Financial Management: Some DOD Contractors Abuse the Federal Tax System with Little Consequence
Published: 2004-02-12T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: GAO was asked to determine (1) the magnitude of unpaid federal taxes owed by Department of Defense (DOD) contractors, (2) whether indications exist of abuse or criminal activity by DOD contractors related to the federal tax system, (3) whether DOD and the Internal Revenue Service (IRS) have effective processes and controls in place to use the Treasury Offset Program (TOP) in collecting unpaid federal taxes from DOD contractors, and (4) whether DOD contractors with unpaid federal taxes are prohibited by law from receiving contracts from the federal government.
section_title: What GAO Found
paragraphs: DOD and IRS records showed that over 27,000 contractors owed about $3 billion in unpaid taxes as of September 30, 2002. DOD has not fully implemented provisions of the Debt Collection Improvement Act of 1996 that would assist IRS in levying up to 15 percent of each contract payment to offset a DOD contractor's federal tax debt. We estimate that DOD could have collected at least $100 million in fiscal year 2002 had it and IRS fully utilized the levy process authorized by the Taxpayer Relief Act of 1997. As of September 2003, DOD had collected only about $687,000 in part because DOD provides contractor payment information from only 1 of its 16 payment systems to TOP. DOD had no formal plans at the completion of our work to provide payment information from its other 15 payment systems to TOP. Furthermore, we found abusive or potentially criminal activity related to the federal tax system through our audit and investigation of 47 DOD contractors. The 47 contractors provided a variety of goods and services, including parts or support for weapons and other sensitive military programs. The businesses in these case studies owed primarily payroll taxes with some dating back to the early 1990s. These payroll taxes included amounts withheld from employee wages for Social Security, Medicare, and individual income taxes. However, rather than fulfill their role as "trustees" and forward these amounts to IRS, these DOD contractors diverted the money for personal gain or to fund the business. For example, owners of two businesses each borrowed nearly $1 million from their companies and, at about the same time, did not remit millions of dollars in payroll taxes. One owner bought a boat, several cars, and a home outside the United States. The other paid over $1 million for a furnished home. Both contractors received DOD payments during fiscal year 2002, but one went out of business in 2003. The business, however, transferred its employees to a relative's company (also with unpaid taxes) and recently received DOD payments on a previous contract. IRS's continuing challenges in collecting unpaid federal taxes also contributed to the problem. In several case studies, IRS was not pursuing DOD contractors due to resource and workload management constraints. For other cases, control breakdowns resulted in IRS freezing collection activity for reasons that were no longer applicable. Federal law does not prohibit contractors with unpaid federal taxes from receiving federal contracts. OMB is responsible for providing overall direction to governmentwide procurement policies, regulations, and procedures, and is in the best position to develop policy options for prohibiting federal government contract awards to businesses and individuals that abuse the tax system.

section_title: Letter
paragraphs: In fiscal year 2002, the Department of Defense (DOD) awarded contracts  totaling nearly $165 billion.  This is nearly two-thirds of the federal  government’s contracting activity.  Since 1990, we have periodically  reported on federal programs and operations that are high risk due to their  greater vulnerabilities to fraud, waste, and abuse.  Lasting solutions to high- risk problems offer the potential to save billions of dollars, dramatically  improve service to the American public, strengthen public confidence and  trust in the performance and accountability of our national government,  and ensure the ability of the government to deliver on its promises.
DOD and the Internal Revenue Service (IRS) face a variety of high-risk  challenges.  Of the 26 areas on our governmentwide “high risk” list, 6 are  DOD program areas, and the department shares responsibility for 3 other  high-risk areas that are governmentwide in scope.  Financial management,  1 of the 6 DOD high-risk program areas, has weaknesses, including the lack  of effective and efficient asset management and accountability, unreliable  estimates of environmental and disposal liabilities, lack of accurate budget  and cost information, nonintegrated and proliferating financial  management systems, and fundamental flaws in the overall control  environment.  As we have documented in numerous reports, DOD’s  financial management problems leave it highly vulnerable to fraud, waste,  and abuse.  IRS high-risk areas include financial management weaknesses  and difficulties in collecting unpaid taxes.  Both areas continue to expose  the federal government to significant losses of tax revenue and  disproportionately increase the burden on compliant taxpayers to fund  government activities.  This report addresses issues related to three high- risk areas: DOD and IRS financial management and IRS collection of  unpaid taxes.
For the last several years, Congress and others have expressed concern  that declines in IRS compliance and collections programs are eroding  taxpayer confidence in the fairness of our federal tax system.  As of  September 30, 2002, IRS had confirmed unpaid taxes, including interest and  penalties, totaling $249 billion nationwide, of which nearly $49 billion  represented unpaid payroll taxes.
As you requested, this report addresses (1) the magnitude of unpaid federal  taxes owed by DOD contractors, (2) whether DOD and IRS have effective  processes and controls in place to use the Treasury Offset Program (TOP)  and Federal Payment Levy Program (FPLP) in collecting unpaid federal  taxes from DOD contractors, (3) whether indications exist of abuse or  criminal activity by DOD contractors related to the federal tax system, and  (4) whether DOD contractors with unpaid federal taxes are prohibited by  law from receiving federal contracts.
Our work was performed from March 2003 through September 2003 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.  Details on our scope and methodology are included in  appendix I.  The results of 17 of the 47 case studies we audited and  investigated are shown in tables 2 and 3.  The results of the other 30 case  studies are included in appendix II.
subsections: section_title: Background
paragraphs: As the largest purchaser of goods and services in the federal government,  DOD awarded contracts valued at nearly $165 billion in fiscal year 2002.   Within the federal government, DOD represented about two-thirds of the  federal contract spending reported in fiscal year 2002, as shown in figure 1.   Spending at the next three largest federal agencies, the Department of  Energy (DOE), the General Services Administration (GSA), and the  National Aeronautics and Space Administration (NASA), represented only  about half of the remaining 34 percent of federal contract awards during  the same period.
In 1998, DOD established the CCR database as the primary repository for  contractor information shared with other agencies.  With minor exceptions,  contractors are required to register in the CCR database prior to award of a  DOD contract.  In addition to a one-time registration process, contractors  are required to keep all registered information current, and must confirm  the registered information is accurate and complete annually.  The CCR  database contains a wide variety of contractor information including  contractor name, address, points of contact, electronic payment  information, and tax identification number (TIN).  As of June 2003, the CCR  database contained almost 224,000 active contractor registrations.  DOD;  NASA; the Departments of the Treasury, Transportation, and the Interior; as  well as the Office of Personnel Management currently use CCR to register  contractors.  According to CCR officials, while some contractors engage in  business with more than one agency (e.g., DOD and NASA), prospective  and current DOD contractors represented the majority of CCR  registrations.  On October 1, 2003, a final rule change to the Federal  Acquisition Regulation (FAR) was announced that generally requires all  federal contractors to register in the CCR database.
Unlike most federal agencies that rely on the Department of the Treasury’s  Financial Management Service (FMS) for issuing payments, DOD has its  own disbursing authority.  The Defense Finance and Accounting Service  (DFAS) has overall payment responsibility for goods and services  purchased by DOD.  As part of a reorganization in April 2001, DFAS  separated its commercial payment services into two areas—contract pay  and vendor pay.  Contract pay handles invoices for formal, long-term  contracts that are typically administered by the Defense Contract  Management Agency (DCMA).  These contracts tend to cover complex,  multiyear purchases with high-dollar values, such as major weapon  systems.  The single DOD automated system used in contract pay  disbursed over $86 billion to contractors in fiscal year 2002.  While  somewhat of a misnomer, vendor pay is handled by 15 DOD payment and  disbursing systems operating in 22 DFAS offices, and cumulatively  disbursed another $97 billion to contractors during fiscal year 2002.
Overhauling DOD’s financial management represents a major challenge  that goes far beyond financial accounting to the very fiber of the  department’s range of business operations and management culture.  Of the  26 areas on our governmentwide “high-risk” list, 6 are DOD program areas,  and the department shares responsibility for 3 other high-risk areas that are  governmentwide in scope.  Financial management, one of the 6 DOD  program areas, has weaknesses, including the lack of effective and efficient  asset management and accountability, unreliable estimates of  environmental and disposal liabilities, lack of accurate budget and cost  information, nonintegrated and proliferating financial management  systems, and fundamental flaws in the overall control environment.  As we  have documented in numerous reports, DOD’s financial management  problems leave it highly vulnerable to fraud, waste, and abuse.
In our high-risk list, IRS also shares responsibility for three areas that are  governmentwide in scope, as well as two IRS program areas pertinent to  this report: IRS financial management and collection of unpaid taxes.  In  both of these areas, weaknesses continue to expose the federal  government to significant losses of tax revenue, and compliant taxpayers  bear the increased burden of financing the government’s activities.  IRS  attempts to identify businesses and individuals that do not pay the taxes  they owe through its various enforcement programs.  However, inadequate  financial and operational information has rendered IRS unable to develop  reliable cost-based performance information for its tax collection and  enforcement programs, and to judge whether the agency is appropriately  allocating available resources among competing management priorities.   As of September 2002, IRS had an inventory of known unpaid taxes,  including interest and penalties, totaling $249 billion, of which $112 billion  has some collection potential and thus is at risk.
Our recent testimonies and reports have highlighted large and pervasive  declines in IRS compliance and collection programs.  These programs  generally experienced larger workloads, smaller staffing, and fewer  numbers of cases closed per employee from 1996 through 2001.  By the end  of fiscal year 2001, IRS was deferring collection action for about one of  three tax delinquencies assigned to the collection programs.  In a  September 2002 report to the IRS Oversight Board, former IRS  Commissioner Rossotti said that IRS has been facing a growing compliance  workload at the same time that resources were declining.  He said the  result is a "huge gap" between the number of taxpayers that are not filing,  not reporting, or not paying what they owe and IRS’s capacity to deal with  them.
