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 addressed issues related to three high-risk areas including the Department of Defense (DOD) and the Internal Revenue Service (IRS) financial management and IRS collection of unpaid taxes. This testimony provides a perspective on (1) the magnitude of unpaid federal taxes owed by DOD contractors, (2) whether indications exist of abuse or criminal activity by DOD contractors related to the federal tax system, (3) whether DOD and IRS have effective processes and controls in place to use the Treasury Offset Program (TOP) in collecting unpaid federal taxes from DOD contractors, and (4) whether DOD contractors with unpaid taxes are prohibited by law from receiving federal contracts. In a companion report issued today.
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. In response to our draft report, DOD developed a schedule to provide payment information to TOP for all of its additional payment systems by March 2005. Furthermore, we found abusive or potentially criminal activity related to the federal tax system through our audit and investigation of 47 DOD contractor case studies. The 47 contractors provided a variety of goods and services, including building maintenance, catering, dentistry, funeral services, and parts or support for weapons and other sensitive military programs. The businesses in these case studies owed primarily payroll taxes with some dating back to the early 1990s. These payroll taxes included amounts withheld from employee wages for Social Security, Medicare, and individual income taxes. However, rather than fulfill their role as "trustees" and forward these amounts to IRS, these DOD contractors diverted the money for personal gain or to fund the business. For example, owners of two businesses each borrowed nearly $1 million from their companies and, at about the same time, did not remit millions of dollars in payroll taxes. One owner bought a boat, several cars, and a home outside the United States. The other paid over $1 million for a furnished home. Both contractors received DOD payments during fiscal year 2002, but one went out of business in 2003. The business, however, transferred its employees to a relative's company (also with unpaid taxes) and recently received payments on a previous contract. IRS's continuing challenges in collecting unpaid federal taxes also contributed to the problem. In several case studies, IRS was not pursuing DOD contractors due to resource and workload management constraints. For other cases, control breakdowns resulted in IRS freezing collection activity for reasons that were no longer applicable. Federal law does not prohibit contractors with unpaid federal taxes from receiving federal contracts. OMB is responsible for providing overall direction to governmentwide procurement policies, regulations, and procedures, and is in the best position to develop policy options for prohibiting federal contracts to contractors that abuse the tax system.

section_title: Letter
paragraphs: Thank you for the opportunity to discuss payments to Department of  Defense (DOD) contractors that abuse the federal tax system.  Our related  report, released today and developed at the request of this Subcommittee  and Representative Schakowsky, addresses issues related to three high-risk  areas: DOD and Internal Revenue Service (IRS) financial management and  IRS collection of unpaid taxes.  Since 1990, we have periodically reported  on federal programs and operations that are high risk due to their greater  vulnerabilities to fraud, waste, and abuse.  As a result of the fraud and  abuse identified in our series of testimonies and reports on DOD’s purchase  card program, you requested more comprehensive audits and  investigations of controls over payments to DOD contractors.
DOD and IRS face a variety of high-risk challenges.  Of the 26 areas on our  governmentwide “high risk” list, 6 are DOD program areas, and the  department shares responsibility for 3 other high-risk areas that are  governmentwide in scope.  Financial management, 1 of the 6 DOD program  high-risk areas, has weaknesses, including nonintegrated and proliferating  financial management systems, and fundamental flaws in the overall  control environment.  As we have documented in numerous reports, DOD’s  financial management problems leave it highly vulnerable to fraud, waste,  and abuse.  IRS high-risk areas include financial management weaknesses  and difficulties in collecting unpaid taxes.  Both areas continue to expose  the federal government to significant losses of tax revenue and  disproportionately increase the burden on compliant taxpayers to fund  government activities.
