' claims of financial hardship or bankruptcy. Tens of billions of dollars in federal payments were not compared against tax debts for potential levy because FMS did not proactively manage and oversee the levy program. Until we brought it to FMS's attention, FMS did not know that it did not submit $40 billion of contractor payments from some civilian agencies for potential levy. FMS also did not identify payment files that did not contain contractor tax identification numbers, names, or both, resulting in $21 billion in payments to contractors that could not be levied. FMS also excluded billions of dollars from levy because of what it considered programming limitations without taking proactive steps to overcome those limitations. Further, civilian agency purchase card payments to contractors totaling $10 billion could not be levied. Improvements at FMS could result in tens of millions of dollars of additional levies annually.

section_title: Letter
paragraphs: The success of our tax system hinges on the public’s perception of its  fairness, including the extent to which taxpayers believe their friends,  neighbors, and business competitors are complying with the tax laws and  are actually paying their taxes. The Internal Revenue Service’s (IRS) own  data in this regard are not encouraging. IRS reported that the federal  government does not receive hundreds of billions of dollars in taxes owed  annually. Recent IRS data, released in March 2005, showed that the  estimated net annual tax gap—the difference between what taxpayers  should pay on a timely basis and what IRS collected through voluntary  compliance and enforcement activities—ranged from $250 billion to nearly  $300 billion.
A portion of the tax gap is owed by contractors receiving payments from  the federal government. For example, in February 2004, we reported that  some Department of Defense (DOD) contractors abuse the federal tax  system with little consequence. In our report and during a related  congressional hearing, we pointed out that based on our analysis of a  limited number of DOD disbursement systems, more than 27,000 DOD  contractors owed nearly $3 billion in unpaid federal taxes. We also  reported that some of these contractors were engaged in abusive and potentially criminal activities. Due to the significance of the issues raised  at that hearing, you asked us to provide additional information about  whether contractors for other federal agencies were engaged in similar tax  abuses and to provide recommendations to increase the effectiveness and  efficiency of tax revenue collections from federal contractors under the  Federal Payment Levy Program (FPLP).
This is the first in a series of reports to respond to your request. The  specific objectives of this first audit and investigation were, to the extent  possible, to (1) quantify the magnitude of unpaid taxes of contractors at  federal civilian agencies that are paid through the Department of the  Treasury’s (Treasury) Financial Management Service (FMS); (2) identify  some statutory or policy impediments and control weaknesses that impede  tax collections under the FPLP; and (3) determine, using case studies,  whether indications exist that federal contractors with unpaid taxes are  engaged in abusive or potentially criminal activities. To identify the extent  of such activities, we analyzed the tax debt and activity of entities with  either the same owners or officers, common taxpayer identification  numbers (TIN) or addresses, or other relationships as a group to identify  patterns of abusive or potentially criminal activities. We will address issues  surrounding the amount of tax debt IRS sends to the FPLP in subsequent  reports.
To meet our first two objectives, we (1) identified civilian agency  contractors receiving federal payments that owe taxes by comparing the  database of FMS contractor payments with the IRS database of unpaid  taxes, (2) estimated the potential dollar amount that could be collected if  all unpaid taxes owed by civilian contractors and all FMS payments to  civilian contractors were subject to the FPLP, (3) reviewed major federal  laws and regulations and FMS policies on the FPLP, and (4) interviewed  FMS and IRS officials on processes and procedures related to the FPLP. To  avoid overstating the tax debt and potential levy amount, we limited the  population of tax debts from which we performed our analysis to tax debts  that have been agreed to by the taxpayers or confirmed by the courts, tax  debts for periods prior to calendar year 2004, tax debts of more than $100,  and fiscal year 2004 civilian contractor payments paid through FMS of  more than $100. We used data mining techniques to meet our third  objective—identifying civilian agency contractors engaged in abusive or  potentially criminal activity.
Although we were able to validate that the payment data provided by FMS  reflected disbursements to contractors, we were unable to confirm that the  disbursement data we received reflect all payments made to contractors.  Specifically, FMS was unable to provide us with electronic disbursement  data related to payments made to contractors through Fedwire, a large  system used for payments requiring same-day settlement. Further, IRS’s  databases do not identify all unpaid federal taxes caused by a contractors’  underreporting of income or failure to file taxes. Because of these  problems, the FMS and IRS data we used will likely understate the  magnitude of contractors with unpaid federal taxes and the potential levy  collection. Further details on our scope and methodology are included in  appendix I.
Our work was performed from May 2004 through May 2005 in accordance  with generally accepted government auditing standards. The investigative  portion of our work was completed in accordance with investigative  standards established by the President’s Council on Integrity and  Efficiency. The results of 10 case studies we investigated are shown in  table 3. The results of another 40 case studies are included in appendix II.  We requested comments on a draft of comments on a draft of this report  from the Commissioner for Internal Revenue or his designee and from the  Commissioner, Financial Management Service or his designee. We received  written comments from the Internal Revenue Service and the Financial  Management Service, which are reprinted in appendixes III and IV of  this report.
subsections: section_title: Background
paragraphs: In its role as the nation’s tax collector, IRS is responsible for collecting  taxes, processing tax returns, and enforcing the nation’s tax laws.  Treasury’s FMS is the central disbursing authority for civilian agencies.  With limited exceptions, FMS processes most disbursements for civilian  agencies in the executive branch. FMS is also the federal government’s  central debt collection agency. Since fiscal year 2000, FMS has operated the  FPLP in conjunction with IRS to collect unpaid federal taxes, including tax  debt owed by federal contractors.
subsections: section_title: IRS’s Collection of Unpaid Taxes
paragraphs: Since 1990, we have designated IRS’s enforcement of tax laws as a  governmentwide high-risk area. In attempting to ensure that taxpayers  fulfill their obligations, IRS is challenged on virtually every front. While  IRS’s enforcement workload—measured by the number of taxpayer returns  filed—has continually increased, until fiscal year 2005, the resources IRS  has been able to dedicate to enforcing the tax laws have declined.  Enforcement efforts are designed to increase compliance and reduce the  tax gap. However, IRS recently reported that the gross tax gap, that is, the  difference between what the taxpayers should pay on a timely basis and  what they actually pay, exceed $300 billion annually. IRS estimated the  gross tax gap to be between $312 billion and $353. IRS further reported that  its enforcement activities, coupled with late payments, recover just  $55 billion of that amount, leaving a net tax gap of from $257 billion to  $298 billion. Preliminary IRS estimates indicate that noncompliance is from  15 percent to 16.6 percent of taxpayers’ true tax liability, which further  fuels congressional and public concern that declines in IRS compliance and  collections programs are eroding taxpayer confidence in the fairness of our  federal tax system.
section_title: FMS Disbursements
paragraphs: In fiscal year 2004, FMS made over 940 million disbursements totaling over  $1.5 trillion. FMS’s major disbursing activities include paying Social  Security benefits, veterans’ compensation, federal tax refunds, federal  salaries and pensions, and contractor and miscellaneous payments. For  statutory and logistical reasons, a limited number of other governmental  agencies, such as DOD and the U.S. Postal Service, have their own  authority to disburse funds. Those agencies that have the authority to  disburse federal funds are referred to as Non-Treasury Disbursing Offices.
Although FMS is the disbursing agent for most of the federal government,  that is, it physically writes the checks or sends the electronic payments, it  does so on the behalf of, and at the direction of, the various federal  agencies. Federal agencies may have multiple offices or locations that  perform accounting for and preparation of payment information, referred  to by FMS as agency locations or paying stations. To generate a payment,  an agency payment location sends FMS a payment file, along with an  accompanying payment certification requesting that FMS disburse funds.  Agencies typically send the certification and detailed payment information  in an automated form, and FMS loads the payment data into its payment  system. Once loaded, FMS verifies that all payment requests were properly  authorized and certified and that the amount on the payment file agrees  with the certification amount before processing the payments for  disbursement.
FMS disburses federal funds via three main mechanisms: electronic funds  transfer (EFT) via Automated Clearing House (ACH), Fedwire, and checks.  Fedwire is also an EFT that provides for immediate transfers of funds from  the government’s account in the Federal Reserve to the contractors’ bank  accounts. According to FMS records, of the approximately $1.5 trillion  disbursed by FMS in fiscal year 2004, about 66 percent was disbursed using  ACH, 17 percent via Fedwire, and the remaining 17 percent as checks.
Once payments are disbursed, payment information related to ACH and  checks are sent to FMS’s Payments, Claims, and Enhanced Reconciliation  (PACER) system, which maintains payment data and provides federal  payment agencies online access to these data. Among other payments,  PACER contained about 12.9 million contractor payments valued at  $247 billion for fiscal year 2004. Unlike checks and ACH payments, detailed  information regarding Fedwire payments is not sent to the PACER payment  database.
section_title: Treasury Offset and Federal Payment Levy Programs
paragraphs: In 1996, Congress passed the Debt Collection Improvement Act 1996  (DCIA) to maximize the collection of delinquent nontax debts owed to  federal agencies. As part of implementing its responsibilities under DCIA,  Treasury established the TOP, to be administered by FMS, to centralize the  process by which certain federal payments are withheld or reduced (offset)  to collect delinquent nontax debts owed to federal agencies. Under the  regulations implementing DCIA, FMS and other disbursing agencies are  required to compare their payment records with debt recorded in the TOP  database. If a match occurs, the disbursing agency must offset the  payment, thereby reducing or eliminating the nontax debt.
To improve collection of unpaid taxes, the Taxpayer Relief Act of 1997  authorized IRS to continuously levy up to 15 percent of specified federal  payments made to businesses and individuals with unpaid federal taxes.  The continuous levy program, now referred to as FPLP, was implemented  in July 2000. The FPLP provides for the levy of various federal payments,  including federal employee retirement payments, certain Social Security  payments, selected federal salaries, and contractor payments. For  payments disbursed by FMS on behalf of most federal agencies, the amount  to be levied and credited to IRS is deducted before FMS disburses the  payment. In fiscal year 2004, IRS received $114 million through the FPLP  for delinquent taxes, $16 million of which was from payments to civilian  contractors.
IRS coordinated with FMS to utilize the TOP database as the means of  collecting taxes under the FPLP. Each week IRS sends FMS an extract of its  tax debt files containing updated account balances of tax debts that are  already in TOP, the new tax debts that need to be added to TOP, and all  taxes in TOP that need to be rescinded. These data are uploaded into TOP.  For a payment to be levied through the FPLP, a debt has to exist in TOP and  a payment has to be available. Figure 1 provides an overview of this  process.
FMS sends payment data to TOP to be matched against unpaid federal  taxes. TOP electronically compares the names and TINs on the payment  files to the control names (first four characters of the names) and TINs of  the debtors listed in TOP. If there is a match and IRS has updated TOP to  reflect that it has completed all legal notifications, the federal payment is  reduced (levied) to help satisfy the unpaid federal taxes.
section_title: Federal Contractor Tax Compliance Task Force
paragraphs: To address issues raised by our February 12, 2004, report and testimony, a  multi-agency task force was established to help improve the FPLP. The task  force includes representatives from the Department of Defense, Defense  Finance and Accounting Service, IRS, FMS, General Services  Administration (GSA), Office of Management and Budget, and Department  of Justice.