In addition, we reported in 1999 that nearly 2 million businesses owed  about $49 billion in payroll taxes, which was about 22 percent of the total  outstanding balance of IRS unpaid tax assessments.  As of September 30,  2002, the amount of unpaid payroll taxes remained about the same (nearly  $49 billion).  In our 1999 report, we noted that according to IRS records,  IRS had assessed $15 billion in penalties against approximately 185,000  individuals found to be willful and responsible for the nonpayment of  payroll taxes withheld from employees.  We reported that much of this  amount was not being collected, and that businesses and individuals owing  payroll taxes received significant federal benefits and other federal  payments.
The Taxpayer Relief Act of 1997 enhanced IRS’s ability to collect unpaid  federal taxes by authorizing IRS to continuously levy up to 15 percent of  certain federal payments made to businesses and individuals.  The  continuous levy program, now referred to as FPLP, was implemented in  July 2000.  This program provides an automated process for serving tax  levies and collecting unpaid taxes through Treasury’s FMS and its TOP  process.
Treasury established the TOP as part of implementing the DCIA.   Congress passed DCIA to maximize the collection of delinquent nontax  debts owed to federal agencies.  TOP centralizes the process by which  certain federal payments are withheld or reduced to collect delinquent  debts, and as part of that program, FMS has a centralized database of debts  that DCIA requires federal agencies to refer to FMS.  Under the  regulations implementing DCIA, disbursing agencies, including DOD and  others that independently disburse rather than having it done on their  behalf by FMS, are required to compare their payment records with the  TOP database.  If a match occurs, the disbursing agency must offset the  payment, thereby reducing or eliminating the nontax debt.
FMS assists IRS in implementing FPLP through a feature of the TOP  process, thus enabling IRS to electronically serve a tax levy.  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.   For payments disbursed directly by other federal agencies, such as DOD,  FMS identifies the amount to be levied from the disbursing agency’s  payment information and notifies the disbursing agency to deduct the levy  amount before payment is made.
As a practical matter, FMS cannot honor a tax levy through TOP unless the  disbursing agency has fulfilled its DCIA responsibilities to compare  payment records with the TOP database.  When a disbursing agency  provides FMS with payment information for comparison with the TOP  database, FMS has an opportunity to notify the disbursing agency of an IRS  levy.  To the extent disbursing agencies are not providing payment  information to TOP, the implementation of FPLP is hindered.
DCIA also requires agencies to refer certain debt to Treasury for  centralized collection.  FMS reported that the debt referrals to TOP  totaled more than $186 billion as of September 2002.  Of this amount, $81  billion were federal tax debt, $71 billion were child support debt, $3 billion  were state tax debt, and $31 billion were federal nontax debt (e.g., student  loans).
Under the levy process, IRS supplies FMS with an electronic file containing  unpaid tax information for inclusion in the TOP database.  FMS compares  the TIN and name on federal payment records with the TIN and name on  unpaid tax records provided by IRS.  When FMS identifies a business or  individual with unpaid taxes that is scheduled to receive a federal payment,  it informs IRS, which issues a notice of intent to levy to the delinquent  taxpayer (unless the notice was previously sent).  Once a notice of  impending levy is received, the delinquent taxpayer has several options for  action and a minimum of 30 days to respond.  The options are as follows:  The taxpayer may disagree with IRS’s assessment and collection of tax  liability, and appeal the action by requesting a hearing with the IRS  Office of Appeals.  Generally, IRS must suspend any levy actions while  the hearing and related appeals are pending.
The taxpayer may elect to pay the debt in full.
The taxpayer may negotiate with IRS to establish an alternative payment  arrangement, such as an installment agreement or an offer in  compromise.  IRS is precluded from continuing with a levy action  while it considers a taxpayer’s proposed installment agreement or offer  in compromise.
The taxpayer may apply to IRS for a hardship determination, for which a  business or individual demonstrates to IRS that making any payment  would result in a significant financial hardship.  In such cases, IRS may  agree to delay collection action until the taxpayer’s financial condition  improves.
If the delinquent taxpayer does not respond to the levy notice, IRS will  instruct FMS to proceed with the continuous levy and reduce all scheduled  payments by up to 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.  Since the  inception of the levy program in July 2000, IRS has used it to collect $76  million in tax debt, including over $60 million in tax debt during fiscal year  2002, by directly levying federal payments.  In earlier reviews, we  estimated that IRS could use the levy program to potentially recover  hundreds of millions of dollars in tax debt.
section_title: DOD Contractors Owe Billions in Unpaid Federal Taxes
paragraphs: The federal government pays billions of dollars to DOD contractors that  abuse the federal tax system.  Further, as of September 2002, businesses  and individuals registered in DOD’s CCR database owed nearly $3 billion in  unpaid federal taxes.  Data reliability issues with respect to DOD and IRS  records prevented us from identifying an exact amount.  Consequently, the  total amount of unpaid federal taxes owed by DOD contractors is not  known.
subsections: section_title: Magnitude of Unpaid Federal Taxes Owed by DOD Contractors
paragraphs: DOD and IRS records showed that the nearly $3 billion in unpaid federal  taxes is owed by about 27,100 contractors registered in CCR.  This  represents almost 14 percent of the contractors registered as of February  2003.  Of this number, over 25,600 were businesses that primarily had  unpaid payroll taxes.  Many also had unpaid federal unemployment taxes.   The other approximately 1,500 contractors were primarily individuals who  did not pay income taxes on their business profits or individual income.
The amount of unpaid taxes for DOD contractors registered in CCR ranged  from a small amount owed by an individual for a single tax period to  millions of dollars owed by a business over more than 60 tax periods.  The  type of unpaid taxes owed by these contractors varied and consisted of  payroll, corporate income, excise, unemployment, individual income, and  other types of taxes.  In the case of unpaid payroll taxes, an employer  withheld federal taxes from an employee’s wages, but did not send the  withheld payroll taxes or the employer’s required matching amount to IRS.   As shown in figure 2, about 42 percent of the total tax amount owed by  DOD contractors was for unpaid payroll taxes.
Employers are subject to civil and criminal penalties if they do not remit  payroll taxes to the federal government.  When an employer withholds  taxes from an employee’s wages, the employer is deemed to have a  responsibility to hold these amounts “in trust” for the federal government  until the employer makes a federal tax deposit in that amount.  To the  extent these withheld amounts are not forwarded to the federal  government, the employer is liable for these amounts, as well as the  employer’s matching Federal Insurance Contribution Act (FICA)  contributions.  Individuals within the business (e.g., corporate officers)  may be held personally liable for the withheld amounts not forwarded and  assessed a civil monetary penalty known as a trust fund recovery penalty  (TFRP).  Failure to remit payroll taxes can also be a criminal felony  offense punishable by imprisonment of more than a year, while the failure  to properly segregate payroll taxes can be a criminal misdemeanor  offense punishable by imprisonment of up to a year.  The law imposes no  penalties upon an employee for the employer’s failure to remit payroll taxes  since the employer is responsible for submitting the amounts withheld.   The Social Security and Medicare trust funds are subsidized or made whole  for unpaid payroll taxes by the general fund, as we discussed in a previous  report.  Over time, the amount of this subsidy is significant.  As of  September 1998, the last date on which information was readily available,  the estimated cumulative amount of unpaid taxes and associated interest  for which the Social Security and Medicare trust funds were subsidized by  the general fund was approximately $38 billion.
Based on our case study analysis, we found that contractors with unpaid  federal taxes provide a wide range of goods and services to DOD, including  building maintenance, catering, construction, consulting, custodial,  dentistry, music, and funeral services.  Several of these contractors  provided parts or services related to aircraft components for several DOD  and civilian programs.
A substantial amount of the unpaid federal taxes shown in IRS records as  owed by DOD contractors had been outstanding for several years.  As  reflected in figure 3, 78 percent of the nearly $3 billion in unpaid taxes was  over a year old as of September 30, 2002, and 52 percent of the unpaid taxes  was for tax periods prior to September 30, 1999.
Our previous work has shown that as unpaid taxes age, the likelihood of  collecting all or a portion of the amount owed decreases.  This is due, in  part, to the continued accrual of interest and penalties on the outstanding  tax debt, which, over time, can dwarf the original tax obligation.
section_title: DOD Contractor Unpaid Taxes Are Likely Understated
paragraphs: Although the nearly $3 billion in unpaid federal taxes owed by DOD  contractors as of September 30, 2002, is a significant amount, it may not  reflect the true amount of unpaid taxes owed by these businesses and  individuals.  Data integrity issues with DOD’s contractor database and the  nature of IRS’s taxpayer account database prevented us from identifying  the true extent of DOD contractor unpaid taxes.
For example, we found that some contractors providing goods and services  to DOD could not be identified.  We analyzed the TINs reported by  contractors in the CCR database.  A TIN field is completed during a CCR  registration, and contractors are responsible for the TIN’s accuracy.  During  our review, we found that the CCR database included nearly 4,900  employer identification numbers (EIN) that did not match the IRS Master  Files.  Our examination also identified some invalid TINs that were  either all the same digit (e.g., 999999999) or an unusual series of digits (e.g.,  123456789).  Invalid TINs in the CCR database prevented us from  determining if the contractor had unpaid taxes.  We recently  recommended to IRS and OMB that options to routinely validate all TINs in  the CCR be considered, and use of contractor and TIN information from  CCR be required for tax reporting by all federal agencies.
As previously mentioned, some contractors that received DOD payments  were not registered in CCR.  Our analysis of fiscal year 2002 disbursements  totaling almost $20 billion through one DFAS vendor payment system  identified payments totaling about $1 billion with a TIN that did not match  a contractor TIN in the CCR database.  We also identified contractor  payments totaling over $4 billion that lacked TINs in the same DFAS  system.  Missing TINs in the DOD payment record prevented us from  determining if the payees were contractors with unpaid taxes.  DOD  financial management regulations require that after reasonable efforts to  obtain the TIN have been unsuccessful, federal income tax at 31 percent  should be withheld and the balance of the payment forwarded to the payee.