Today, we will summarize our work on DOD payments to contractors that  abuse the federal tax system.  Our testimony will provide a perspective on  (1) the magnitude of unpaid federal taxes owed by DOD contractors,   (2) whether DOD and IRS have effective processes and controls in place to  use the Treasury Offset Program (TOP) and Federal Payment Levy Program  (FPLP) in collecting unpaid federal taxes from DOD contractors,   (3) whether indications exist of abuse or criminal activity by DOD  contractors related to the federal tax system, and (4) whether DOD  contractors with unpaid federal taxes are prohibited by law from receiving  federal contracts.
subsections: section_title: DOD Contractors Owe Billions in Unpaid Federal Taxes
paragraphs: The nearly $3 billion in unpaid federal taxes owed by over 27,000  contractors registered in DOD’s Central Contractor Registration system  (CCR) represented almost 14 percent of the registered contractors as of  February 2003.  In addition, DOD contractors receiving fiscal year 2002  payments from five of the largest DFAS contract and vendor payment  systems represented at least $1.7 billion of the nearly $3 billion in unpaid  federal taxes shown on IRS records.  Data reliability issues with respect to  DOD and IRS records prevented us from identifying an exact amount of  unpaid federal taxes.  Consequently, the total amount of unpaid federal  taxes owed by DOD contractors is not known.
The type of unpaid taxes owed by these DOD contractors varied and  consisted of payroll, corporate income, excise, unemployment, individual  income, and other types of taxes.  Unpaid payroll taxes include amounts  that a business withholds from an employee’s wages for federal income  taxes, Social Security, Medicare, and the related matching contributions of  the employer for Social Security and Medicare.  As shown in figure 1, about  42 percent of the total tax amount owed by DOD contractors was for  unpaid payroll taxes.
Employers are subject to civil and criminal penalties if they do not remit  payroll taxes to the federal government.  When an employer withholds  taxes from an employee’s wages, the employer is deemed to have a  responsibility to hold these amounts “in trust” for the federal government  until the employer makes a federal tax deposit in that amount.  To the  extent these withheld amounts are not forwarded to the federal  government, the employer is liable for these amounts, as well as the  employer’s matching Federal Insurance Contribution Act contributions for  Social Security and Medicare.  Individuals within the business (e.g.,  corporate officers) may be held personally liable for the withheld amounts  not forwarded and assessed a civil monetary penalty known as a trust fund  recovery penalty (TFRP).  Failure to remit payroll taxes can also be a  criminal felony offense punishable by imprisonment of more than a year,  while the failure to properly segregate payroll taxes can be a criminal  misdemeanor offense punishable by imprisonment of up to a year.
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 estimated cumulative amount of  unpaid taxes and associated interest for which the Social Security and  Medicare trust funds were subsidized by the general fund was  approximately $38 billion.
A substantial amount of the unpaid federal taxes shown in IRS records as  owed by DOD contractors had been outstanding for several years.  As  reflected in figure 2, 78 percent of the nearly $3 billion in unpaid taxes was  over a year old as of September 30, 2002, and 52 percent of the unpaid taxes  was for tax periods prior to September 30, 1999.
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 and IRS Are Not Collecting Millions in Unpaid Federal Taxes from Contractors
paragraphs: Until DOD establishes processes to provide information from all payment  systems to TOP, the federal government will continue missing  opportunities to collect hundreds of millions of dollars in tax debt owed by  DOD contractors.  Additionally, IRS’s current implementation strategy  appears to make the levy program one of the last collection tools IRS uses.   Changing the IRS collection program to (1) remove the policies that work  to unnecessarily exclude cases from entering the levy program and   (2) promote the use of the levy program to make it one of the first  collection tools could allow IRS—and the government—to reap the  advantages of the program earlier in the collection process.
subsections: section_title: DOD Is Not Fully Assisting in the Collection of Unpaid Taxes Owed by Its Contractors
paragraphs: We estimate that DOD, which functions as its own disbursing agent, could  have offset payments and collected at least $100 million in unpaid taxes in  fiscal year 2002 if it and IRS had worked together to effectively levy  contractor payments.  However, in the 6 years since the passage of the  Taxpayer Relief Act of 1997, DOD has collected only about $687,000.  DOD  collections to date relate to DFAS payment reporting associated with  implementation of the TOP process in December 2002 for its contract  payment system, which disbursed over $86 billion to DOD contractors in  fiscal year 2002.
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 Treasury’s Financial Management  Service (FMS) with all DFAS payment information.  IRS’s continuous levy  authority authorizes the agency to collect federal tax debts of businesses  and individuals that receive federal payments by levying up to 15 percent of  each payment until the debt is paid.  Under TOP, FMS matches a database  of debtors (including those with federal tax debt) to certain federal  payments (including payments to DOD contractors).  When a match  occurs, the payment is intercepted, the levied amount is sent to IRS, and  the balance of the payment is sent to the debtor.  All disbursing agencies  are to compare their payment records with the TOP database.  Since DOD  has its own disbursing authority, once DFAS is notified by FMS of the  amount to be levied, DOD should deduct this amount from the contractor  payment before it is made to the payee and forward the levied amount to  the Department of the Treasury as described in figure 3.