The objectives of the task force were to (1) identify and implement short- term and long-term operational changes to improve federal tax compliance  of DOD contractors, including increasing the number of tax debts and the  number of DOD contractor payments available for matching through TOP,  and (2) identify potential changes that would enhance efforts to address  federal contractor tax delinquencies and prevent future occurrences of tax  abuse by federal contractors.
The task force issued its report in October 2004. In its report, the task force  identified actions and made recommendations to improve tax compliance  of federal contractors, including maximizing the number of delinquent tax  debts that IRS makes available for matching, maximizing DOD payment  information available for matching, increasing the effectiveness of the  matching and levy processes, and preventing federal contract awards to  those who abuse the tax system. A number of the improvements identified  by the task force have already been implemented.
section_title: Civilian Contractors Have Billions of Dollars in Unpaid Federal Taxes
paragraphs: Our analysis indicates that the failure to pay taxes among DOD contractors  also exists among civilian agency contractors and totaled billions of  dollars. Our analysis of FMS and IRS records indicates that during fiscal  year 2004, FMS made payments on behalf of civilian agencies to about  33,000 federal contractors with over $3.3 billion in unpaid federal taxes as  of September 30, 2004. We estimate that if there were no legal or  administrative impediments to the levy program—if all unpaid federal  taxes were considered and all payments to these 33,000 contractors with  unpaid federal taxes were subjected to the 15 percent levy—FMS could  have collected as much as $350 million in unpaid federal taxes from civilian  contractors during fiscal 2004. Because some unpaid federal taxes are  excluded due to statutory requirements, IRS and FMS would never be able  to collect the entire amount. Over half of the $3.3 billion in tax debt was  coded by IRS as being excluded from the levy program for statutory  reasons, including contractors being in bankruptcy, having installment  payment agreements, or awaiting the completion of the required legal  notifications regarding the tax debt. However, many improvements can be  made to lessen the tax levy collection gap. As will be discussed later in the  report, the American Jobs Creation Act of 2004 increased the maximum  levy to 100 percent of any specified payments to contractors for goods and  services provided the federal government. When implemented, the  maximum levy amount that could be collected is even greater.
subsections: section_title: Characteristics of Contractors’ Unpaid Federal Taxes
paragraphs: The amount of unpaid taxes for these contractors paid through Treasury  FMS ranged from a small amount owed by an individual for a single tax  period to a group of related businesses owing about $13 million for over  300 tax periods. Unpaid taxes owed by these contractors included payroll,  corporate income, excise, unemployment, individual income, and other  types of taxes.
In the case of unpaid payroll taxes, employers withheld federal taxes from  employees’ wages, but did not send the withheld payroll taxes or the  employers’ matching amounts to IRS as required by law, instead diverting  the money for personal gain or to fund their businesses. One IRS official  acknowledged that frequently small businesses are undercapitalized and  use the tax money as operating capital. However, 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 deposit in a  separate bank account these amounts held “in trust” for the federal  government until making 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 Social Security contributions. Individuals within the  business (e.g., corporate officers) may be held personally liable for the  withheld amounts not forwarded, and they can be assessed a civil  monetary penalty known as a trust fund recovery penalty (TFRP).
Willful failure to remit payroll taxes is a criminal felony offense  punishable by imprisonment of not more than 5 years, while the failure to  properly segregate payroll taxes can be a criminal misdemeanor offense  punishable by imprisonment of up to a year. The employee is not  responsible 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 previous reports.  Over time, the amount of this subsidy is significant.
As shown in figure 2, over a third of the total tax amount owed by civilian  contractors was for unpaid payroll taxes and over 40 percent was for  corporate income taxes. The remainder consisted of individual income  taxes, and other taxes. As discussed later in our case studies, some of these  contractors also owe state tax debts.
A substantial amount of the unpaid federal taxes shown in IRS records as  owed by civilian contractors had been outstanding for several years. As  reflected in figure 3, over half of the unpaid taxes owed by civilian  contractors were for tax periods prior to calendar year 2000.
Prompt collection of unpaid taxes is vital because, as our previous work  has shown, 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 federal taxes, which, over time,  can dwarf the original tax obligation. The amount of unpaid federal taxes  reported above does not include all tax debts owed by the civilian agency  contractors due to statutory provisions that give IRS a finite period under  which it can seek to collect on unpaid taxes. Generally, there is a 10-year  statutory collection period beyond which IRS is prohibited from attempting  to collect tax debt.  Consequently, if the contractors owe federal taxes beyond the 10-year statutory collection period, the older tax debt may have  been removed from IRS’s records. We were unable to determine the  amount of tax debt that had been removed.
section_title: While Substantial, the Amount of Unpaid Taxes of Civilian Contractors Is Likely Understated
paragraphs: The amount of unpaid federal taxes we identified among civilian agency  contractors—$3.3 billion—is likely understated for three main reasons:  (1) we intentionally limited our scope to contractors with agreed-to  federal tax debt for tax periods prior to 2004 that had substantial amounts  of both unpaid taxes and payments from civilian agencies; (2) FMS  disbursement files did not always contain the information we needed to  determine whether the contractors owed federal taxes; and (3) the IRS  taxpayer account database contains errors, and the database reflects only  the amount of unpaid taxes either reported by the taxpayer on a tax return  or assessed by IRS through its various enforcement programs. The IRS  database does not reflect amounts owed by businesses and individuals  that have not filed tax returns and for which IRS has not assessed tax  amounts due.
To avoid overestimating the amount owed by government contractors, we  took a number of steps to exclude unpaid federal taxes that federal  contractors recently incurred or that are not individually significant. For  example, some recently assessed tax debts that appear as unpaid taxes  through a matching of PACER and IRS records may involve matters that are  routinely resolved between the taxpayer and IRS, with the taxes paid,  abated, or both within a short period. We attempted to eliminate these  types of debt by focusing on unpaid federal taxes for tax periods prior to  calendar year 2004 and eliminating tax debt of $100 or less. We also  eliminated all tax debt identified by IRS as not being agreed to by the  contractor. Additionally, we eliminated contractors with tax debt that  received payments of $100 or less during fiscal year 2004.
Regarding the completeness of FMS disbursement information, we found  that some contractors paid through FMS could not be identified due to  blank or obviously erroneous TINs, such as TINs made up of all zeros or all  nines. The lack of TINs prevented us from determining whether  contractors had unpaid federal taxes and, if so, the amount of unpaid taxes  owed by the contractors. Additionally, as will be discussed in more detail in  a later section of this report, FMS does not maintain detailed electronic  payment information for a large disbursement system—Fedwire—that also  makes disbursements to contractors, and thus the value of unpaid taxes  associated with contractors paid through that system could not be  determined.
As we have previously reported, IRS records contain errors that affect the  accuracy of taxpayer account information. Consequently, some of the  $3.3 billion may not reflect true unpaid taxes, although we cannot quantify  this amount. Nonetheless, we believe the $3.3 billion represents a  conservative estimate of unpaid federal taxes owed by civilian contractors  paid through FMS.
Also limiting the completeness of our estimate of the unpaid federal taxes  of civilian contractors is the fact that the IRS tax database reflects only the  amount of unpaid taxes either reported by the contractor on a tax return or  assessed by IRS through its various enforcement programs. The IRS  database does not reflect amounts owed by businesses and individuals that  have not filed tax returns and for which IRS has not assessed tax amounts  due. During our review, we identified instances in which civilian  contractors failed to file tax returns for a particular tax period and,  therefore, were listed in IRS records as having no unpaid taxes for that  period. Further, our analysis did not attempt to account for businesses or  individuals that purposely underreported income and were not specifically  identified by IRS. According to IRS, underreporting of income is the largest  component of the roughly $300 billion tax gap. Preliminary IRS estimates  show underreporting accounts for more than 80 percent of the total tax  gap. Consequently, the true extent of unpaid taxes for these businesses and  individuals is not known.
section_title: Actual Levy Collections Significantly Less Than Maximum Potential Levy Amount
paragraphs: There is a large tax levy collection gap between the maximum potential  levy we calculated and the amount FMS actually collected under the FPLP.  We estimate that if there were no legal or administrative provisions that  remove some tax debt from the levy program and if all PACER contractor  payments were subjected to a 15 percent levy to satisfy all the unpaid taxes  of those civilian contractors, FMS could have collected as much as  $350 million in fiscal year 2004. However, during fiscal year 2004, FMS  collected about $16 million from civilian contractors—or about 5 percent  of the approximately $350 million maximum levy collection estimate we  calculated. As discussed earlier in this report, because some unpaid federal  taxes are excluded due to statutory requirements, IRS and FMS will never  be able to close the levy collection gap completely. For example, over half  of the $3.3 billion in tax debt was coded by IRS as being excluded from the  levy program for statutory reasons, including contractors being in  bankruptcy, having installment agreements, or awaiting the completion of  the required initial legal notifications. However, many improvements can  be made to narrow the tax levy collection gap.
We found that a vast majority of the collection gap is attributable to debts  that are excluded from TOP because of current law and IRS policies. While  we will provide an overview of the exclusions later in this report, we will  examine in detail in a later report the accuracy and reasonableness of the  exclusions and IRS’s applications of those exclusions. The remaining gap— to be covered in detail in this report—between what could be collected and  what was actually collected is attributable to the fact that not all FMS  payments could be matched against unpaid federal taxes for levy. We  estimate that the federal government could have collected at least  $50 million more in unpaid federal taxes in fiscal year 2004 using the FPLP  if all PACER contractor payments could be matched against tax debts  in TOP.
section_title: Legal Requirements and IRS Policy Decisions Contribute to the Levy Collection Gap
paragraphs: The actual collection of unpaid federal taxes from the levy program does  not approach our maximum estimate largely because IRS excludes—either  for statutory or policy reasons—almost two-thirds of unpaid federal taxes  from potential levy collection. Since we last reported on DOD contractors  that abused the federal tax system, IRS has added about $28 billion in  unpaid federal taxes to the levy program from categories it formerly  excluded (from its total population of all tax debts). Despite these efforts,  the amount that is excluded from the levy program is significant. Our  analysis of all tax debt recorded by IRS—$269 billion in unpaid taxes— including amounts owed by civilian contractors, indicates that $171 billion  was excluded from potential levy collection as of April 2005. For the  civilian contractors in fiscal year 2004, these exclusions accounted for over  80 percent of the levy collection gap. As shown in figure 4, $71 billion  (26 percent) of all unpaid federal taxes are excluded from the levy program  as a result of statutory requirements, while another $100 billion  (37 percent) of unpaid federal taxes are excluded due to IRS policy  decisions, leaving approximately $98 billion (37 percent) potentially  subject to collection through the levy program. While the exclusion of  unpaid federal taxes from the levy program is justified depending on the  circumstances, it nevertheless results in the loss of potentially hundreds  of millions of dollars in tax collections from the levy program.