Another factor that contributes to understating the amount of unpaid  federal taxes owed by DOD contractors is that the IRS taxpayer account  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.  During our review, we identified  instances in which a DOD contractor failed to file tax returns for a  particular tax period and, therefore, was listed in IRS records as having no  unpaid taxes.  Consequently, the true extent of unpaid taxes for these  businesses and individuals is not known.
It is important to note that timing issues could result in some DOD  contractors that we identified with unpaid taxes having already paid the  amounts due.  For example, some very recent amounts that appear as  unpaid taxes through a matching of DOD 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.  Also, it should be noted  that some assessments developed by IRS through third party information  may be overstated due to a lack of taxpayer information (e.g., deductions).   Similarly, as we have previously reported, IRS records contain errors that  affect the accuracy of taxpayer account information, and lead to both lost  opportunities to collect outstanding taxes and a burden on taxpayers  because IRS continues to pursue amounts from taxpayers that are no  longer owed.  Consequently, some of the nearly $3 billion may not reflect  true unpaid taxes, although we cannot quantify this amount.  Nonetheless,  we believe the nearly $3 billion represents a reasonable yet conservative  estimate of unpaid federal taxes owed by DOD contractors.
section_title: DOD and IRS Are Not Collecting Millions in Unpaid Federal Taxes from Contractors
paragraphs: We estimate that DOD, which functions as its own disbursing agent, could  have levied payments and collected at least $100 million in unpaid taxes in  fiscal year 2002 if it and IRS had worked together to effectively levy  contractor payments.  However, in the 6 years since the passage of the  Taxpayer Relief Act of 1997, DOD has collected only about $687,000.  DOD  collections to date relate to DFAS payment reporting associated with  implementation of the TOP process in December 2002 for its  Mechanization of Contract Administration Services (MOCAS) contract  payment system, which disbursed over $86 billion to DOD contractors in  fiscal year 2002.  DFAS had no plans or schedule at the completion of our  review to report payment information to TOP for any of its 15 vendor  payment systems, which disbursed another $97 billion to DOD contractors  in fiscal year 2002.
IRS’s continuing challenges in pursuing and collecting unpaid taxes also  hinder the government’s ability to take full advantage of the levy program.   For example, due to resource constraints, IRS has established policies that  either exclude or delay referral of a significant number of cases to the  program.  The IRS review process for taxpayer requests, such as  installment agreements or certain offers in compromise, which IRS is  legally required to consider, often takes many months, during which time  IRS excludes these cases from the levy program.  In addition, inaccurate or  outdated information in IRS systems prevents cases from entering the levy  program.  Our audit and investigation of 47 DOD contractor case studies,  discussed in detail later in this report, also show IRS continuing to work  with businesses and individuals to achieve voluntary compliance and  taking enforcement actions, such as levies of federal contractor payments,  later in the collection process.
From a governmentwide perspective, making payments to federal  contractors without requiring the businesses or individuals to meet their  tax obligations through methods such as levying payments to collect  unpaid taxes is not a sound business practice.  Until DOD begins to fulfill  its responsibilities under DCIA by fully assisting IRS in its attempts to levy  contractor payments and IRS fully utilizes its authority under the Taxpayer  Relief Act of 1997, the federal government will continue to miss  opportunities to collect on hundreds of millions of dollars in unpaid federal  taxes owed by DOD contractors.
subsections: section_title: DOD Is Not Fully Assisting in the Collection of Unpaid Taxes Owed by Its Contractors
paragraphs: Although it has been more than 7 years since the passage of DCIA, DOD has  not fully assisted IRS in using its continuous levy authority for the  collection of unpaid taxes by providing FMS with all DFAS payment  information.  IRS’s continuous levy authority authorizes the agency to  collect federal tax debts of businesses and individuals that receive federal  payments by levying up to 15 percent of each payment until the debt is  paid.  Under TOP, FMS matches a database of debtors (including those with  federal tax debt) to certain federal payments (including payments to DOD  contractors).  When a match occurs, the payment is intercepted, the levied  amount is sent to IRS, and the balance of the payment is sent to the debtor.   The TOP database includes federal tax and nontax debt, state tax debt, and  child support debt.  All disbursing agencies are to compare their payment  records with the TOP database.  Since DOD has its own disbursing  authority, once DFAS is notified by FMS of the amount to be levied, it  should deduct this amount from the contractor payment before it is made  to the payee and forward the levied amount to the Department of the  Treasury.  By fully participating in the TOP process, DOD will also aid in the  collection of other debts, such as child support and federal nontax debt  (e.g., student loans).
At the completion of our work, DOD had no formal plans or schedule to  begin providing payment information from any of its 15 vendor payment  systems to FMS for comparison with the TOP database.  These 15 payment  systems disbursed almost $97 billion to DOD contractors in fiscal year  2002.  DFAS officials contend that it would be difficult to provide this  payment information to TOP because the systems are decentralized and  nonintegrated in 22 different payment locations.  As we have previously  reported, DOD’s business systems environment is stovepiped and not well  integrated.  DOD recently reported that its current business operations  were supported by approximately 2,300 systems in operation or under  development, and requested approximately $18 billion in fiscal year 2003  for the operation, maintenance, and modernization of its business  systems.  In addition, DFAS did not have an organizational structure in  place to implement the TOP payment reporting process.  DOD recently  communicated a timetable for implementing TOP reporting for its vendor  payment systems with completion targeted for March 2005.  Until DOD  establishes processes to provide information from all payment systems to  TOP, the federal government will continue missing opportunities to collect  hundreds of millions of dollars in unpaid taxes owed by DOD contractors.
Although DFAS recently began providing payment information to TOP from  its largest payment system, total collections to date have been minimal.  In  December 2002, DFAS began providing FMS with payment information for  its MOCAS contract payment system, which disbursed over $86 billion to  contractors in fiscal year 2002.  According to IRS, from December 2002  through September 2003, DOD collected about $687,000 in unpaid taxes  from contractor payments.  However, our analysis of IRS records for DOD  contractors receiving fiscal year 2002 payments from MOCAS showed that  these contractors owed about $750 million in unpaid federal taxes as of  September 30, 2002.
As mentioned previously, IRS records showed that over 27,100 contractors  in DOD’s CCR database owed nearly $3 billion in unpaid federal taxes as of  September 30, 2002.  We reviewed payment transactions in five of the  largest DOD disbursement systems covering about 72 percent of the fiscal  year 2002 disbursements, or almost $131 billion, from DFAS contract and  vendor payment systems.  Contractors paid through these five DOD  automated systems represented at least $1.7 billion of the nearly $3 billion  in unpaid federal taxes shown on IRS records.  We estimate that DOD could  have offset contractor payments to collect at least $100 million of this amount in fiscal year 2002 if DOD had been fulfilling its responsibilities  under DCIA to compare its payment records with the TOP database.
section_title: IRS Policies Exclude Cases from the Levy Program
paragraphs: Although the levy program could provide a highly effective and efficient  method of collecting unpaid taxes from contractors that receive federal  payments, IRS policies restrict the number of cases that enter the program  and the point in the collection process they enter the program.  For each of  the collection phases listed below, IRS policy either excludes or severely  delays putting cases into the levy program.
Phase 1: Notify taxpayer of unpaid taxes, including a demand for  payment letter.
Phase 2: Place the case into the Automated Collection System (ACS)  process.  The ACS process consists primarily of telephone calls to the  taxpayer to arrange for payment.
Phase 3: Move the case into a queue of cases awaiting assignment to a  field collection revenue officer.
Phase 4: Assign the case to field collections where a revenue officer  attempts face-to-face contact and collection.
As of September 30, 2002, IRS listed $81 billion of cases in these four  phases: 17 percent were in notice status, 17 percent were in ACS, 26  percent were in field collection, and 40 percent were in the queue awaiting  assignment to the field.  At the same time these four phases take place,  sometimes over the course of years, DOD contractors with unpaid taxes  continue to receive billions of dollars in contract payments.  IRS excludes  cases in the notification phase from the levy program to ensure proper  notification rules are followed.  However, as we previously reported, once  proper notification has been completed, IRS continues to delay or exclude  from the levy program those accounts placed in the other three phases.   IRS policy is to exclude accounts in the ACS phase primarily because  officials believed they lack the resources to issue levy notices and respond  to the potential increase in telephone calls from taxpayers responding to  the notices.  Additionally, IRS excludes the majority of cases in the queue  phase (awaiting assignment to field collection) from the levy program for 1  year.  Only after cases await assignment for over a year does IRS allow  them to enter the levy program.  Finally, IRS excludes most accounts from  the levy program once they are assigned to field collection because revenue  officers said that the levy action could interfere with their successfully  contacting taxpayers and resolving the unpaid taxes.
These policy decisions, which may be justified in some cases, result in IRS  excluding millions of cases from potential levy.  IRS officials who work on  ACS and field collection inventories can manually unblock individual cases  they are working in order to put them in the levy program.  However, by  excluding cases in the ACS and field collection phases, IRS records  indicate it excluded as much as $34 billion of cases from the levy program  as of September 30, 2002.  In January 2003, IRS unblocked and made  available for levy those accounts identified as receiving federal salary or  annuity payments.  However, other accounts remain blocked from the levy  program.  IRS stated that it intended to unblock a portion of the remaining  accounts sometime in 2005.  Additionally, $32 billion of cases are in the  queue, and thus under existing policy, would be excluded from the levy program for the first year each case is in that phase.  IRS policies along  with its inability to more actively pursue collections, both of which IRS has  in the past attributed to resource constraints, combine to prevent many  cases from entering the levy program.  Since IRS has a statutory limitation  on the length of time it can pursue unpaid taxes, generally 10 years from  the date of the assessment, these long delays greatly decrease the potential  for IRS to collect the unpaid taxes.