The TOP database includes federal tax and nontax debt, state tax debt, and  child support debt.  By fully participating in the TOP process, DOD will also  aid in the collection of other debts, such as child support and federal  nontax debt (e.g., student loans).
At the completion of our work, DOD had no formal plans or schedule to  begin providing payment information from any of its 15 vendor payment  systems to FMS for comparison with the TOP database.  These 15  decentralized payment systems disbursed almost $97 billion to DOD  contractors from 22 different payment locations in fiscal year 2002.  In  response to our draft report, DOD developed a schedule to provide  payment information to TOP for all of its additional payment systems by  March 2005.  As we have previously reported, DOD’s business systems  environment is stovepiped and not well integrated.  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 DOD business systems.  In addition, DFAS did not have  an organizational structure in place to implement the TOP payment  reporting process.  DOD recently communicated a timetable for  implementing TOP reporting for its vendor payment systems with  completion targeted for March 2005.
section_title: IRS Policies Exclude Cases from the Levy Program
paragraphs: IRS’s continuing challenges in pursuing and collecting unpaid taxes also  hinder the government’s ability to take full advantage of the levy program.   For example, due to resource constraints, IRS has established policies that  either exclude or delay referral of a significant number of cases to the  program.  Also, the IRS review process for taxpayer requests, such as  installment agreements or certain offers in compromise which IRS is  legally required to consider, often takes many months, during which time  IRS excludes these cases from the levy program.  In addition, inaccurate or  outdated information in IRS systems prevents cases from entering the levy  program.  Our audit and investigation of 47 case studies also showed IRS  continuing to work with businesses and individuals to achieve voluntary  compliance, and taking enforcement actions such as levies of federal  contractor payments later in the collection process.  We recently  recommended that IRS study the feasibility of submitting all eligible unpaid  federal tax accounts to FMS on an ongoing basis for matching against  federal payment records under the levy program, and use information from  any matches to assist IRS in determining the most efficient method of  collecting unpaid taxes, including whether to use the levy program.  The  study was not completed at the time of our audit.  In earlier reviews, we  estimated IRS could use the levy program to potentially recover hundreds  of millions of dollars in tax debt.
Although the levy program could provide a highly effective and efficient  method of collecting unpaid taxes from contractors that receive federal  payments, IRS policies restrict the number of cases that enter the program  and the point in the collection process they enter the program.  For each of  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 that 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 limited to 10  years from the date of the assessment, these long delays greatly decrease  the potential for IRS to collect the unpaid taxes.
We identified specific examples of IRS not actively pursuing collection in  our review of 47 selected cases involving DOD contractors.  In one case,  IRS cited resource and workload management considerations.  IRS is not  currently seeking collection of about $14.9 billion of unpaid taxes citing  these considerations–about 5 percent of its overall inventory of unpaid  assessments as of September 30, 2002.  In another case, IRS cited financial  hardship where the taxpayer was unable to pay.  This puts collection  activities on hold until the taxpayer’s adjusted gross income (per  subsequent tax return filings) exceeds a certain threshold.  Some cases  repeatedly entered the queue awaiting assignment to a field collection  revenue officer and remained there for long periods.
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 take place, IRS enters a code in its  automated system that excludes the case from entering the levy program.   Although these actions are appropriate, IRS may lose opportunities to  collect through the levy program if the processing of agreements is not  timely or prompt action is not taken to cancel the exclusion when the  event, such as a dismissed bankruptcy petition, is concluded.
Delays in processing taxpayer documents and errors in taxpayer records  are long-standing problems at IRS and can harm both government interests  and the taxpayer.  Our review of cases involving DOD contractors with  unpaid federal taxes indicates that problems persist in the timeliness of  processing taxpayer applications and in the accuracy of IRS records.  For  example, we identified a number of cases in which the processing of DOD  contractor applications for an offer in compromise or an installment  agreement was delayed for long periods, thus blocking the cases from the  levy program and potentially reducing government collections.  We also  found that inaccurate coding at times prevented both IRS collection action  and cases from entering the levy program.  For example, if these blocking  codes remain in the system for long periods, either because IRS delays  processing taxpayer agreements or because IRS fails to input or reverse  codes after processing is complete, cases may be needlessly excluded from  the levy program.