In addition to not sending the majority of unpaid federal taxes to the levy  program, FMS records indicate that as of September 30, 2004, about  70 percent of the unpaid taxes that IRS submitted to TOP had not yet  completed the collection due process requirements necessary to allow the  levying of payments to begin. As a result, only a small portion of unpaid  federal taxes is available for immediate levy. We will examine in detail in a  later report the accuracy and reasonableness of the IRS exclusions and  IRS’s applications of those exclusions. What follows is a more detailed  description of the amounts and types of unpaid taxes excluded from the  FPLP for statutory and policy reasons, as well as a detailed discussion of  the limitations associated with much of the unpaid federal taxes that are  referred to the FPLP.
subsections: section_title: A Substantial Portion of Unpaid Federal Taxes Are Legally Excluded from the Levy Program
paragraphs: According to IRS records, as of April 2005, IRS had coded about $71 billion  of unpaid federal taxes as being legally excluded from the levy program.  As shown in figure 5, IRS records indicate that bankruptcy and taxpayer  agreements—including installment or offer in compromise (OIC)  agreements—each account for about a quarter of all statutory exclusions.  Another $27 billion (38 percent) of the $71 billion in statutory exclusions is  due to IRS not having completed all initial taxpayer notifications required  by law before a tax debt could be referred to TOP—these are cases that IRS  refers to as being in notice status.
For tax debt in notice status—the first phase of IRS’s collection process— IRS sends a series of up to four separate notices to tax debtors asking them  to pay their tax debt. Upon receipt of each of the notices, the debtors have  a minimum of 30 days to respond in various ways:  disagree with IRS’s assessment and collection of tax liability and appeal   negotiate with IRS to set up an alternative payment arrangement, such  as an installment agreement or an offer in compromise;  apply to IRS for a hardship determination, whereby tax debtors  demonstrate to IRS that making any payments at all would result in a  significant financial hardship; or  elect to pay off the debt in full.
Each time the debtor responds to a notice, the matter must be resolved  before IRS can proceed with further notices or other collection actions. For  example, IRS must determine whether to accept or reject an installment  agreement or determine that the tax debtor is in financial hardship before  proceeding with the collection process. During this entire notice phase, IRS  is required to exclude the tax debt from the levy program. IRS does not  begin further collection action, for example, the unpaid federal taxes are  excluded from levy, until the series of initial notifications are complete. IRS  also sends out an annual notification letter requesting payment of the  unpaid federal taxes.
section_title: IRS Policy Decisions Exclude Many Tax Debts from the Levy Program
paragraphs: In addition to legal restrictions, IRS makes policy and operational decisions  that exclude about $100 billion in unpaid tax debts from the levy program.  Categories of unpaid tax debts IRS has coded as being excluded due to  policy decisions include those of tax debtors with financial hardship, tax  debtors working with IRS to voluntarily comply, and tax debtors under  active criminal investigation. Figure 6 shows that slightly over half  ($51 billion) of all policy exclusions are due to IRS’s determination that the  tax debtor is in financial hardship. Another 40 percent ($40 billion) of the  policy exclusions include tax debtors who are deceased and those tax  debtors that have filed appeals, claims, or amended returns. About  7 percent ($7 billion), referred to as tax administration exclusions, is  excluded from the levy program because an IRS official is working to  encourage the affected tax debtor to voluntarily pay the federal taxes  owed. About 2 percent ($2 billion) are excluded due to active criminal  investigations.
Since our 2004 report on DOD contractors who abuse the tax system, in  which we recommended that IRS change or eliminate policies that prevent  businesses and individuals with federal contracts from entering the levy  program, IRS has taken specific actions to include more tax debt in the  levy program. Specifically, IRS submitted an additional $28 billion to  the levy program by removing many of the systemic exclusions for cases being actively pursued by IRS officials for collection (i.e., those excluded  for tax administration purposes). As a result of these and other  improvements (including DOD submitting more of its payments in the levy  program), collections from contractor payments under the levy program  increased over 200 percent in fiscal 2004 over fiscal 2003. Collections  continued to increase in the first half of fiscal year 2005.
Our past audits have indicated that IRS records contain coding errors that  affect the accuracy of taxpayer account information—including exclusion  categories. While we did not evaluate the appropriateness of the exclusion  categories in this report, the categories used by IRS are only as good as the  codes IRS has input into its systems. In our previous work on DOD  contractors with tax debt, we found that inaccurate coding at times  prevented both IRS collection action and cases from entering the levy  program. Therefore, the effective management of these codes is critical  because if these exclusion codes (such as codes identifying a contractor as  being in bankruptcy or having an installment agreement) 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.
section_title: Most Tax Debt IRS Submits to the Levy Program Is Not Legally Ready for Levy
paragraphs: FMS records indicate that as of September 30, 2004, about 70 percent of the  tax debt IRS sent to the levy program is not available for immediate levy  because IRS has not completed all the necessary legal notifications before  the levying of payments can begin. In addition to the initial series of notice  letters that are sent out at the beginning of IRS’s collection efforts, IRS is  required to send the debtor an additional notice of intent to levy that  includes information regarding the tax debtor’s right to a hearing prior to  levy action—also referred to as a collection due process notice. Although  the tax debtor has up to 30 days to respond to this notice under the law,  IRS has chosen to wait 10 weeks before proceeding with collection actions,  such as levying. Until the due process notification and waiting period have  been completed, a tax debt may be submitted to TOP but is not subject to  immediate levy. For civilian contractors, IRS generally does not initiate the  collection due process notifications until FMS identifies that the contractor  is to receive a federal payment.
Once the debtor receives the notice of impending levy, IRS gives the debtor  up to 10 weeks to respond to the notice. As in the initial notice process, the  debtor can respond to IRS by disagreeing with IRS’s assessment (in this  case, filing for a due process hearing), negotiating with IRS to set up an  alternative payment arrangement, applying for a hardship determination, or  making payment in full. If a tax debtor does not respond to IRS and take  advantage of those options within the notification period, IRS will instruct  FMS to start levying future payments. The tax debt in the levy program is  then coded for immediate levy. For future payments, FMS will proceed with  the continuous levy by reducing each scheduled payment to the tax debtor  by 15 percent—or the exact amount of tax owed if it is less than 15 percent  of the payment—until the tax debt is satisfied.
Not having tax debt ready for levy results in the loss of millions of dollars  of tax revenue for the federal government. For example, for our 50 case  studies we identified payments totaling $1.6 million in which the TIN of the  contractor matched an IRS tax debt, but no levy was taken because IRS had  not yet completed the collection due process activities. This situation  contributes to these contractors facing little or no consequences for their  abuse of the federal tax system. IRS has an automated process in place by  which, once a match is made against a tax debt in the levy program, a due  process notice is automatically sent to the contractor. However, the  payments made between the time of the initial match and when IRS  completes its due process notification process—usually 10 weeks—cannot  be levied and the potential collections are lost to the federal government.  Additionally, if the tax debtor files for a due process hearing once it  receives the notice, the tax debt will continue to be excluded from levy  until the process—which could take months—is complete.
Prior to 1998, IRS was authorized to levy a payment immediately upon  matching a tax debt with a federal payment so long as the collection due  process notice had been sent. At that time, IRS did not have to wait before  proceeding with the levy. This allowed the levy program to capture the  payment before it was made to preserve the government’s right to the  payment while providing the contractor a postlevy due process. However,  the IRS Restructuring and Reform Act of 1998 requires that debtors be  afforded an opportunity for a collection due process hearing before a levy  action can take place. To comply with this provision, IRS has chosen to  wait a minimum of 10 weeks for the tax debtor to respond to the collection  due process notice. However, IRS’s 10-week waiting period causes the  federal government to miss levying some contractor payments.
IRS has acknowledged that the delay in initiating the due process notice  can result in lost collections and is investigating ways to begin the process  earlier. The joint task force established after our previous audit has  supported making the due process for the FPLP a postlevy process. This  would allow IRS to levy payments when first identified and provide  contractors with procedural due process remedies afterwards. To expedite  the notification, IRS officials stated that they had begun matching new  DOD contracts valued at over $25,000 against tax debt and sending out  collection due process notifications at that time rather than waiting until  payments are made. To address this same issue, the task force is also  exploring avenues to combine the collection due process notice with the  last of its initial notification letters sent to tax debtors. This would allow  IRS to have all tax debt legally ready for levy prior to it being sent to TOP to  be matched against federal payments. We fully support the task force’s and  IRS’s efforts to increase the amount of tax debt that is ready for immediate  levy.
section_title: Lack of FMS Oversight and Proactive Management Further Contribute to the Levy Collection Gap
paragraphs: FMS has contributed to the tax levy collection gap by not taking a proactive  stance in overseeing and managing the levy program. GAO’s Standards for  Internal Controls in the Federal Government considers a positive control  environment—which includes the establishment of mechanisms to monitor  or oversee program operations—to be the foundation for all other  standards. For FMS, such management control and oversight is critical in  its role as the federal government’s debt collector and chief money  disburser. However, because of a lack of oversight, FMS did not detect and  have agencies correct obviously inaccurate information for tens of billions  of dollars in payments to contractors, and therefore was not able to match  these payments against tax debts for potential levy. Further, because of a  lack of proactive management, FMS did not send tens of billions of dollars  more in payments to the levy program. We estimate that these deficiencies  resulted in at least $50 million in lost levy collections from civilian agency  contractors during fiscal year 2004. Table 1 provides a breakdown of the  deficiencies that result in payments not being subject to levy. Further  discussion of these deficiencies will be provided in detail later in  this report.
In addition to these deficiencies, FMS also faces design challenges in the  levy program that limit its effectiveness at collecting unpaid taxes. These  challenges include the difficulty in matching the name of the contractor  recorded in the payment files to the name recorded in IRS’s tax records and  the difficulty in levying vendors paid with government purchase cards. FMS  also has not implemented a provision of the American Jobs Creation Act of  2004, which allows the federal government to levy up to 100 percent of  payments to contractors with unpaid federal taxes.
subsections: section_title: FMS Did Not Include All Agency Payments in the Levy Program
paragraphs: FMS has not updated its TOP database to capture payments from about 150  agency paying stations, resulting in $40 billion of fiscal year 2004 civilian  agency contractor payments being excluded from potential levy. Although  effective internal control would generally include oversight of key agency  functions, FMS did not perform the management oversight necessary to  identify that a significant portion of all its disbursements were not included  in the levy program. Of the $40 billion not sent to TOP, we determined that  approximately $9 billion in payments were made to civilian contractors  with tax debts, none of which could be levied.
Federal agencies may have multiple offices or locations that perform  accounting for and preparation of payment information, referred to as  agency payment locations or paying stations. For a payment to be matched  against tax debts for the purpose of levy, the paying station from which the  payment originates needs to be programmed into the TOP database. If a  paying station is not in the TOP database, TOP considers that location to be  excluded from the levy program, and thus payments from that location will  not be matched against unpaid federal taxes for potential levy. The  approximately 150 paying stations not included in TOP are paying stations  for portions of a majority of federal departments, including the  Departments of Homeland Security, the Interior, Justice, State, the  Treasury, and Health and Human Services.