We identified specific examples of IRS not actively pursuing collection in  our audit and investigation of 47 selected cases involving DOD contractors.   For example, IRS used a special code within its automated systems to  block collection action for almost 10 months for one DOD contractor that  owed nearly $260,000 in unpaid taxes.  Specifically, IRS closed collection  actions against this case (using an administrative transaction code it refers  to as 530-39) citing resource and workload management considerations.   IRS is not currently seeking collection of about $14.9 billion of unpaid taxes  because of this administrative code—about 5 percent of its overall  inventory of unpaid assessments as of September 30, 2002.  Once IRS  reversed the special code, it placed the contractor into its queue of cases  awaiting assignment for collection action.  The contractor remained in the  queue, awaiting assignment, from October 2001 through the time of our  review in May 2003—19 months.  DOD paid this contractor over $110,000 in  fiscal year 2002, missing opportunities to collect as much as $17,000  through the 15 percent levy.
For another DOD contractor, IRS coded the individual within its automated  systems in 1999 as having financial hardship and therefore unable to pay.   This code put collection activities on hold until the individual’s adjusted  gross income (per subsequent tax return filings) exceeded a certain  threshold.  At the same time, IRS entered a code to prevent further  collection actions because of its own resource constraints.  IRS automated  systems are designed to automatically reverse the financial hardship code  when the adjusted gross income exceeds a certain threshold.  That reversal  would put the contractor back into the IRS collection system.  However,  before that occurred, the contractor stopped filing tax returns in 1997 and  the IRS resource constraint code had the unintended effect of IRS not  attempting to obtain the unfiled tax returns.  This combination of codes  effectively stopped collection action from taking place for this contractor  and created a catch–22 situation since one code prevents IRS from  pursuing the individual until a filed tax return reports higher income and  the other code prevents IRS from pursuing the individual to obtain non- filed tax forms.  DOD paid this individual nearly $220,000 in 2002 and  almost $700,000 since 1999.  If an effective 15 percent levy had been in  place, the government could have collected over $30,000 of the unpaid  taxes in 2002.  Because of the individual’s failure to file, the true amount of  unpaid taxes is not known, but could be significantly greater than the over  $160,000 currently reflected in IRS records.
Some cases repeatedly enter the queue awaiting assignment to a field  collection revenue officer and remain there for long periods.  For example,  one DOD contractor had gone between ACS and the queue awaiting  assignment since 1998.  This individual’s case entered the queue three times  but was never assigned.  As of May 2003, this case spent almost 3 and a half  years in the queue.  Moving a case in and out of the queue affects its  eligibility for the levy program.  For another contractor involving over  $100,000 in unpaid taxes, IRS put the case into ACS in July 2000.  As noted  previously, IRS routinely blocks ACS cases from entering the levy program.   Nine months later, in April 2001, IRS moved this case from ACS into the  queue to await assignment to a revenue officer.  Again, in accordance with  IRS policy, IRS excludes cases in the queue from entering the levy program  for 1 year.  After 1 year, the case was referred to the levy program, so this  case took about 21 months from the time it initially went to ACS until it was  moved into the levy program.  The contractor received over $350,000 in  federal payments from 1999 to 2002, and current payments would not be  subject to the 15 percent levy because DOD is not reporting information  from the vendor payment system to TOP.
section_title: IRS Delays in Processing and Inaccurate Records Exclude Cases from the Levy Program
paragraphs: In addition to excluding cases for various operational and policy reasons as  described above, IRS excludes cases from the levy program for particular  taxpayer events, such as bankruptcy, litigation, or financial hardship, as  well as when taxpayers apply for an installment agreement or an offer in  compromise.  When one of these events takes place, IRS enters a code in its  automated system that excludes the case from entering the levy program.   Although these actions are appropriate, IRS may lose opportunities to  collect through the levy program if the processing of agreements is not  timely or prompt action is not taken to cancel the exclusion when the  event, such as a dismissed bankruptcy petition, is concluded.
Delays in processing taxpayer documents and errors in taxpayer records  are long-standing problems at IRS and can harm both government interests  and the taxpayer.  In 2002, the IRS Taxpayer Advocate Service reported  that over 65 percent of all offers in compromise take longer than 6 months  to process.  Similarly, in our audits of IRS financial statements, we reported  on delays in processing offers in compromise.  In those audits, we  identified delays in processing that were outside IRS’s control (such as  taxpayer failure to provide appropriate documentation to support the  offer), as well as delays caused by IRS inactivity.  These findings are  consistent with an earlier IRS internal audit report that found, in a majority  of cases sampled, that IRS had periods of inactivity that lasted 60 days or  more.  Similarly, past audits have identified instances in which inaccurate  records allowed tax refunds to be released to citizens who owe taxes and  other cases in which IRS erroneously assessed millions of dollars due to  inaccurate records.  Our audit of cases involving DOD contractors with  unpaid federal taxes indicates that problems persist in the timeliness of  processing taxpayer applications and in the accuracy of IRS records.
In our review of DOD contractors with unpaid federal taxes, we identified a  number of cases in which the processing of DOD contractor applications  for an offer in compromise or an installment agreement was delayed for  long periods, thus blocking the cases from the levy program and potentially  reducing government collections.  For example, in one case, a DOD  contractor with nearly $400,000 in unpaid federal taxes applied for an offer  in compromise in mid-1999, but IRS did not reject the offer until July  2000—over a year later.  In this same case, the individual filed for an  installment agreement in March 1999, but it took IRS over 2 years—until  mid-2001—to reject the proposed agreement.  During this period, the  individual’s account was blocked from potential levying.  From 1999 to  2001, DOD paid this individual over $200,000 in contract payments.  Had  DOD been reporting its payments to TOP during this period and had IRS  not blocked the account for a potential levy, a 15 percent levy of these  payments could have generated over $30,000 in collections for the  government.
In another example, there was both a long delay by IRS in deciding whether  to accept a DOD contractor’s proposed installment agreement as well as a  failure to properly reverse the codes once a decision was made.  The case  had a levy block due to a proposed installment agreement submitted by the  business in mid-2000.  As mentioned above, under IRS regulations, once a  code is entered into the system indicating that a taxpayer has applied for or  is currently under an offer in compromise or installment agreement, the  case is automatically blocked from the levy program.  IRS rejected the  installment agreement offer after a year.  However, IRS had not properly  reversed the code in its systems that indicated an installment agreement  application was pending, as of our review in May 2003.  Consequently, this  account with over $60,000 in unpaid taxes was inappropriately excluded  from the levy program for 2 years.  Meanwhile, this business received  nearly $30,000 in payments from DOD while the statutory period in which  IRS had to collect the unpaid taxes continued to run.
We found that inaccurate coding at times prevented both IRS collection  action and cases from entering the levy program.  Because the coding  within a taxpayer’s account determines whether the account will enter the  levy program, effective management of these codes is critical.  If these  blocking codes remain in the system for long periods, either because IRS  delays processing taxpayer agreements or because IRS fails to input or  reverse codes after processing is complete, cases may be needlessly  excluded from the levy program.
For example, as of May 2003, one DOD contractor had been assigned to  field collection since the spring of 1996.  However, the case entered  bankruptcy, thus blocking it from the levy program and preventing all  collection action on the case.  Although the bankruptcy was settled in 1998,  the case was never released for collection action.  IRS had incorrectly  entered a reversal code, causing the case to remain in bankruptcy status  and therefore blocking it from the levy program.  On the basis of our  review, IRS was attempting to reverse the bankruptcy code and begin  collection action against the case.  Similarly, in another case, a DOD  contractor entered into an installment agreement with IRS in the spring of  1999, at which time IRS posted the appropriate code to block other  collection activities.  The individual defaulted on the agreement, after  making three payments, in 1999.  However, IRS did not post the code  required to cancel the installment agreement, leaving the individual’s  account blocked from collection activities, such as the levy program.  If the  correct code had been posted, IRS systems would have automatically put  the individual in the levy program in late 2000 when IRS implemented the  program.
section_title: IRS Subordinates Use of the Levy Program to Other Collection Efforts
paragraphs: Although the nation’s tax system is built upon voluntary compliance, when  businesses and individuals fail to pay voluntarily, the government has a  number of enforcement tools to compel compliance or elicit payment.  Our  review of DOD contractors with unpaid federal taxes indicates that  although the levy program could be an effective, reliable collection tool,  IRS is not using the program as a primary tool for collecting unpaid taxes  from federal contractors.  For the cases we audited, IRS subordinated the  use of the levy program in favor of negotiating voluntary tax compliance  with the business or individual.
We recently recommended that IRS study the feasibility of submitting all  eligible unpaid federal tax accounts to FMS on an ongoing basis for  matching against federal payment records under the levy program, and use  information from any matches to assist IRS in determining the most  efficient method of collecting unpaid taxes, including whether to use the  levy program.  Although IRS raised concerns that increasing the use of the  levy program would increase workload for its staff and would entail  excessively high computer programming costs, it agreed to study the  feasibility of such an arrangement.  The study was not completed at the  time of our review.
For the DOD contractors we audited and investigated, IRS attempts to gain  voluntary compliance often resulted in minimal or no actual collections.   For example, one case involved a sole proprietorship that had gross  revenue of over $40 million in 2001, about 10 percent of which came from  DOD contract payments.  Although this business worked primarily for  federal agencies, it failed to remit payroll and unemployment taxes and had  accumulated unpaid federal taxes of nearly $10 million.  Even with the  mounting tax debt, revenue officers continued working to get the business  to make payments, including executing an installment agreement, on which  the business defaulted.  After defaulting, IRS did not put the case into the  levy program.  In November 2002, the revenue officer put a 1-year  collection hold on the business to see if it could restructure, cut costs, and  become profitable so that it could enter into another installment agreement  to voluntarily pay the tax debt.  Throughout this period, the business rarely  paid its taxes on time or in full (essentially additional payroll taxes), yet the  business continued to operate and increase the amount of unpaid federal  taxes owed.  In this case, IRS did not levy the business’s assets because it  thought a levy would cause the business to fail.  However, the state in  which the business operated seized funds from the business’s bank account  in early 2003 to partially settle the business’s state tax debt.  This caused  the business to cease operations in early 2003, leaving IRS with a  potentially uncollectible debt of nearly $10 million.
As another example, shortly after one business in our selection of DOD  contractors defaulted on an installment agreement, it requested and  received another installment agreement.  The business promised to make  current tax payments.  However, after only a few months the business was  not paying its current tax liabilities (essentially additional payroll taxes)  and had fallen behind on the installment agreement.  Even without the  business accumulating more debt, the installment agreement required the  business to make monthly payments for 13 years.  Given the business’s  history of default, failure to pay its current tax debt, and default on the  current agreement, indications were the business would not fulfill this  obligation.  However, instead of canceling this long-term payment plan and  preventing the business from accumulating additional debt due to its  failure to remit current quarterly payroll taxes, IRS reinstated the  installment agreement and declined to put a lien on the business’s  properties.  The business again defaulted on the installment agreement less  than 2 months after initiation, and at the time of our review, IRS was  negotiating with the business for yet another installment agreement.
section_title: Challenges for IRS Collections
paragraphs: The nation’s tax system is rooted in the doctrine of its citizens voluntarily  complying with the tax laws.  IRS has a difficult task in maintaining a  balance between this key doctrine and effectively fulfilling its role as the  nation’s tax collector.  The philosophical thrust of this doctrine can,  however, negatively affect IRS’s ability to collect what is legitimately owed  to the government.  If IRS fails or is limited in its ability to act quickly and  aggressively against businesses and individuals that repeatedly fail to pay  the taxes they owe, it runs the risk of not fulfilling its mission.  IRS also  risks further weakening voluntary compliance as declines in enforcement  programs may erode taxpayer confidence in the fairness of our federal tax  system and may create the perception that there is little risk in  noncompliance.  The potential revenue losses and the threat to voluntary  compliance make the collection of unpaid taxes a high-risk area.  Congress  and others have been concerned that declines in IRS enforcement  programs are eroding taxpayer confidence in the fairness of our tax  system.
Prompt collection is important because, as discussed earlier, IRS generally  has a finite period under which to seek collection for unpaid taxes.   Generally, there is a 10-year statutory collection period beyond which IRS  is prohibited from attempting to collect.  Unless the collection period is  extended, IRS removes unpaid taxes that exceed this statutory period from  its records.  Even if a case is not actively worked for extended periods, the  collection period continues to move toward expiration, reducing IRS’s  opportunity to collect the amount due.
The levy program could help IRS take prompt enforcement action and  operate more efficiently.  In addition, from a governmentwide perspective,  paying billions of dollars to DOD contractors that at the same time have  substantial unpaid taxes is not a sound business practice.  Withholding up  to 15 percent of these payments is an effective collection method and is  authorized by law.  Additionally, the levy program can assist other  collection activities.  For example, in one case the levy helped IRS collect  against a DOD contractor it was unable to locate.  The IRS revenue officers  tried without success for 5 years to contact this business owner.  However,  after placing a lien on the owner’s assets and putting the case into FPLP,  which began to levy payments from the business’s contract with another  federal agency, the contractor was ready to cooperate with IRS.
As the above case indicates, the levy program can have a far greater impact  on the tax program than just the dollars levied.  We reported in the past that  businesses and individuals are more likely to pay voluntarily when faced  with a notice of intent to levy.  Our audit of DOD contractors also found  this to be true.  For example, IRS issued a levy notice to one DOD  contractor in the spring of 2003.  After complaining that the levy would  force it into bankruptcy, the contractor agreed to begin making voluntary  installment payments.  IRS accepted this offer and therefore did not levy.   At the time of our review in May 2003, IRS had received two payments from  the contractor to begin paying the liability from its earliest tax period.  In  addition, the business paid two tax deposits for current (2003) periods of  over $160,000.  This sequence of events indicates that, as we reported  previously, the threat of IRS levy action often brings about tax payments  and greater taxpayer compliance and fairness to those that do pay their  taxes.
In a previous report, we estimated that after receiving a notice of intent to  levy, about 29 percent of taxpayers take action that enables IRS to remove  them from the active inventory of unpaid taxes or move them to an inactive  status.  Specifically, we estimated that subsequent to receiving a levy  notice, about 19 percent of the taxpayers resolved their liability and were  removed from the active inventory, while about 10 percent obtained  determinations of financial hardship.  By reclassifying some active  accounts to an inactive status and removing others, the levy program helps  IRS prioritize its inventory of unpaid taxes more efficiently and enables IRS  to focus more of its resources on unpaid accounts that have more  collection potential.
As described above, the advantages of the levy program to IRS in assisting  its collection efforts are clear given its claims of resource constraints.   However, IRS’s current implementation strategy appears to make the levy  program one of the last collection tools IRS uses.  Changing the program to  (1) remove the policies that work to unnecessarily exclude cases from  entering the levy program and (2) promote the use of the levy program to  make it one of the first collection tools could allow IRS—and the  government—to reap the advantages of the program earlier in the  collection process.
section_title: DOD Contractors Involved in Abusive or Potentially Criminal Activity Related to the Federal Tax System
paragraphs: To determine whether there are instances of abusive or potentially criminal  activity by DOD contractors related to the federal tax system, we selected  47 case study businesses and individuals that had unpaid taxes and were  receiving DOD contractor payments in fiscal year 2002.  We excluded cases  that IRS categorized as “compliance assessment,” business cases with  total unpaid taxes under $10,000, and individual cases with total unpaid  taxes under $5,000.  Our selection was based upon a business or individual  having a large number of unpaid tax periods, owing large tax debt, and  receiving DOD contractor payments.  For more information on our criteria  for the selection of the 47 case studies, see appendix I.
For all 47 cases that we audited and investigated, we found abusive or  potentially criminal activity related to the federal tax system.  Thirty-four of  these case studies involved businesses with employees who had unpaid  payroll taxes dating as far back as the early 1990s, some for as many as 62  tax periods.  However, rather than fulfill their role as “trustees” of this  money and forward it to IRS, these DOD contractors diverted the money  for other purposes.  To reiterate, the diversion of payroll taxes for personal  or business use is potentially criminal activity.  The other 13 case studies  involved individuals that had unpaid income taxes dating as far back as the  1980s.  We are referring the 47 cases detailed in this report to IRS for  evaluation and additional collection action or criminal investigation.
subsections: section_title: Nature of Business for Case Study Contractors
paragraphs: DOD is a large and complex organization with a budget of about $400  billion and operations across the world.  Because DOD contracts for a large  variety of goods and services, it is not surprising that we found DOD  contractors that have unpaid taxes from a large number of industries.   Table 1 shows a breakdown for our 47 contractor case studies by the type  of goods and services provided to DOD.
section_title: Examples of Abusive or Potentially Criminal Activity Related to the Federal Tax System by Businesses
paragraphs: As discussed previously, businesses with employees are required by law to  collect, account for, and transfer income and employment taxes to IRS,  which the employer withholds from an employee’s wages.  IRS refers to  these withheld payroll taxes as trust fund taxes because the employer  holds the employee’s money “in trust” until the employer makes a federal  tax deposit in that amount.  Businesses that fail to remit payroll taxes to the  federal government are liable for the amounts withheld from employees,  and IRS can assess a TFRP equal to the total amount of taxes not  collected or not accounted for and paid over against individuals who are  determined by IRS to be “willful and responsible” for the nonpayment of  withheld payroll taxes.  Typically, these individuals are the officers of a  corporation, such as a president or treasurer.  As we have found in previous  reviews, collections of TFRP assessments from officers are generally  minimal.
In addition to civil penalties, criminal penalties exist for an employer’s  failure to turn over withheld employee payroll taxes to IRS.  The act of  willfully failing to collect or pay over any tax is a felony.  Additionally, the  failure to comply with certain requirements for the separate accounting  and deposit of withheld income and employment taxes is a misdemeanor.
Our audit and investigation of the 34 case study business contractors  showed substantial abuse or potential criminal activity as all had unpaid  payroll taxes and all diverted funds for personal or business use.  In table 2,  and on the following pages, we highlight 13 of these businesses and  estimate the amounts that could have been collected through the levy  program based on fiscal year 2002 DOD payments.  For these 13 cases, the  businesses owed unpaid taxes for a range of 6 to 30 quarters (tax periods).   Eleven of these cases involved businesses that had unpaid taxes in excess  of 10 tax periods, and 5 of these were in excess of 20 tax periods.  The  amount of unpaid taxes associated with these 13 cases ranged from about  $150,000 to nearly $10 million; 7 businesses owed in excess of $1 million.   In these 13 cases, we saw some cases where IRS filed tax liens on property  and bank accounts of the businesses, and a few cases where IRS collected  minor amounts through the levying of non-DOD federal payments.  We also  saw 1 case in which the business applied for an offer in compromise, which  IRS rejected on the grounds that the business had the financial resources to  pay the outstanding taxes in their entirety, and 2 cases in which the  business is entered into, and subsequently defaulted on, installment  agreements to pay the outstanding taxes.  In 5 of the 13 cases, IRS assessed  the owners or business officers with TFRPs, yet no collections were  received from these penalty assessments.
The following provides illustrative detailed information on several of these  cases.