An FMS official stated that at the time FMS implemented TOP in the 1990s,  it had a centralized monitoring system to verify that payments from all  payment locations were included in TOP. According to the official, after the  initial group of paying units was incorporated into TOP, FMS did not take  steps to ensure that the TOP database was up to date and that payments  from new payment locations were incorporated into TOP. FMS was  unaware that a large percentage of its disbursements were being excluded  from potential levy. Since we brought the problem to their attention, FMS  officials stated that efforts are under way to update TOP for the paying stations we identified as being excluded from the levy program. The  officials also stated that they plan to reinstate the centralized monitoring to  ensure that paying stations are updated in TOP so that payments from  these stations would be available for potential levy.
section_title: FMS Disbursed Payments to Contractors without Proper TINs
paragraphs: During fiscal year 2004, FMS disbursed over $17 billion in payments to  civilian agency contractors without TINs or with obviously inaccurate  TINs. Valid TIN information is critical to the levy program because  payments lacking this information cannot be matched against tax debts.  The DCIA requires executive agencies to obtain TINs from contractors  and to include TINs on certified payment vouchers, which are submitted to  Treasury. Without a proper TIN, payments cannot be levied.
We found that payment records with blank or obviously inaccurate TINs in  the TIN fields are prevalent in the payment files submitted to FMS by some  agencies. For example, over half of payments at one agency and over three- quarters of payments at another agency were made to contractors that had  blank or obviously erroneous TINs, such as TINs made up of all zeros or all  9s. While certain vendors are exempt from the requirements to have a TIN,  the exemptions are rare and are generally limited to foreign companies  providing goods and services to federal agencies in a foreign country or  companies performing classified work. However, FMS does not gather  information to determine whether the payments to contractors without  TINs or with obviously inaccurate TINs are exempt from the TIN  requirement or that all nonexempt payments include TINs. FMS officials  stated that the responsibility for gathering and submitting TIN information  was solely that of the paying agency. In subsequent audit efforts, we will  evaluate selected agencies’ controls over obtaining and submitting TIN  information for all nonexempt payments.
FMS officials stated that FMS tabulates payment records with obviously  inaccurate TINs by agency to compile a monthly TIN Compliance Report.  This report is used to monitor agencies that send in payment requests with  obviously inaccurate TINs. According to FMS officials, in cases of  significant noncompliance, FMS encourages agencies to send payment files  with valid TINs. However, FMS does not enforce the TIN requirement by  rejecting agency payments without TINs or requiring the agencies to certify  that the payments not containing TINs meet one of the TIN exclusion  criteria. As a result, agencies continue to submit payment requests without  TINs, which cannot be levied to collect unpaid federal taxes.
We found that some civilian agency contractors without TINs or with  obviously inaccurate TINs in the agency payment files received payments  during fiscal year 2004 and had unpaid federal taxes. For example, FMS  paid about $700,000 to one contractor with an invalid TIN. Based on  investigative work, we were able to determine that this contractor had  failed to pay all its payroll taxes and owed more than $50,000 in unpaid  taxes. Had the payment file contained a TIN and if the tax debt were  subject to immediate levy, the government could have collected the full  amount of unpaid taxes from this contractor during fiscal year 2004.
section_title: FMS Made Disbursements to Contractors without Proper Names
paragraphs: FMS made disbursements of nearly $3.8 billion in fiscal year 2004 to  contractors whose payment files did not contain the name of the contractor  receiving the payment. We found that instead of the contractor’s name, the  disbursement file name field was either blank or contained only numeric  characters. The lack of a name on the payment file does not prevent the  payment from occurring because FMS made these disbursements  electronically via direct deposit into the contractors’ bank accounts.  However, valid name information is critical because the levy program  requires a match between both the name and TIN for a levy to occur. The  lack of a proper name could have been detected if FMS had conducted a  cursory review of the payment files submitted by the agencies.
For example, our review readily identified that most of the payment files  submitted by the State Department did not contain valid contractor names.  In addition, about $3.2 billion of the nearly $3.8 billion we identified as  payments made to contractors without names in the payment files were  made on behalf of the State Department. Until we brought the matter to  their attention, senior officials at both the State Department and FMS were  not aware that the State Department’s contractor payments did not contain  valid names. At our request, a State Department official investigated and  found that the department’s payment systems did contain valid names but  that a programming error resulted in the wrong field being sent to FMS as  the name field. The official told us that the error in the payment file is not  new because the structure of the payment file sent to FMS had remained  the same since the 1980s. Once we brought this to the attention of State  Department officials, they were quickly able to identify corrective actions,  and according to the State Department, they have since corrected the  deficiency.
Our analysis of FMS payment data found that FMS made disbursements  without contractor names, totaling approximately $400 million, to about  2,000 companies that had about $370 million in unpaid federal taxes. FMS’s  failure to detect and correct missing names had a direct impact on the levy  program. For example, one contractor with unpaid taxes received from the  State Department payments totaling over $400,000, which could not be  levied because of the missing name. The same contractor also received  payments from other civilian agencies. However, because the contractor’s  name was included in the payment files from the other agencies, the levy  program collected over $50,000 from those payments. If FMS or the State  Department had identified and corrected the name problem, an additional  $60,000 in unpaid federal taxes from this contractor could have been  collected through the levy program.
section_title: FMS Made Payments without Proper Payment Type Codes
paragraphs: FMS disbursed $5 billion in payments using checks based on agency- submitted payment files that did not contain data in the payment type field  during fiscal year 2004. FMS uses the payment type field in the agency- submitted payment files to determine if the payment is required to be  included in the levy program. If a payment file record has a blank payment  type field, it is not matched in the levy program to collect unpaid federal  taxes. As a result, none of the $5 billion in payments we identified as having  a blank payment type field could have been levied to collect the  contractors’ unpaid federal taxes. FMS lacked the oversight to detect that  the payment files submitted by agencies were not adequately coded. After  we brought this to management’s attention, an FMS official stated that FMS  planned to establish a new centralized program to monitor the  completeness of agency information.
section_title: FMS Has Not Taken Action to Include All Categories of Contractor Payments in the Levy Program
paragraphs: FMS has not been proactive in including many categories of payments in  the levy program, and has therefore kept tens of billions of dollars in  contractor payments from being subject to potential levy collection. FMS  uses several payment mechanisms to make its disbursements. FMS  payment mechanisms (payment categories) include what it refers to as  type A, type B, which includes Automated Clearing House-Corporate Trade  Exchange (ACH-CTX), and Fedwire. However, FMS has only taken action  to include a portion of type B payments in the levy program. FMS has not  taken action to include the other categories of payments due to what it  considers to be programming limitations. Therefore, none of those  payments can be levied to collect unpaid federal taxes.
Although it is responsible for the levy program, FMS also could not quantify  the magnitude of federal contractor payments that it was not sending to the  levy program, nor could FMS estimate the amount of levy collections it was  missing because it had not included all payment categories in the program.  FMS officials estimated that FMS paid about $11 billion in contractor  payments via ACH-CTX in fiscal year 2004, and our analysis identified at  least $15 billion in type A contractor payments. The combined amount of  those two categories—$26 billion, though likely understated—represents  almost 11 percent of all contractor disbursements recorded in FMS’s  PACER database. In addition, FMS disbursed approximately $191 billion  in Fedwire payments, but FMS could not identify the value of Fedwire  contractor payments that were not sent to the levy program.
subsections: section_title: Type A Payments
paragraphs: FMS officials stated FMS had not included type A payments in the levy  program because it is waiting for a new disbursement system to be  deployed. Type A payments are payments whereby the agency certifies the  payment in the same file that contains detailed payment information.  Although FMS had performed some preliminary studies in 2001 regarding  how to send type A payments to TOP, officials were unable to provide  information regarding the cost of making system corrections. At that time,  FMS was developing a new payment system that it estimated would be  completed as early as 2003 and therefore decided not to make the system  changes. However, at the time of our audit, the new system was still not  fully deployed. Consequently, over the last 4 years the federal government  has lost the collections that could have been levied from those payments.  FMS officials stated that FMS is continuing to focus on completing the  deployment of a new disbursement system, which it now estimates will be  fully operational in 2006, rather than including type A payments in its  current system. FMS tentatively plans to incorporate type A payments into  TOP in calendar year 2006 when its new system is scheduled to be  operational.
section_title: ACH-CTX Payments
paragraphs: FMS officials stated that FMS does not send ACH-CTX payments to TOP for  levy. According to FMS officials, ACH-CTX can be used to pay multiple  invoices to a single contractor. However, the structure of the ACH-CTX  payments requires that the total payment amount disbursed to the  contractor match exactly the total of the invoices that the payment is to  cover. If a levy were to take place, the total payment amount would differ  from the total amount of the invoices that support the payment.  Consequently, FMS officials stated that they cannot levy a portion of the  payment. Officials stated that although they could not separately identify  them in the PACER database, FMS made about $11 billion in ACH-CTX  payments to contractors during fiscal year 2004.
FMS officials stated they had not developed an implementation plan  or timeline to incorporate ACH-CTX contractor payments into the  levy program.
section_title: Fedwire Payments
paragraphs: As with type A payments, FMS officials stated that FMS is currently  focused on completing a new disbursement system prior to incorporating  Fedwire payments—payments requiring same-day settlement—into TOP.  FMS officials recognized that Fedwire payments, as a whole, are not  specifically exempt from levy, though individual Fedwire payments may be  exempt. FMS officials stated that the decision to exclude Fedwire  payments from the levy program was also based on the limited time  window FMS has to send Fedwire payments to the Federal Reserve and the  operational and system changes necessary to send those payments to  TOP. FMS’s TOP implementation plan, dated January 2005, called for  incorporating Fedwire payments into TOP in calendar year 2007, over  10 years after DCIA first required the establishment of a centralized offset  program. However, FMS officials recently informed us that they are going  to study the costs of submitting Fedwire payments to TOP and may not  attempt to include them in the levy program. As a result, FMS officials  stated that they no longer have a timeline to incorporate Fedwire payments  into TOP. We recognize that submitting Fedwire to the levy program could  result in a delay in disbursement, but until FMS fully explores and identifies  options for submitting Fedwire payments through TOP, potentially billions  of dollars may be disbursed to contractors with unpaid federal taxes  without the possibility of being levied.
section_title: FMS Does Not Offset Contractor Payments to Collect Tax Debts of Individuals
paragraphs: Because payment systems do not identify whether the payment is being  made to a business or individual, FMS does not offset contractor payments  to collect the unpaid federal taxes owed by individuals. Our analysis  determined that civilian agency contractors with unpaid federal taxes who  are individuals received payments totaling nearly $2 billion while owing  over $290 million in unpaid federal taxes.
Agency payment records do not distinguish payments made to individuals,  such as those who are self-employed or sole proprietors, from payments  made to businesses. IRS decided that due to the lack of distinction between  these two types of payments in FMS’s system and the possibility of  improperly levying payments, contractor payments should not be levied to  satisfy the unpaid federal taxes of individuals. According to IRS, an  improper levy could occur because a business’s TIN could be the same as  an individual’s Social Security number (the individual’s TIN). According to  FMS officials, IRS instructed FMS not to match any contractor payments  against unpaid federal taxes owed by individuals for potential levy  following discussions between FMS and IRS.