Case # 1 - This base support contractor provided services such as trash  removal, building cleaning, and security at U.S. military bases.  The  business had revenues of over $40 million in 1 year, with over 25 percent  of this coming from federal agencies.  This business’s outstanding tax  obligations consisted of unpaid payroll taxes.  In addition, the  contractor defaulted on an IRS installment agreement.  IRS assessed a  TFRP against the owner.  The business reported that it paid the owner a  six figure income and that the owner had borrowed nearly $1 million  from the business.  The business also made a down payment for the  owner’s boat and bought several cars and a home outside the country.   The owner allegedly has now relocated his cars and boat outside the  United States.  This contractor went out of business in 2003 after state  tax authorities seized its bank account.  The business transferred its  employees to a relative’s business, which also had unpaid federal taxes,  and submitted invoices and received payments from DOD on a previous  contract through August 2003.
Case # 2 - This engineering research contractor received nearly  $400,000 from DOD during 2002.  At the time of our review, the  contractor had not remitted its payroll tax withholdings to the federal  government since the late 1990s.  In 1996, the owner bought a home and  furnishings worth approximately $1 million and borrowed nearly $1  million from the business.  The owner told our investigators that the  payroll tax funds were used for other business purposes.
Case # 3 - This aircraft parts manufacturer did not pay payroll  withholding and unemployment taxes for 19 of 20 periods through the  mid- to late 1990s.  IRS assessed a TFRP against several corporate  officers, and placed the business in FPLP in 2000.  This business claims  that its payroll taxes were not paid because the business had not  received DOD contract payments; however, DOD records show that the  business received over $300,000 from DOD during 2002.
Case # 5 - This janitorial services contractor reported revenues of over  $3 million and had received over $700,000 from DOD in a recent year.   The tax problems of this business date back to the mid-1990s.  At the  time of our review, the business had both unpaid payroll and  unemployment taxes of nearly $3 million.  In addition, the business did  not file its corporate tax returns for 8 years.  IRS assessed a TFRP  against the principal officer of the business in early 2002.  This  contractor employed two officers who had been previously assessed  TFRPs related to another business.
Case # 7 - This furniture business reported gross revenues of over  $200,000 and was paid nearly $40,000 by DOD in a recent year.  The  business had accumulated unpaid federal taxes of over $100,000 at the  time of our review, primarily from unpaid employee payroll taxes.  The  business also did not file tax returns for several years even after  repeated notices from IRS.  The owners made an offer to pay IRS a  portion of the unpaid taxes through an offer in compromise, but IRS  rejected the offer because it concluded that the business and its owners  had the resources to pay the entire amount.  At the time of our audit, IRS  was considering assessing a TFRP against the owners to make them  personally liable for the taxes the business owed.  The owners used the  business to pay their personal expenses, such as their home mortgage,  utilities, and credit cards.  The owners said they considered these  payments a loan from the business.  Under this arrangement, the owners  were not reporting this company benefit as income so they were not  paying income taxes, and the business was reporting inflated expenses.
Case # 9 - This family-owned and operated building contractor  provided a variety of products and services to DOD, and DOD provided  a substantial portion of the contractor’s revenues.  At the time of our  review, the business had unpaid payroll taxes dating back several years.   In addition to failing to remit the payroll taxes it withheld from  employees, the business had a history of filing tax returns late,  sometimes only after repeated IRS contact.  Additionally, DOD made an  overpayment to the contractor for tens of thousands of dollars.   Subsequently, DOD paid the contractor over $2 million without  offsetting the earlier overpayment.
Case # 10 - This base support services contractor has close to $1  million in unpaid payroll and unemployment taxes dating back to the  early 1990s, and the business has paid less than 50 percent of the taxes it  owed.  IRS assessed a TFRP against one of the corporate officers.  This  contractor received over $200,000 from DOD during 2002.
section_title: Examples of Abuse of the Federal Tax System by Individuals
paragraphs: Individuals are responsible for the payment of income taxes, and our audit  and investigation of 13 individuals showed significant abuse of the federal  tax system similar to what we found with our DOD business case studies.   In table 3, and on the following pages, we highlight four of the individual  case studies.  In all four cases, the individuals had unpaid income taxes.  In  one of the four cases, the individual operated a business as a sole  proprietorship with employees and had unpaid payroll taxes.  Taxes owed  by the individuals ranged from four to nine tax periods, which equated to  years.  Each individual owed in excess of $100,000 in unpaid income taxes,  with one owing in excess of $200,000.  In two of the four cases, the  individuals had entered into, and subsequently defaulted on, at least one  installment agreement to pay off the tax debt.
The following provides illustrative detailed information on these four  cases.
Case # 14 - This individual’s business repaired and painted military  vehicles.  The owner failed to pay personal income taxes and did not  send employee payroll tax withholdings to IRS.  The owner owed over  $500,000 in unpaid federal business and individual taxes.  Additionally,  the TOP database showed the owner had unpaid child support.  IRS  levied the owner’s bank accounts and placed liens against the owner’s  real property and business assets.  The business received over $100,000  in payments from DOD in a recent year, and the contractor’s current  DOD contracts are valued at over $60 million.  In addition, the business  was investigated for paying employee wages in cash.  Despite the large  tax liability, the owner purchased a home valued at over $1 million and a  luxury sports car.
Case # 15 - This individual, who is an independent contractor and  works as a dentist at a military installation, had a long history of not  paying income taxes.  The individual did not file several tax returns and  did not pay taxes in other periods when a return was filed.  The  individual entered into an installment agreement with IRS but defaulted  on the agreement.  This individual received $78,000 from DOD during a  recent year, and DOD recently increased the individual’s contract by  over $80,000.
Case # 16 - This individual is another independent contractor who also  works as a dentist on a military installation.  DOD paid this individual  over $200,000 in recent years, and recently signed a multiyear contract  worth over $400,000.  At the time of our review, this individual had paid  income taxes for only 1 year since the early 1990s and had accumulated  unpaid taxes of several hundred thousand dollars.  In addition, the  individual’s prior business practice owes over $100,000 in payroll and  unemployment taxes for multiple periods going back to the early 1990s.
Case # 17 - DOD paid this individual nearly $90,000 for presenting  motivational speeches on management and leadership.  This individual  has failed to file tax returns since the late 1990s and had unpaid income  taxes for a 5-year period from the early to mid-1990s.  The total amount  of unpaid taxes owed by this individual is not known because of the  individual’s failure to file income tax returns for a number of years.  IRS  placed this individual in the levy program in late 2000; however, DOD  payments to this individual were not levied because DFAS payment  information was not reported to TOP as required.
See appendix II for details on the other 30 DOD contractor case studies.
section_title: Contractors with Unpaid Taxes Are Not Prohibited by Law from Receiving Contracts from the Federal Government
paragraphs: Federal law does not prohibit a contractor with unpaid federal taxes from  receiving contracts from the federal government.  Existing mechanisms for  doing business only with responsible contractors do not prevent  businesses and individuals that abuse the federal tax system from receiving  contracts.  Further, the government has no coordinated process for  identifying and determining the businesses and individuals that should be  prevented from receiving contracts and for conveying that information to  contracting officers for use before awarding contracts.
In previous work, we supported the concept of barring delinquent  taxpayers from receiving federal contracts, loans and loan guarantees, and  insurance.  In March 1992, we testified on the difficulties involved in using  tax compliance as a prerequisite for awarding federal contracts.  In May  2000, we testified in support of H.R. 4181 (106th Congress), which would  have amended DCIA to prohibit delinquent federal debtors, including  delinquent taxpayers, from being eligible to contract with federal  agencies.  Safeguards in the bill would have enabled the federal  government to procure goods or services it needed from delinquent  taxpayers for designated disaster relief or national security.  Our testimony  also pointed out implementation issues, such as the need to first ensure  that IRS systems provide timely and accurate data on the status of taxpayer accounts.  However, this legislative proposal was not adopted and there is  no existing statutory bar on delinquent taxpayers receiving federal  contracts.
Federal agencies are required by law to award contracts to responsible  sources.  This statutory requirement is implemented in the FAR, which  requires that government purchases be made from, and government  contracts awarded to, responsible contractors only.  To effectuate this  policy, the government has established a debarment and suspension  process and established certain criteria for contracting officers to consider  in determining a prospective contractor’s responsibility.  Contractors  debarred, suspended, or proposed for debarment are excluded from  receiving contracts and agencies are prohibited from soliciting offers from,  awarding contracts to, or consenting to subcontracts with these  contractors, unless compelling reasons exist.  Prior to award, contracting  officers are required to check a governmentwide list of parties that have  been debarred, suspended, or declared ineligible for government  contracts, as well as to review a prospective contractor’s certification on  debarment, suspension, and other responsibility matters.  Among the  causes for debarment and suspension is tax evasion.  In determining whether a prospective contractor is responsible, contracting officers are  also required to determine that the contractor meets several specified  standards, including “a satisfactory record of integrity and business ethics.”   Except for a brief period during 2000 through 2001, contracting officers  have not been required to consider compliance with federal tax laws in  making responsibility determinations.
Neither the current debarment and suspension process nor the  requirements for considering contractor responsibility effectively prevent  the award of government contracts to businesses and individuals that  abuse the tax system.  Since most businesses and individuals with unpaid  taxes are not charged with tax evasion, and fewer still convicted, these  contractors would not necessarily be subject to the debarment and  suspension process.  None of the contractors described in this report were  charged with tax evasion for the abuses of the tax system we identified.
A prospective contractor’s tax noncompliance, other than tax evasion, is  not considered by the contracting officer before deciding whether to award  a contract.  Further, no coordinated and independent mechanism exists for  contracting officers to obtain accurate information on contractors that  abuse the tax system.  Such information is not obtainable from IRS because  of a statutory restriction on disclosure of taxpayer information.  As we  found in November 2002, unless reported by prospective contractors  themselves, contracting officers face significant difficulties obtaining or  verifying tax compliance information on prospective contractors.
Moreover, even if a contracting officer could obtain tax compliance  information on prospective contractors, a determination of a prospective  contractor’s responsibility under the FAR when a contractor abused the tax  system is still subject to a contracting officer’s individual judgment.  Thus, a  business or individual with unpaid taxes could be determined to be  responsible depending on the facts and circumstances of the case.  Since  the responsibility determination is largely committed to the contracting  officer’s discretion and depends on the contracting situation involved,  there is the risk that different determinations could be reached on the basis  of the same tax compliance information.  On the other hand, if a  prospective contractor’s tax noncompliance results in mechanical  determinations of nonresponsibility, de facto debarment could result.   Further, a determination that a prospective contractor is not responsible  under the FAR could be challenged.
Because individual responsibility determinations can be affected by a  number of variables, any implementation of a policy designed to consider  tax compliance in the contract award process may be more suitably  addressed on a governmentwide basis.  The formulation and  implementation of such a policy may most appropriately be the role of  OMB’s Office of Federal Procurement Policy.  The Administrator of Federal  Procurement Policy provides overall direction for governmentwide  procurement policies, regulations, and procedures.  In this regard, OMB’s  Office of Federal Procurement Policy is in the best position to develop and  pursue policy options for prohibiting federal contract awards to businesses  and individuals that abuse the tax system.
section_title: Conclusions
paragraphs: Thousands of DOD contractors that failed in their responsibility to pay  taxes continue to get federal contracts.  Allowing these contractors to do  business with the federal government while not paying their federal taxes  creates an unfair competitive advantage for these businesses and  individuals at the expense of the vast majority of DOD contractors that do  pay their taxes.  DOD’s failure to fully comply with DCIA and IRS’s  continuing challenges in collecting unpaid taxes have contributed to this  unacceptable situation, and have resulted in the federal government  missing the opportunity to collect hundreds of millions of dollars in unpaid  taxes from DOD contractors.  Working closely with IRS and Treasury, DOD  needs to take immediate action to comply with DCIA and thus assist in  effectively implementing IRS’s legislative authority to levy contract  payments for unpaid federal taxes.  Also, IRS needs to better leverage its  ability to levy DOD contractor payments, moving quickly to use this  important collection tool.  Beyond DOD, the federal government needs a  coordinated process for dealing with contractors that abuse the federal tax  system, including taking actions to prevent these businesses and  individuals from receiving federal contracts.
section_title: Matters for Congressional Consideration
paragraphs: In view of congressional interest in both tax collection and government  contracting, Congress may wish to consider the following two actions.
Until such time as DOD is able to demonstrate that it is meeting its  responsibilities under DCIA, including providing payment information to  TOP for offsetting unpaid federal taxes, and to facilitate action by the  department, Congress may wish to consider requiring that DOD report  periodically to Congress on its progress in implementing DCIA for each of  its contract and vendor payment systems.  This report should include  details of actual collections by system and in total for all contract and  vendor payment systems during the reporting period.
In addition, Congress may wish to consider requiring that OMB report to  Congress on progress in developing and pursuing options for prohibiting  federal government contract awards to businesses and individuals that  abuse the federal tax system, including periodic reporting of actions taken.
section_title: Recommendations for Executive Action
paragraphs: To improve collection of DOD contractor tax debt, we recommend that  DOD take four corrective actions, IRS take four corrective actions, and  OMB take one corrective action.
To comply with the DCIA and support IRS efforts under the Taxpayer Relief  Act of 1997 to collect unpaid federal taxes, we recommend that the  Secretary of Defense direct the Under Secretary of Defense (Comptroller)  to take four long- and short-term actions.  For the long term, we  recommend that the Under Secretary develop a formal plan to implement  DCIA by providing payment information to TOP for all DFAS payment  systems.  At a minimum, the plan should designate officials responsible for  implementing DCIA responsibilities for each payment system, including  firm implementation dates for each payment system.
For the short term, we recommend that the Under Secretary  collaborate with Treasury’s FMS to develop interim procedures for  identifying active DOD contactors in TOP and   develop manual procedures so that the levy of contractor payments can  be started immediately for all DOD payment systems.
For both the long and short term, we recommend that the Under Secretary  devote sufficient resources to implementing all aspects of TOP and the  DOD plan.
To help improve the effectiveness of IRS collection activities, we  recommend that the Commissioner of Internal Revenue capitalize on the  potential of the FPLP by taking the following three actions:  using the levy program as one of the first steps in the IRS collection   changing or eliminating policies that prevent businesses and individuals  with federal contracts from entering the levy program, and  evaluating the cost versus benefits of keeping businesses and  individuals in the levy program once placed in the program until the  taxes are fully paid.
We further recommend that the Commissioner of Internal Revenue  evaluate the 47 referred cases detailed in this report and consider whether  additional collection action or criminal investigation is warranted.
To help ensure that the federal government does not award contracts to  businesses and individuals that have flagrantly disregarded their federal tax  obligations (e.g., failed to remit payroll taxes for several tax periods or  broken installment agreements), we recommend that the Director of OMB  develop and pursue policy options for prohibiting federal contract awards  to contractors in cases in which abuse to the federal tax system has  occurred and the tax owed is not contested.  Options could include  designating such tax abuse as a cause for governmentwide debarment and  suspension or, if allowed by statute, authorizing IRS to declare such  businesses and individuals ineligible for government contracts.  We further  recommend that any option OMB develops should  consider whether additional legislation is needed;  minimize administrative burdens on contracting officials, for example,  by distributing the names of abusive contractors debarred, suspended,  or declared ineligible on the governmentwide list of excluded parties  that contracting officers are already required to check before awarding  contracts;  fully comply with the statutory restriction on disclosure of taxpayer   address any necessary exceptions, such as when the goods or services  cannot be obtained from other sources or for national security.
section_title: Agency Comments and Our Evaluation
paragraphs: We received written comments on a draft of this report from the Under  Secretary of Defense (Comptroller) (see app. III) and the Commissioner of  Internal Revenue (see app. IV).
DOD concurred with three of the four recommendations and partially  concurred with the remaining recommendation.  However, DOD disagreed  with our matter for congressional consideration related to progress  reporting.  For the three recommendations with which it concurred, DOD  stated that actions are under way to address our recommendations and  provided a schedule of estimated implementation dates for all DFAS  vendor payment systems.  The schedule estimates completion of 17 vendor  payment systems by March 2005.  However, our report discusses 15 vendor  pay systems because, during our review, DOD represented that there were  only 15 vendor payment systems.  We encourage DOD to continue to  identify additional payment systems to be included in its implementation  schedule.  DOD added that it will devote the necessary resources to  support the offset/levy program and will reevaluate the level of resources  as the program progresses.
Although DOD concurred with our second recommendation regarding  collaboration with Treasury for identifying active DOD contractors in TOP,  the comments point out that for the one payment system that DOD has  included in the levy program, the initial matches of contractors with the  TOP database have been low.  We did not review the methodology or  process used by DFAS or by Treasury to make the matches.  However, as  stated in this report, we believe that an effective levy program at DOD  would yield hundreds of million of dollars in tax collections.  DOD further  noted that it has been and will continue to be proactive in working with  Treasury to generate as many collections as possible.  With the exception of  actions taken with the MOCAS system, this statement is not accurate.   DOD’s comments in response to this report represent its initial schedule for  reporting payment information to TOP for the 15 reported vendor payment  systems through which it disbursed almost $97 billion to contractors in  fiscal year 2002.
Regarding the partial concurrence to our third recommendation dealing  with development of manual procedures as a short-term corrective action,  DOD stated that its implementation plan has been accelerated to 6 months  for most payments systems, and that DOD’s focus should remain on  implementing a system-based process rather than temporary manual  procedures.  As previously mentioned, until the drafting of DOD’s  comments to this report, there were no formal plans for reporting payment  information to TOP for any of DOD’s vendor payment systems.  Therefore,  there was no plan for DOD to accelerate.  In addition, we believe that given  the magnitude of potential collections, it is unreasonable to wait for a  systems solution, which may not be available for a long time.  Manual  procedures should be employed so that the offset of DOD payments can be  started immediately.
Regarding the disagreement with the matters for congressional  consideration, DOD stated that a requirement is not necessary for DOD to  report to Congress on its progress in implementing the DCIA.  We continue  to believe that Congress may wish to consider such oversight since DOD  has failed to fully implement the offset requirements of DCIA since its  passage more than 7 years ago, and the federal government continues to  miss opportunities to collect hundreds of millions of dollars in unpaid taxes  owed by DOD contractors.
IRS agreed with the issues raised in the report with respect to DOD  contractors that abuse the federal tax system, and agreed that FPLP can  become a more effective tool for collecting delinquent federal taxes owed  by businesses and individuals that receive federal payments, including  DOD contractors.  Although IRS did not explicitly agree or disagree with  the recommendations in our report, it noted a number of actions that it had  taken or was taking to address the issues raised in this report, including  steps to accelerate the collection of delinquent taxes.  Specifically, IRS  noted that it had made enhancements to its Inventory Delivery System to  identify certain businesses with payroll taxes as high-priority work and that  such cases would bypass the ACS phase of the collection process.  IRS  pointed out that it had made improvements to the cycle time of a number of  its collection processes and cited recent improvements in expediting  processing of offers in compromise.  IRS stated that it had reviewed the  systemic blocks on its FPLP procedures and information systems and,  based on this review, will be making changes to its information systems to  modify a number of blocks on cases in the queue and certain ACS business- related cases.  IRS will also work with DOD to ensure that contractor TINs  in the CCR database are accurate and will work with both DOD and OMB in  support of any changes they make with respect to how the federal  government deals with contactors with unpaid taxes.  Finally, IRS indicated  that it would review the 47 case studies included in our report and take  additional action as appropriate.