However, both FMS and IRS officials have indicated that the potential risk  of an improper levy is small. For a levy to occur, a match must exist  between the TIN and name in the payment files and the TIN and name  control in the tax debt file. FMS indicated it has performed a study and  found that only a small number of cases potentially have a business TIN  and name that would match with an individual’s TIN and name. After we  met with IRS and FMS officials regarding this issue, IRS directed FMS to  begin levying contractor payments against tax debts owed by individuals.  FMS officials stated that they will need to make system changes to  implement this action.
section_title: FMS Faces Challenges in Addressing Other Program Limitations
paragraphs: FMS faces management challenges in addressing certain limitations in the  levy program that result in reduced collections. Specifically, almost  $2 billion of contractor payments could not be levied due to difficulties in  matching both the name and TIN in the payment records to the tax debt in  the TOP database. Additionally, nearly $10 billion in federal payments made  via purchase cards to contractors are not subject to levy because the  government payment is made to the bank, not the contractor doing  business with the government. Finally, FMS faces challenges in  implementing a provision contained in the American Jobs Creation Act of  2004, which provides for increasing the amount of levy to a maximum of  100 percent of payments to contractors with unpaid tax debts.
subsections: section_title: Limitations in TIN/Name Match Reduces Levy Collections
paragraphs: Potentially thousands of payments are not levied every week because the  TINs and names from the payment records do not match against the names  and TINs in TOP for potential levy. Data from FMS’s PACER and TOP  databases indicate that about $1.7 billion of payments made to contractors  with unpaid federal taxes in TOP could not be levied because the control  name supplied by IRS did not match the payee name in PACER. As a result,  none of these payments could be levied to collect delinquent tax debt.
IRS provides TOP with both a TIN and a “control name” of both companies  and individuals with unpaid federal taxes. In general, the control name is  the first four characters of an individual’s last name or the first four  characters of the business name. TOP analyzes the name in the payment  files to determine if it contains the IRS control name. If it identifies the  control name (first four characters of the IRS name) anywhere within the  name field of the payment file, TOP levies the payment to collect the  unpaid taxes. If the control name is not found in the payment record’s name  field, TOP records the mismatch on a report that it sends to IRS to identify  the mismatches.
We reviewed an example of the report containing approximately  2,400 different payments that could not be levied to identify some of the  causes for the mismatches. We found that a number of payments were not  levied because the payments were made using an individual’s name and the  business’s TIN. The following hypothetical example based on an actual  case illustrates the difficulty in matching names under the levy program. In  one case, the payment was made to an individual doctor, J. Doctor, MD.  However, the TIN provided was to the doctor’s practice, Jenny Doctor, MD  PA. For IRS, the control name of the business TIN was “JENN.” As a result,  although the TIN of the payment matched the TIN of the tax debt, the  control name “JENN” did not appear within the payment name “J Doctor.”  Because the names did not match, the payments to this contractor were  not levied.
After we brought this to FMS’s and IRS’s attention, IRS began working with  FMS to increase the number of control names it sends to TOP. According to  IRS officials, IRS is taking action to begin sending up to 10 additional  business control names to FMS to be matched against payment data. IRS  officials believed that this should increase the number of matches available  under the levy program. IRS is also evaluating additional changes to  increase the number of name controls that it sends to FMS for matching  with payments to individuals.
section_title: Billions of Dollars in Purchase Card Payments Are Not Levied
paragraphs: Due to the structure of the credit card program, whereby payments are  made to the government purchase card bank and not directly to  contractors with unpaid tax debts, none of the $10 billion in purchase card  payments made during fiscal year 2004 were able to be offset or levied.  FMS officials have acknowledged the need to address those challenges and  stated that FMS has met with certain bank officials and another federal  agency regarding how to approach the issues. However, they have not yet  determined how to collect federal debts from contractors paid with the  government purchase card.
The Governmentwide Commercial Purchase Card Program was established  to streamline federal agency acquisition processes by providing a low-cost,  efficient vehicle for obtaining goods and services directly from contractors.  Governmentwide efforts to promote increased use of purchase cards for  small and routine purchases have dramatically increased purchase card  spending. As shown in figure 7, purchase card expenditures by civilian  agencies increased from nearly $3 billion in fiscal year 1997 to nearly  $10 billion in fiscal year 2004. The use of purchase cards has accrued  significant benefits to the federal government; however, contractors  receiving payments through purchase cards are not currently subject to the  levy program.
All purchase card payments are made to one of the five banks that issue  government purchase cards—Bank One, Bank of America, CitiBank,  Mellon Bank, or US Bank. In accordance with standard credit card payment  procedures, those banks are responsible for interfacing with Visa or  MasterCard and the contractor’s bank to pay for the goods or services  provided. This payment process shields the identity of the contractor that  is ultimately paid by the civilian agency receiving the goods or services  from the levy program. Consequently, the disbursement file contains only  the name of the purchase card issuing bank and its TIN and not the  contractor that was actually doing business with the government.
Without identifying the contractor doing business with the government, the  federal government is unable to collect federal debts from payments to  these contractors. To demonstrate the effect of payments to contractors  using the purchase card, we obtained the National Aeronautics and Space  Administration’s (NASA) fiscal year 2004 purchase card transactions and  compared the contractors from which NASA purchased goods and services  to the IRS unpaid taxes database. During fiscal year 2004, NASA used  purchase cards to pay about 12,000 contractors nearly $80 million.
According to IRS’s data on unpaid tax debts, over 750 of those contractors  had about $440 million in unpaid federal taxes. However, none of the  purchase card payments made to these contractors could be levied to  collect the unpaid federal taxes. In contrast, in analyzing the TOP database,  we found that non-purchase card payments made during fiscal year 2004 to  49 of these same contractors were levied.
FMS recognizes purchase card payments as a significant problem for the  government’s debt collection and lists the government purchase card  program among the payment streams that need to be incorporated into  TOP. FMS officials have stated they face both operational and legal issues  to incorporate such payments into TOP and that the process of paying the  purchase card issuing bank may prevent FMS from using TOP to collect  from contractors paid with purchase cards. Until the challenge is  thoroughly examined by FMS and IRS and solutions are identified, the  federal government will continue to be unable to levy or otherwise collect  from tens, if not hundreds, of billions of dollars in payments to civilian  contractors.
section_title: Statutory Authorization for Increased Levy Has Yet to Be Implemented
paragraphs: FMS has not fully implemented a new provision, authorized by Congress in  2004, that increased the maximum levy percentage on contractor  payments. In October 2004, Congress passed the American Jobs Creation  Act 2004 to increase the maximum continuous levy from 15 percent to up  to 100 percent of payments to contractors with unpaid taxes. The act  specifically increased the continuous levy on payments to vendors for  “goods and services” sold or leased to the government. According to IRS,  the legal language, which specified that goods and services be subject to  the 100 percent levy provision, excludes real estate, such as rent payments,  from the new levy requirement. This exclusion presents significant  implementation challenges for FMS because the civilian agencies’ payment  systems cannot separately identify real estate transactions from other  contractor payments. Without the ability to distinguish between these  payments, FMS could not implement the new law for civilian payments in  such a way as to exempt real estate transactions from the 100 percent levy.  FMS officials stated they had recently been able to implement the  100 percent levy provision for certain DOD payments, but were unable to  do so for their own disbursements. According to FMS and IRS officials, a  specific legislative change is being sought to make real estate payments  subject to the new 100 percent levy requirement.
We estimate that increasing the levy percentage from 15 to 100 could cause  a dramatic increase in collections. We performed a separate analysis of our  maximum levy potential estimate as if there were no legal or administrative  impediments—estimated at $350 million for a 15 percent levy—and found  that if a 100 percent levy rate had been applied in fiscal year 2004, FMS  could have collected as much as $800 million from civilian contractors if all  payments had been matched against all tax debt.
section_title: Civilian Agency Contractors Involved in Abusive and Potentially Criminal Activity Related to the Federal Tax System
paragraphs: We found abusive and potentially criminal activity related to the federal tax  system for all 50 cases that we audited and investigated. The case studies  were selected from the population of about 33,000 contractors that were  receiving federal payments during fiscal year 2004 and owed over  $3.3 billion in unpaid federal taxes as of September 30, 2004, using a non- probability selection approach. The basis for selecting each of the case  study contractors was that they all had unpaid taxes totaling more than  $100,000 and federal payments totaling more than $10,000. When our audit  and investigative work indicated that the 50 contractors we originally  selected were related to other entities—defined as entities sharing the  same owner or officer or common addresses—we performed additional  work to determine whether the related entities and the owners owed tax  debts as of September 30, 2004, and received other federal payments during  fiscal year 2004. While we were able to identify some related entities, in  some cases other related entities might exist that we were not able to  identify. In addition, we found that 3 of the 50 case studies involve owners  or officers who had been either convicted or indicted for non-tax-related  criminal activities, or were under IRS investigation. We are referring the  50 cases detailed in this report to IRS so that a determination can be made  as to whether additional collection action or criminal investigations are  warranted. For more information on our criteria for the selection of the  50 case studies, see appendix I.
subsections: section_title: Nature of Business for Case Study Contractors
paragraphs: The federal government is a large and complex organization, consisting of  15 cabinet-level agencies—one defense and 14 civilian agencies—and  numerous independent agencies, administrations, and other entities that  collectively spent more than $2.5 trillion in fiscal year 2004. Civilian  agencies operate throughout the country and in more than 250 foreign  countries, carrying out a multitude of missions and programs. Because  civilian agencies contract for a large variety of goods and services to carry  out functions as diverse as guarding the nation’s borders, providing medical  benefits to veterans, administering justice, and exploring space, it is not  surprising that civilian agency contractors with unpaid taxes operate in a  large number of industries. The industries are typically wage-based, while  the 50 case studies are mostly small, many of them closely held by the  owners and officers. Table 2 shows a breakdown for the 50 contractor case  studies by the type of goods and services provided.
section_title: Examples of Abusive or Potentially Criminal Activity Related to the Federal Tax System by Businesses
paragraphs: Our audits and investigations of the 50 case study business contractors  showed substantial abuse and potential criminal activity related to the tax  system. All 48 of the contractors in our case studies that file business tax  returns had tax periods in which the contractors withheld taxes from their  employees’ paychecks but did not remit them to IRS. Rather, these  companies diverted the money to fund business operations, for personal  gain, or for other purposes. As discussed earlier in this report, businesses  with employees are required by law to remit employment taxes to IRS or  face potential civil or potential criminal penalties. Specifically, the act of  willfully failing to collect or pay any tax is a felony while the failure to  comply with certain requirements for the separate accounting and deposit  of withheld income and employment taxes is a misdemeanor.
Six of the case study businesses involved owners or officers who were  “multiple abusers,” those involved with a group of related companies that  owed taxes. The owners or operators of some of these businesses not only  failed to have their businesses pay taxes, but several also failed to pay  their own individual income taxes, with three individuals having more  than $100,000 in unpaid individual income taxes. The related businesses  involving these multiple abusers repeatedly failed to pay taxes. For  example, several groups of related businesses owed taxes for more than  50 tax periods—one group of about 20 businesses owed taxes for over  300 tax periods. One case study business owner (whose businesses  received more than $1 million in federal payments in fiscal year 2004) has a  pattern of opening a business, failing to remit at least some payroll taxes,  closing the business, and then opening a new business to repeat the same  pattern. The owner repeated this pattern for at least three businesses over  nearly 20 years.
Table 3 highlights 10 case studies with unpaid payroll tax debts. Nine of the  10 cases have unpaid payroll taxes of 10 tax periods or more. The amount  of unpaid taxes associated with these 10 cases ranged from nearly  $400,000 to $18 million—6 businesses owed more that $1 million in unpaid  federal taxes. Our investigations revealed that some owners have  substantial personal assets—including commercial real estate, a sports  team, or multiple luxury vehicles—yet their businesses fail to remit the  payroll taxes withheld from employees’ salaries. Several owners owned  homes worth over $1 million—one owner had over $3 million and another  had over $30 million in real estate holdings. Others informed our agents  that they diverted payroll taxes they did not remit to IRS for personal gain  or to fund their business, while others were engaged in activities that  indicated potential diversion of payroll taxes for personal gain. For  example, one owner transferred the payroll taxes he withheld from  employees to a foreign bank account and was using the money to build a  home in that country, while another contractor doubled the salary of an  officer in a 5-year period to over $750,000 at the same time that the  business failed to remit payroll taxes and declared losses of more than  $2 million. Another purchased a number of multimillion-dollar properties  and an unrelated business at the same time that his many businesses owed  taxes, while yet another owner purchased, within a 2-year period, four  vehicles totaling nearly $200,000 after the owner’s business started  accumulating unpaid tax debts.
IRS has taken some collection actions against the contractors in our case  studies, but has not been successful at collecting the unpaid taxes. For  example, we found that in all 10 cases shown in table 3, IRS has assessed  trust fund penalties on the owners or officers for willful failure to remit to  the government amounts they withheld from their employees’ salaries.  However, as we have previously reported, IRS seldom collects on trust fund  penalties. As of September 30, 2004, the balance on the trust fund penalties  owed by the owners or officers of the 10 case studies was over $19 million.  IRS has also taken some collection actions against all 10 contractors, such  as placing liens on the assets of the companies or owners. Although some  of the owner/officers had substantial assets, including expensive homes  and luxury automobiles, the information we reviewed did not identify  that IRS has performed seizures of these assets. However, we identified  that 3 of the 10 owners or officers had been convicted or indicted for  non-tax-related offenses or were under active IRS investigation for  tax-related offenses.
The following provides illustrative detailed information on several of  these cases.
Case 1: This case includes many related companies that provide health  care services to the Department of Veterans Affairs, for which they  received over $300,000 in payments during fiscal year 2004. The related  companies have different names, operate in a number of different  locations, and use at least several other TINs. However, they share a  common owner and contact address. The businesses collectively owed  more than $18 million in tax debts—of which nearly $17 million is  unpaid federal payroll taxes dating back to the mid-1990s. IRS has  assessed a multimillion-dollar trust fund penalty for willful failure to  remit payroll taxes on each of two officers. During the early 2000s, at the  time when the owner’s business and related companies were still  incurring payroll tax debts, the owner purchased a number of  multimillion-dollar properties, an unrelated business, and a number of  luxury vehicles. Our investigation also determined that real estate  holdings registered to the owner totaled more than $30 million.
Case 2: This case comprises a number of related entities, all of which  provide waste collection and recycling services. These entities received  fiscal year 2004 payments from the Department of Justice totaling over  $700,000, about half of which is from purchase card payments, while  owing in aggregate over $2 million in tax debt. These taxes date to the  late 1990s and consist primarily of payroll taxes. Despite the fact that  the company reportedly used legally available means to repeatedly  block federal efforts to file liens against the company, liens totaling  more than $1 million exist against the company. IRS has also assessed  trust fund penalties against the two officers. At the same time that the  entities were incurring the tax debt, cash withdrawals totaling millions  of dollars were made against the business’s bank account. Further, since  the company started owing taxes, the owner had sold real estate valued  at over $1 million. The executives of these entities also drive late-model  luxury or antique automobiles. Recently, the company started to make  payments on its taxes.
Case 3: This case includes several nursing care facilities, three of which  owed taxes—primarily payroll—totaling nearly $9 million. In addition,  an owner’s individual income tax debt totaled more than $400,000. One  business provides nursing care services to the Department of Veterans  Affairs, for which it was paid over $200,000 during fiscal year 2004. An  officer of the company has been assessed a multimillion-dollar trust  fund penalty for willful failure to remit payroll taxes and was recently  arrested on fraud charges. Our investigative work indicates that an  owner of the company made multiple cash withdrawals, each valued at  tens of thousands of dollars, in the early 2000s while owing payroll  taxes, and that those cash withdrawals were used for gambling. We  further determined that cash transfers totaling over $7 million were  made in a 7-month period in the early 2000s.
Case 7: This contractor provided guard and armed security services to  the Department of Homeland Security and the Department of Veterans  Affairs, for which it was paid over $200,000 during fiscal year 2004. This  business has a history of noncompliance with federal tax laws.  Specifically, the business was consistently delinquent in paying its taxes  since the late 1990s and has not filed all its income and payroll tax  returns for a number of years in the late 1990s. The owner of this  business also has not filed individual income tax returns for a number  of years since the late 1990s. In the last 1-year period that the business  made payroll tax deposits, the business reported that it owed nearly  $80,000 in payroll taxes but made payments totaling less than $4,000— about one-twentieth of the taxes owed. At the same time that the owner  withheld but failed to remit payroll taxes, the owner diverted the money  into a foreign bank account to build a house overseas.
Case 8: During fiscal year 2004, this company provided consulting  services to the Smithsonian Institution, for which it received over  $200,000. Starting in the late 1990s, the company did not remit to the  government all the money it withheld from its employees’ salaries.  However, at about the time the company was failing to remit the taxes, it  nearly doubled one officer’s salary to over $750,000. IRS assessed a trust  fund penalty on the officers of this company for willfully failing to remit  payroll taxes withheld from their employees’ salaries. Those officers  own homes valued at millions of dollars in exclusive neighborhoods in a  large metropolitan area and several late-model luxury vehicles.
section_title: Contractors Also Had Unpaid State or Local Tax Debt
paragraphs: In addition to problems with paying federal taxes, contractors in at least  9 of the 10 case studies had unpaid state and or local tax debt. We  determined that the amount and severity of the unpaid state and or local  taxes were significant enough for state and local tax authorities to file liens  against those contractors. As we will be reporting in a related product,  neither the states nor FMS has pursued potentially beneficial agreements to  authorize the levying of federal payments, including contractor payments,  to satisfy delinquent state tax debts.
section_title: Levy Collection
paragraphs: The 50 case studies we selected illustrate FMS’s inability to collect the  maximum levy amount. Although we found that payments to a number of  contractors were not levied because IRS excluded their tax debts from TOP  for at least a part of fiscal year 2004 for statutory or policy reasons, many  others were not levied because of FMS’s lack of effective oversight or  proactive management of the levy program. One case study contractor in  particular illustrated the problems associated with the levy program that  we discussed earlier in this report. This contractor received $4 million  during fiscal year 2004, but only about $600,000 of those payments were  levied. Of the remaining $3.4 million that was not levied, about two-thirds  was not levied because the tax debt was either not referred to TOP or it  was referred to TOP but it was still in the notice process during the first 7  months of fiscal year 2004. The remaining one-third was not levied because  the name provided in the payment files did not match the IRS control name  in TOP or because payments were made using one of its specialized  mechanisms. We estimate that if all the tax debt and all of the payments of  the 50 case studies were subjected to a levy of 15 percent, FMS could have  collected about $3.8 million in unpaid federal taxes in fiscal year 2004. In  contrast, FMS actually collected $240,000 from these case study  contractors.
section_title: Conclusions
paragraphs: In the current environment of federal deficits and rising obligations, the  federal government cannot afford to leave hundreds of millions of dollars  in taxes uncollected each year. However, this is precisely what has been  occurring with respect to the FPLP, which our work shows has largely  failed to approach its potential. The levy program has thus far been  inhibited from achieving its potential primarily because substantial tax  debt is not subject to levy and because FMS, the nation’s debt collector, has  exercised ineffective oversight and management of the program.
Further, by failing to pay taxes on their income or diverting the payroll  taxes withheld from their employees’ salaries to fund business operations  or their own personal lifestyles, contractors with unpaid tax debts  effectively decrease their operating costs. The lower operating costs  provide these individuals and their companies with an unfair competitive  advantage over the vast majority of companies that pay their fair share of  taxes. Federal contractors should be held to a higher degree of  responsibility to pay their fair share of taxes owed because they are being  paid by the government, and the failure to effectively enforce the tax laws  against them encourages noncompliance among other contractors as well.  The federal government will continue to lose hundreds of millions of  dollars in tax collections annually until actions are taken to send all  payments to the levy program, ensure that all payments have the  information necessary to allow them to be levied, and establish a proactive  approach toward managing the levy program.
section_title: Recommendations for Executive Action
paragraphs: To comply with DCIA, further implement the Taxpayer Relief Act, and  support the federal government’s efforts to collect unpaid federal taxes, we  recommend that the Commissioner of the Financial Management Service  take the following 18 actions:  To obtain reasonable assurance that payments from all paying locations  are subjected to potential levy in TOP,  update the TOP database to include payments from all agency paying  locations in TOP for potential levy and  develop and implement a monitoring process to ensure TOP’s list of  agency paying locations is consistently updated.
To obtain reasonable assurance that payment files contain a TIN for  each payment requiring a TIN,  enforce requirements that federal agencies must include TINs on all  payment vouchers submitted to FMS for disbursement or expressly  indicate that the contractor meets one of the criteria that exempts  the contractor from providing a TIN and  develop and implement procedures to review payments submitted by  paying agencies to verify that each payment has either a TIN or a  certification that the contractor is exempt from providing a TIN.
To obtain reasonable assurance that all payment files submitted by  agencies contain a contractor’s name, develop procedures to  evaluate payment files to identify payments with blank or obviously   notify agencies of deficiencies in payment files regarding blank or  obviously inaccurate name fields;  collaborate with agencies submitting payment files with blank or  obviously inaccurate names in the name field, including the State  Department, to develop and implement procedures to capture the  contractors’ names in the payment files; and  reject agency requests for payments with blank or obviously  inaccurate names.
To obtain reasonable assurance that payment files contain a payment  type and thus, if appropriate, are subject to a levy,  instruct all agencies that they must indicate a payment type on all   implement monitoring procedures to verify that all payments indicate  payment type.
To obtain reasonable assurance that all categories of eligible payments  to contractors with unpaid federal taxes are subjected to the TOP levy  process,  develop and implement procedures to submit type A payments to  TOP for potential levy,  develop and implement procedures to submit ACH-CTX payments to  TOP for potential levy, and  develop and implement procedures to submit Fedwire payments to  TOP for potential levy.
To collect unpaid taxes of individuals, make changes to TOP to levy  contractor payments to collect the unpaid federal taxes owed by  individuals.
To ensure that more payments are matched against tax debt in TOP, take  actions necessary to incorporate IRS’s expanded list of control names  into TOP.