While IRS agreed with the issues raised in the report, it pointed out that the  statutory requirements under which IRS must operate, coupled with  concerns for taxpayer rights, sometimes require IRS to remove a taxpayer  from FPLP or prevent it from taking any enforcement action.  IRS added  that such requirements and considerations require IRS to take a more  balanced approach to FPLP versus a cost-benefit approach.  We recognize  the statutory environment in which IRS operates in its efforts to collect  outstanding taxes and that statutory requirements affect how the FPLP is  used.  We continue to believe, however, that FPLP provides an effective,  reliable means of ensuring at least some collections on unpaid taxes and  that IRS needs to consider a more aggressive and likely administratively  efficient approach, subject to legal requirements, for government  contractors that fail to pay their tax debt.
On January 15, 2004, we received oral comments from representatives of  OMB’s Office of Federal Procurement Policy, Office of Federal Financial  Management, and Office of the General Counsel. OMB questioned the need  for developing or pursuing additional mechanisms to prohibit federal  contract awards to “tax abusers.”  OMB said that defining “tax abuse”  would not be a function of OMB and would be more appropriate for the  Treasury Office of Tax Policy or Congress.  In addition, officials said that  current FAR guidance on responsibility (48 C.F.R. Subpart 9.1) as well as  causes for suspension and debarment (48 C.F.R. Subpart 9.4) and the  Nonprocurement Common Rule on Suspension and Debarment, recently  updated November 26, 2003 (68 Fed. Reg. 66533), provide contracting  officers and grant officers with ample discretion to consider tax-related  problems as a criterion for making awards.  Specifically, they noted that  FAR 9.104-1(d) requires prospective contractors to have, among other  things, satisfactory records of integrity and business ethics.  Accordingly,  they said, failure to pay taxes or abuse of the tax system would be a factor  in making this determination.
OMB’s comments provide us no basis to change our recommendation that  OMB develop and pursue policy options for prohibiting federal contract  awards to contractors that abuse the tax system.  While we agree with OMB  that the definition of “tax abuse” should be developed in consultation with  those government officials responsible for administering the nation’s tax  laws, as the agency responsible for governmentwide procurement policy,  we believe that OMB should assume a leadership role in ensuring that  contractors that abuse the tax system are prohibited from receiving federal  contracts.
As we discussed in this report, contracting officers have the discretion to  consider tax-related concerns in making determinations as to a contractor’s  responsibility, specifically as to its record of integrity and business ethics.   However, contracting officers are not required to consider a prospective  contractor’s tax noncompliance, other than tax evasion, in deciding  whether to award a contract and, as all 47 case studies in our report clearly  illustrate, contracting officers are not doing so.  There is no guidance for  contracting officers on considering tax information, even if the information  is legally available to them, nor is there any coordinated mechanism to help  contracting officers obtain accurate information on contractors that abuse  the tax system.
As OMB pointed out, the existing suspension and debarment process  includes an “other” category that provides for consideration of matters of  “so serious or compelling a nature” that they affect a contractor’s present  responsibility.  However, OMB did not explain how this effectively prevents  awards to contractors that abuse the federal tax system or provide  examples of such debarred or suspended contractors.  Because the  debarment and suspension process does not appear to be preventing  federal awards to contractors that abuse the tax system, we continue to  suggest that tax abuse be specifically designated or authorized as a cause  for debarment, suspension, or ineligibility.
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 Defense; the Secretary of the  Treasury; the Director, Office of Management and Budget; the  Commissioner of the Financial Management Service; the Commissioner of  Internal Revenue; the Under Secretary of Defense for Acquisition,  Technology, and Logistics; the Under Secretary of Defense (Comptroller);  the Director, Defense Finance and Accounting Service; the Director,  Defense Logistics Agency; and interested congressional committees and  members.  We will 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, John J.  Ryan at (202) 512-9587 or ryanj@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.
section_title: Scope and Methodology
paragraphs: To identify DOD contractors, we obtained a copy of Department of  Defense’s (DOD) Central Contractor Registration (CCR) database as of  February 2003 from the Defense Logistics Information Service (DLIS) in  Battle Creek, Michigan.  Because DOD does not have all contractor  information in a single automated system, the CCR database provided the  best available source of DOD contractor information.
To identify DOD contractors with unpaid federal taxes, we matched  contractor records from the CCR database to Internal Revenue Service  (IRS) tax records using the tax identification number  (TIN) fields, which  resulted in about 27,100 matching records with nearly $3 billion in unpaid  taxes.  We used data mining software to select, match, summarize, and  report on DOD and IRS records.  We also identified over 5,000 contractors  with potentially invalid TINs by matching the contractor employer  identification number (EIN) and Social Security number (SSN) fields from  CCR to IRS tax records, and by providing an electronic file of contractor  SSNs from CCR to the Social Security Administration for matching against  its records.
To evaluate DOD and IRS processes and controls over the collection of  unpaid federal taxes, we discussed this issue and reviewed current policies  and procedures with the Defense Finance and Accounting Service (DFAS),  IRS, and Financial Management Service (FMS) officials.  We did not audit  the effectiveness of the DFAS process for providing Mechanization of  Contract Administration Services (MOCAS) payment information to  Treasury Offset Program (TOP).  In December 2003, we obtained  information from IRS on FPLP collections from MOCAS payments through  September 2003.  We visited the IRS Processing Center in Kansas City,  Missouri, to help determine the effectiveness of the continuous levy  program.  In addition, we reviewed related laws and regulations governing  the levy program and TOP process.
To determine the DOD business activity of the about 27,100 contractors, we  obtained copies of fiscal year 2002 payment files for five of the largest DOD  payment systems: MOCAS for Defense Contract Management Agency  (DCMA) payments, One Bill Pay for Navy payments, Integrated Accounts  Payable System (IAPS) for Air Force payments, and Computerized  Accounts Payable System (CAPS) Clipper and CAPS Windows for Army  and Marine Corps payments.  These payment files represented about 72  percent of the $183 billion disbursed to DOD contractors in fiscal year  2002.  The five payment files are used to detect payment fraud and  overpayments by the DFAS Internal Review group with the DOD Operation  Mongoose program at the Defense Manpower Data Center in Seaside,  California.  Using TINs, we matched the about 27,100 contractors to the  five fiscal year 2002 DOD payment files.  We also estimated the potential  fiscal year 2002 collections under an effective tax levy program of at least  $100 million using the assumptions that all unpaid federal taxes were  referred by IRS to FMS for inclusion in the TOP database, and fiscal year  2002 payment information from the five DOD payment files was provided  to FMS for matching against the TOP database.  The estimated collection  amount under an effective tax levy program was calculated on 15 percent  of the DOD contractor payments up to the amount of unpaid taxes.
To identify indications of abuse or potential criminal activity, we selected a  group of DOD contractors as case studies for a detailed audit and  investigation.  To select the case studies, we used the about 27,100  contractors described above and, using TINs, we matched the contractors  to the five fiscal year 2002 DOD payment files.  This matching yielded about  8,500 active DOD contractors, which we further reduced based on the  amount of unpaid taxes, number of unpaid tax periods, and DOD  contractor payments.  We reviewed the IRS tax records and excluded  contractors that had recently paid off their unpaid tax balances or were  categorized by IRS as compliance assessments, and considered other  factors before reducing the number of cases for study to 47.  We selected 34  businesses and 13 individuals for further audit and investigation, and  obtained copies of their automated tax transcripts from IRS as of May 2003.   We reviewed the transcripts for any steps taken to resolve the unpaid taxes.   We also obtained detailed tax records (e.g., tax returns, revenue officer  notes, and collection and assessment files) and reviewed them at the IRS  processing center in Kansas City, Missouri.  We obtained additional  information from IRS to determine what enforcement actions had been  taken against these contractors.  For the 47 case studies, we identified DOD  contract awards using the DOD Electronic Document Access system, and  had criminal, financial, and public record searches performed by our Office  of Special Investigations (OSI).  We provided the case study list to FMS to  identify the tax and nontax debt in the TOP database.  For some case  studies, we contacted the responsible DOD contracting officers to inquire  about the contractors’ goods or services, performance, and current DOD  contracts.  OSI investigators contacted some contractors and performed  interviews in California, the District of Columbia, Maryland, Michigan,  Pennsylvania, Texas, and Virginia.
To determine whether DOD contractors with unpaid federal taxes are  prohibited by law from receiving contracts from the federal government,  we reviewed prior GAO work and relevant laws.
We performed our work at DOD headquarters in Arlington, Virginia; the  DFAS office in Columbus, Ohio; the DLIS in Battle Creek, Michigan; the  Defense Manpower Data Center in Seaside, California; IRS and FMS  headquarters in Washington, D.C.; and the IRS processing center in Kansas  City, Missouri.
section_title: DOD Contractors with Unpaid Federal Taxes
paragraphs: Tables 2 and 3 provide data on 17 detailed case studies.  Tables 4 and 5  show the 30 remaining business and individual case studies that we audited  and investigated.  As with the 17 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 30 case studies.  The case  studies involving businesses with employees primarily involved unpaid  payroll taxes, some for as many as 62 tax periods.  The case studies  involving individuals primarily involved unpaid income taxes.
section_title: Comments from the Department of Defense
section_title: Comments from the Internal Revenue Service
section_title: GAO Contacts and Staff Acknowledgments
subsections: section_title: GAO Contacts
section_title: Acknowledgments
paragraphs: In addition to the individuals named above, Tida Barakat, Gary Bianchi,  Ray Bush, William Cordrey, Francine DelVecchio, K. Eric Essig, Kenneth  Hill, Jeff Jacobson, Shirley Jones, Jason Kelly, Rich Larsen, Tram Le,  Malissa Livingston, Christie Mackie, Julie Matta, Dave Shoemaker, Wayne  Turowski, Jim Ungvarsky, and Adam Vodraska made key contributions to  this report.
section_title: GAO’s Mission
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subsections: section_title: Order by Mail or Phone
section_title: To Report Fraud, Waste, and Abuse in Federal Programs
section_title: Public Affairs