To address challenges of collecting unpaid taxes of contractors paid  using purchase cards, in conjunction with IRS, monitor payments to  assess the extent to which contractors paid with purchase cards owe   assess alternatives available to levy or otherwise collect unpaid taxes  from those contractors.
To address challenges associated with implementing the authorized  increase of the levy to 100 percent, work with IRS to determine steps  necessary to implement the increased levy percentage.
Finally, we recommend that the Commissioner of Internal Revenue  evaluate the 50 referred cases detailed in this report and consider whether  additional collection action or criminal investigations are warranted.
section_title: Agency Comments and Our Evaluation
paragraphs: We received written comments on a draft of this report from the  Commissioner of Internal Revenue (see app. III) and the Commissioner  of the Financial Management Service (see app. IV).
subsections: section_title: Response from IRS and Our Evaluation
paragraphs: In responding to a draft of our report, IRS agreed that continued efforts are  needed to improve and enhance the use of the levy program as a tool to  deal with contractors that abuse the tax system. IRS noted that it had taken  or was taking a number of actions toward this goal. For example, IRS  stated that it had begun, with DOD’s assistance, to issue collection due  process notices to DOD contractors at the time of contract award rather  than after a contract payment is made, thereby allowing IRS to levy more  DOD contractor payments without delay. IRS stated that it planned to  expand this process to contractors at other agencies later in 2005. IRS also  stated that it is working to change its notice process so that more debts can  be ready for levy at the time of inclusion in TOP. IRS reiterated the progress  it has made to remove systematic exclusions, resulting in an additional  $28 billion in tax debts being included in the FPLP, which we noted in our  report. These actions have resulted in the federal government collecting, in  the first 7 months of fiscal year 2005, $12.2 million in unpaid tax debts from  civilian contractors—a nearly threefold increase from the same period in  fiscal year 2004. IRS further stated that it would continuously evaluate its  policies so that it does not unnecessarily exclude tax debts from the  levy program.
IRS concurred with our finding that the matching of the TIN and name of  contractor payments against records of unpaid federal taxes could be  improved, and stated that it will begin sending a greater number of control  names—up to 10 variations of the contractor’s name as recorded in IRS’s  files—to FMS to match against FMS’s payment data. IRS also stated that it  was working to develop a consent-based TIN verification system for  contractors doing business with the federal government and that it  anticipated implementation of this system later this year. We believe that  the completion of these actions can significantly improve collections of  outstanding federal tax debt through the levy program.
With respect to the report’s recommendations, IRS agreed to work with  FMS and other agencies through the Federal Contractor Tax Compliance  Task Force (FCTC) to conduct further analysis of the significant challenge  presented by contractors paid with purchase cards. IRS also stated that as  of April 2005, the 100 percent levy provision had been implemented with  respect to DOD contractors paid through DOD’s largest payment system,  and that IRS was working with Treasury on a technical correction to allow  the 100 percent levy on all federal contractors. Finally, IRS agreed with our  recommendation to review the 50 contractors discussed in our report to  determine what additional actions are warranted.
section_title: Response from FMS and Our Evaluation
paragraphs: In its response to a draft of our report, FMS generally agreed with many of  our findings and recommendations. However, FMS stated that we  mischaracterized its role in the levy process, and that primary  responsibility rests with IRS. FMS also did not concur with our conclusions  that its oversight and management of the program were ineffective.  Additionally, FMS disagreed that it had not fully implemented the  legislatively authorized increase in the maximum amount of contractor  payments subject to levy. FMS also stated that it disagreed with our  recommendation that it withhold payments that do not include a valid  name and stated that it was not in a position to implement our  recommendations with respect to working with IRS regarding issues  associated with collecting outstanding federal tax debt from purchase card  payments. Finally, FMS stated that the numbers and potential levy  collection amounts presented in the report were confusing and could be  misleading.
We do not believe we mischaracterized FMS’s role in the levy process. On  its Web site, FMS states that it “serves as the government’s central debt  collection agency, managing the government’s delinquent debt portfolio.” In  our opinion, the agency that is responsible for managing the government’s  delinquent debt portfolio needs to do so in a proactive manner, which we  did not always find to be the case. While we agree that IRS has a key role in  the levy process, many of the issues in our report touch at the heart of  FMS’s debt collection responsibilities and most of the weaknesses and  challenges discussed in this report can only be addressed by FMS. For  example, it was FMS that did not send billions of dollars of payments to the  levy program because it had no monitoring mechanism in place to  determine that over 100 agency paying locations created since the late  1990s were not included in the levy program. Further, it was FMS that did  not identify and inform agencies to correct payment information for tens  of billion of dollars in payments that did not have the basic information  necessary for the payments to be matched against outstanding federal tax  debt for potential levy. These findings form the basis of our conclusion that  FMS has not exercised effective oversight and management of the levy  program.
Despite the issues raised in our report, which FMS did not dispute, it  disagreed that its management of the program was ineffective. FMS  pointed to increased collections from the levy program in fiscal years 2003,  2004, and 2005, to date, as evidence of excellent leadership and program  management. However, the recent increase in collections in the levy  program is primarily the result of actions stemming from the formation of  the FCTC, which was created in response to issues we raised in our  February 2004 report on DOD contractors that abused the tax system.  Further, the actions that have led to the increased collections were taken  by DOD and IRS. Finally, while collections have increased in the last  3 years, the annual totals to date have not been significant given the  potential of the program and, in the context of the program’s 8-year life, the  annual increases have come about only very recently.
In its response, FMS stated that it is not normally in a position to mandate  changes to agencies. We disagree. FMS is in a unique position to identify  and help correct many of the issues we identified in the program, some of  which are relatively simple and could be quickly addressed. For example, it  took the Department of State (State) about a month to correct the problem  we identified with respect to missing names in the payment file it had been  submitting to FMS for payment once we brought the matter to the  department’s attention. A programming error appears to have resulted in  the names not being in the disbursement files sent to FMS. According to a  State official, the department has likely had names of its payment files  since the 1980s, and it did not know that the names were not getting to  FMS. Because of State’s responsiveness to our finding, FMS is now levying  payments from State’s contractors with unpaid taxes. Had FMS provided  effective oversight and management of the debt collection program, it  could have detected the problem years ago and worked with the State  Department to correct it long before our audit. While we agree that  agencies should be responsible for the completeness and accuracy of the  payment files they send to FMS, we believe FMS should take a more  proactive role in identifying issues that impede the program’s ability to  maximize collections and work with agencies to resolve such issues.
In responding to our report, FMS disagreed with our conclusion that it had  not implemented the provision of the American Jobs Creation Act of 2004  authorizing an increase in the maximum amount of contractor payments  subject to levy of up to 100 percent. FMS noted that it had made the  changes necessary in the levy program to allow for levying at 100 percent,  but that it was unable to implement the provision because civilian agencies’  payment records do not separately identify real estate transactions—which  are not subject to the 100 percent levy—from other contractor payments.  Our report clearly indicates that the 100 percent levy provision had not yet  been fully implemented because of a number of challenges, including the  determination by IRS that real estate transactions are not subject to the  100 percent levy provision, and that agency pay systems are presently  unable to identify real estate transactions from other contractor payments.  We also acknowledged in our report that a legislative change is being  sought to subject real estate payments to the 100 percent levy provision.  Our report describes this issue not as a weakness in the program but,  rather, as another challenge that FMS faces in maximizing collections  under the levy program. Our report also acknowledges that certain DOD  payments are already being levied at the 100 percent maximum.
FMS also did not concur with our recommendation to withhold payments  that do not include a valid name in the payment record. However, FMS said  it would improve monitoring and ensure agencies’ compliance with the  requirement to include names, TINs, and payment types on certified  vouchers. This is in line with our recommendation, and we commend FMS  for its willingness to increase efforts to enforce the requirements. As the  State Department’s prompt response to our findings indicates, when  weaknesses are identified, such as records without payee names, agencies  can take corrective actions, thereby making it unnecessary to withhold  payments. However, FMS has had many years to require agencies to  improve the data in their payment records but has, until now, not done so.  As we point out in the report, in 1997 FMS proposed a rule that would  require disbursing officials to reject agency payment requests that do not  contain TINs (that is, withhold the payment), yet later rescinded the  proposed rule and instead required agencies to submit to FMS  implementation plans to achieve compliance with the TIN requirement.  Although FMS requested the implementation plans in 1997, it has not been  successful in gaining agency compliance. We believe that if FMS had been  more proactive, the intervening years since 1997 would have provided FMS  and the agencies ample opportunities to take corrective action. As such, we  continue to believe FMS needs to take stronger leadership in enforcing the  requirements with respect to the completeness and accuracy of  information in agency-submitted payment files.
In its response, FMS accurately summarizes some of the challenges that we  described in the draft report regarding levying government purchase card  payments. These challenges are precisely why we recommended that FMS  work with IRS and arrive at a solution to subjecting to potential levy or  other form of collection the roughly $10 billion in annual purchase card  payments made to civilian agency contractors. However, FMS suggested  that we instead redirect the recommendation to have GSA work with IRS.  In addition, FMS pointed out that the FCTC could also provide valuable  assistance in determining the most efficient and effective means of  addressing contractors that have unpaid taxes and are being paid via  government purchase cards. While we agree that GSA could assist FMS  and IRS with this challenge, at the same time, we believe that as the  government’s central debt collector, FMS should assume a leadership role  in emerging issues such as the rise in purchase card payments, as it has  significant implications with respect to its debt collection responsibilities.  In our opinion, FMS is the only federal entity with the ability to identify  which contractors that are receiving federal payments have leviable tax  debt. This is a role FMS plays when it compares the TIN and the name on  FMS payments to the list of contractors with unpaid taxes to determine  whether the payment should be levied. If FMS worked with the five banks  that currently issue government purchase cards to routinely obtain  electronic files listing the contractors being paid with purchase cards,  FMS could determine which government contractors that are paid with a  government purchase card have unpaid taxes. Consequently, we continue  to believe that FMS, in conjunction with IRS, would be in the best position  to monitor purchase card payments and assess the extent to which  contractors paid with purchase cards have unpaid federal taxes, and then  to identify solutions to the challenges presented by purchase card  payments.
Finally, in its response, FMS stated that the numbers and potential levy  collection amounts presented in the report are confusing and potentially  misleading. Specifically, FMS stated that our reporting of the levy  collection gap of $350 million was misleading as it suggested that FMS  would be able to collect that amount through the levy program. In our  report, we have taken care to clearly note that the levy collection gap is an  indicator of the amount of tax debt civilian contractors owe that could be  levied from the payments they get from the federal government if all  payments for which we have information could be levied against all  outstanding federal tax debt. We further note throughout the report that  because some tax debts are excluded due to specific statutory  requirements, IRS and FMS are presently restricted by law from collecting  a significant portion of this estimated amount. We do, however, clearly  identify that a portion of the levy collection gap—at least $50 million—that  is directly attributable to weaknesses in internal controls and lack of  proactive management at FMS. This amount is understated due to the  unavailability of Fedwire information at FMS and because we were unable  to estimate collections against many payments that did not contain valid  TINs and payment types. FMS’s response does not recognize that although  IRS has a key responsibility to refer tax debts, FMS has an equally key  responsibility—to make all payments available for levy.
As agreed with your offices, unless you announce the contents of this  report earlier, we will not distribute it until 30 days after its date. At that  time, we will send copies to the Secretary of the Treasury, the  Commissioner of the Financial Management Service, the Commissioner of  Internal Revenue, and interested congressional committees and members.  We will also make copies available to others upon request. In addition, this  report will be available at no charge on the GAO Web site at  http://www.gao.gov.
Please contact Gregory D. Kutz at (202) 512-9095 or kutzg@gao.gov or  Steven J. Sebastian at (202) 512-3406 or sebastians@gao.gov if you or your  staff have any questions concerning this report. Contact points for our  Offices of Congressional Relations and Public Affairs may be found on the  last page of this report. GAO staff who made major contributions to this  report are listed in appendix V.
section_title: Scope and Methodology
paragraphs: To identify the magnitude of unpaid taxes owed by contractors receiving  payments from federal agencies disbursed by the Financial Management  Service (FMS), we obtained information from both the Internal Revenue  Service (IRS) and FMS. To identify taxes owed, we obtained IRS’s unpaid  assessment database as of September 30, 2004. To identify disbursements  FMS made to contractors, we obtained from FMS extracts of the Payments,  Claims, and Enhanced Reconciliation (PACER) database containing data  on payments FMS made to contractors via Automated Clearing House  (ACH) and by check during fiscal year 2004. PACER contains information  such as payee and payment amount for disbursements FMS makes on  behalf of federal agencies. To determine the amount of levies that have  been collected and the amount of tax debt that has been referred to the  Treasury Offset Program (TOP), we obtained from FMS the TOP database  as of September 30, 2004. As discussed later in this appendix, we first  performed work to assess the reliability of the data provided.
To determine the value of unpaid taxes owed by contractors, we matched  PACER disbursements coded as “vendor” to the IRS unpaid assessment  database using the tax identification number (TIN) field in both databases.  This match resulted in the identification of about 63,000 contractors with  more than $5.4 billion in unpaid federal taxes. To avoid overestimating the  amount owed by contractors with unpaid tax debts and to capture only  significant tax debts, we excluded from our analysis tax debts and  payments meeting specific criteria to establish a minimum threshold in the  amount of tax debt and in the amount of payments to be considered when  determining whether a tax debt is significant. The criteria we used to  exclude tax debts and payments are as follows:  tax debts that IRS classified as compliance assessments or memo  accounts for financial reporting,  tax debts from calendar year 2004 tax periods,  contractors with total unpaid taxes of $100 or less, and  contractors with cumulative fiscal year 2004 payments of $100 or less.
The criteria above were used to exclude tax debts that might be under  dispute or generally duplicative or invalid, tax debts that are recently  incurred, and tax debts and payments that are insignificant for the Federal  Payment Levy Program (FPLP). Specifically, compliance assessments or  memo accounts were excluded because these taxes have neither been  agreed to by the taxpayers nor affirmed by the court, or these taxes could  be invalid or duplicative of other taxes already reported. We excluded  calendar year 2004 tax debts to eliminate tax debt that may involve matters  that are routinely resolved between the taxpayer and IRS, with the taxes  paid or abated within a short period. We further excluded tax debts and  cumulative fiscal year 2004 payments of $100 or less because they are  insignificant for the purpose of calculating potential levy collection. Using  the above criteria, we identified about 33,000 contractors with over  $3.3 billion in unpaid taxes as of September 30, 2004.
To determine the potential fiscal year 2004 levy collections, we used  15 percent of the payment or total tax debt amount, whichever is less. Our  analysis was performed as if (1) all unpaid federal taxes were referred to  FMS for inclusion in the TOP database and (2) all fiscal year 2004  disbursements for which FMS maintained detailed information were  included in TOP for potential levy. Because some tax debts are excluded  from the FPLP due to statutory exclusions, a gap will continue to exist  between what could be collected and the maximum levy amount  calculated. However, as discussed in the body of the report, the potential  levy collection amount of $350 million may be understated because we  excluded, by design, specific tax debts and payment amounts from the  calculation of levy, and missing data in FMS’s disbursement information  prevented us from providing the full magnitude of tax debts and potential  levy collection. The American Jobs Creation Act of 2004 provided for a  100 percent levy on vendor payments for goods or services sold or leased  to the federal government, effective October 2004. If unpaid tax debts and  payments to contractors in future years remain consistent with fiscal year  2004 patterns, we determined a potential future levy amount based on a  levy ratio of 100 percent of payments or total tax debt amount, whichever is  less.
To determine the effect of IRS and FMS policies and procedures on the  amounts actually collected through the FPLP, we conducted work at both  agencies related to their respective roles in the implementation of the  FPLP. At IRS, we interviewed agency officials and obtained documentation  that detailed the statutory requirements and policy and administrative  decisions that exclude certain tax debts from the FPLP. We did not evaluate  the accuracy and reasonableness of these exclusions, which will be  examined in detail in a later report. At FMS, we reviewed documentation  and interviewed agency officials to obtain an understanding of FMS’s FPLP  policies, implementing guidance, operating procedures, and internal  controls related to the TOP and disbursement operations. We also visited  the San Francisco Regional Finance Center where we observed work flow  processes. We obtained a copy of the TOP database as of September 30,  2004. The TOP database contains all debt, including tax debt, referred to it  by federal agencies, including IRS. FMS uses the TOP database for levying  contractor payments. As discussed later, we performed work to assess the  reliability of data in TOP.
To identify payments to contractors disbursed through the government  purchase card, we obtained from the Bank of America the database of  purchase card payments made by the National Aeronautics and Space  Administration (NASA). We reconciled control totals for this data with  Bank of America and the General Services Administration. We restricted  purchase card data to one agency to demonstrate the magnitude and effect  of issues surrounding levying purchase card payments.
To identify indications of abuse or potential criminal activity, we selected  50 civilian contractors for a detailed audit and investigation. The 50  contractors were chosen using a nonprobability selection approach based  on our judgment, data mining, and a number of other criteria. Specifically,  we narrowed the 33,000 contractors with unpaid taxes based on the  amount of unpaid taxes, number of unpaid tax periods, amount of FMS  payments, indications that owner(s) might be involved in multiple  companies with tax debts, and representation of these contractors across  government. We specifically included contractors from NASA and the Departments of Homeland Security (Transportation Security  Administration), Justice, State, and Veterans Affairs. These agencies were  selected based on a number of criteria: national security concerns; amount  of payments to contractors, especially those with tax debts; amount of  payments made without TINs, names, or both; amount of levy collected;  and amount of payments made with blank pay types. The reliability of TINs  and contractor names, and whether the agencies’ payment systems are  sufficiently integrated to maximize levy collection, will also be covered in  later work.
We obtained copies of automated tax transcripts and other tax records  (e.g., revenue officer’s notes) from IRS as of December 2004 and reviewed  these records to exclude contractors that had recently paid off their unpaid  tax balances and considered other factors before reducing the number of  businesses to 50 case studies. We performed additional searches of  criminal, financial, and public records. In cases where record searches and  IRS tax transcripts indicate that the owners or officers of a business are  involved in other related entities that have unpaid federal taxes, we  performed detailed audit and investigation on the related entities and the  owner(s) or officer(s), and not just the original business we identified. In  instances where related entities exist, we defined a case study to include all  the related entities, and reported on the combined unpaid taxes and  combined fiscal year 2004 payments for the original business and all the  related entities. We identified civilian agency contract awards using the  Federal Procurement Data System. Our investigators contacted some  contractors and performed interviews.
In addition, while assessing the reliability of the data provided by FMS, we  identified nearly $17 billion in payments that contain either no TIN or an  obviously inaccurate TIN. To determine whether contractors with no TINs  or obviously inaccurate TINs had tax debts, we used investigative  techniques to identify some of those contractors’ TINs and, through  comparison with the IRS records of unpaid taxes, we determined whether  those contractors owed tax debts.
On May 9, 2005, we requested comments on a draft of comments on a draft  of this report from the Commissioner for Internal Revenue or his designee  and from the Commissioner of the Financial Management Service or his  designee. We received written comments from Commissioner of Internal  Revenue dated May 27, 2005, and from the Commissioner of the Financial  Management Service dated May 25, 2005, and reprinted those comments in  appendixes III and IV of this report. We conducted our audit work from  May 2004 through May 2005 in accordance with generally accepted  government auditing standards, and we performed our investigative work  in accordance with standards prescribed by the President’s Council on  Integrity and Efficiency.
subsections: section_title: Data Reliability Assessment
paragraphs: For the IRS database we used, we relied on the work we perform during  our annual audits of IRS’s financial statements. While our financial  statement audits have identified some data reliability problems associated  with the coding of some of the fields in IRS’s tax records, including errors  and delays in recording taxpayer information and payments, we  determined that the data were sufficiently reliable to address the report’s  objectives. Our financial audit procedures, including the reconciliation of  the value of unpaid taxes recorded in IRS’s masterfile to IRS’s general  ledger, identified no material differences.
For PACER and TOP, we interviewed FMS officials responsible for the  databases and reviewed documentation provided by FMS supporting  quality reviews performed by FMS on its databases. In addition, we  performed electronic testing of specific data elements in the databases that  we used to perform our work. Based on our review of FMS’s documents  and our own testing, we concluded that the data elements used for this  report are sufficiently reliable for the purpose of this report. In instances  where we found problems with the data, such as data with missing TINs  and names, we include those in this report. We also compared the PACER  data to the President’s budget and the TOP data to the IRS unpaid  assessment file.
section_title: Contractors with Unpaid Federal Taxes
paragraphs: Table 3 provides data on 10 detailed case studies. Table 4 provides details  of the remaining 40 businesses we selected as case studies. As with the  10 cases discussed in the body of this report, we also found substantial  abuse or potentially criminal activity related to the federal tax system  during our review of these 40 case studies. The case studies primarily  involve businesses with unpaid payroll taxes, some for as many as 35 tax  periods. IRS has imposed trust fund penalties for willful failure to remit  payroll taxes on the officers of 17 of the 40 case studies. In addition to  owing federal taxes, 28 of these 40 case study contractors owed sufficient  state tax debts to warrant state tax authorities to file liens against them. As  we have done in the body of the report, in instances where the business we  selected also had related entities, we considered the business and all  related entities as one case study and reported the civilian agency  payments and unpaid federal tax amount for all related entities in the table.
section_title: Comments from the Internal Revenue Service
section_title: Comments from the Financial Management Service
section_title: Staff Acknowledgments
subsections: section_title: Acknowledgments
paragraphs: The following individuals made major contributions to this report: Beverly  Burke, Ray Bush, Richard Cambosos, William Cordrey, Francine  Delvecchio, F. Abe Dymond, Paul Foderaro, Alison Heafitz, Kenneth Hill,  Aaron Holling, Jason Kelly, John Kelly, Rich Larsen, Tram Le, Mai Nguyen,  Kristen Plungas, Rick Riskie, John Ryan, David Shoemaker, Sid Schwartz,  Esther Tepper, Tuyet-Quan Thai, Wayne Turowski, Matt Valenta, Scott  Wrightson, and Mark Yoder.
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