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 and investigated, IRS  subordinated the use of the levy program in favor of negotiating voluntary  tax compliance with the DOD contractors, which often resulted in minimal  or no actual collections.
section_title: DOD Contractors Involved in Abusive or Potentially Criminal Activity Related to the Federal Tax System
paragraphs: We selected for case study 47 businesses and individuals that had unpaid  taxes and were receiving DOD contractor payments in fiscal year 2002.  For  all 47 cases that we audited and investigated, we found abusive or  potentially criminal activity related to the federal tax system.  Thirty-four of  these case studies involved businesses with employees that had unpaid  payroll taxes dating as far back as the early 1990s, some for as many as 62  tax periods.  However, rather than fulfill their role as “trustees” of this  money and forward it to IRS, these DOD contractors diverted the money  for other purposes.  The other 13 case studies involved individuals that had  unpaid income taxes dating as far back as the 1980s.  We are referring the  47 cases detailed in our related report to IRS for evaluation and additional  collection action or criminal investigation.
subsections: section_title: Examples of Abusive or Potentially Criminal Activity Related to the Federal Tax System by Businesses
paragraphs: Our audit and investigation of the 34 case study business contractors  showed substantial abuse or potential criminal activity as all had unpaid  payroll taxes and all diverted funds for personal or business use.  In table 1,  and on the following pages, we highlight 13 of these businesses and  estimate the amounts that could have been collected through the levy  program based on fiscal year 2002 DOD payments.  For these 13 cases, the  businesses owed unpaid taxes for a range of 6 to 30 quarters (tax periods).   Eleven of these cases involved businesses that had unpaid taxes in excess  of 10 tax periods, and 5 of these were in excess of 20 tax periods.  The  amount of unpaid taxes associated with these 13 cases ranged from about  $150,000 to nearly $10 million; 7 businesses owed in excess of $1 million.   In these 13 cases, we saw some cases where IRS filed tax liens on property  and bank accounts of the businesses, and a few cases where IRS collected  minor amounts through the levying of non-DOD federal payments.  We also  saw 1 case in which the business applied for an offer in compromise, which  IRS rejected on the grounds that the business had the financial resources to  pay the outstanding taxes in their entirety, and 2 cases in which the  businesses entered into, and subsequently defaulted on, installment  agreements to pay the outstanding taxes.  In 5 of the 13 cases, IRS assessed  the owners or business officers with TFRPs, yet no collections were  received from these penalty assessments.
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 audit, the contractor  had not remitted its payroll tax withholdings to the federal government  since the late 1990s.  In 1996, the owner bought a home and furnishings  worth approximately $1 million and borrowed nearly $1 million from the  business.  The owner told our investigators that the payroll tax funds  were used for other business purposes.
Case # 3 - This aircraft parts manufacturer did not pay payroll  withholding and unemployment taxes for 19 of 20 periods through the  mid- to late 1990s.  IRS assessed a TFRP against several corporate  officers, and placed the business in the FPLP in 2000.  This business  claims that its payroll taxes were not paid because the business had not  received DOD contract payments; however, DOD records show that the  business received over $300,000 from DOD during 2002.
Case # 5 - This janitorial services contractor reported revenues of over  $3 million and had received over $700,000 from DOD in a recent year.   The tax problems of this business date back to the mid-1990s.  At the  time of our audit, the business had both unpaid payroll and  unemployment taxes of nearly $3 million.  In addition, the business did  not file its corporate tax returns for 8 years.  IRS assessed a TFRP  against the principal officer of the business in early 2002.  This  contractor employed two officers who had been previously assessed  TFRPs related to another business.
Case # 7 - This furniture business reported gross revenues of over  $200,000 and was paid nearly $40,000 by DOD in a recent year.  The  business had accumulated unpaid federal taxes of over $100,000 at the  time of our audit, primarily from unpaid employee payroll taxes.  The  business also did not file tax returns for several years, even after  repeated notices from IRS.  The owners made an offer to pay IRS a  portion of the unpaid taxes through an offer in compromise, but IRS  rejected the offer because it concluded that the business and its owners  had the resources to pay the entire amount.  At the time of our audit, IRS  was considering assessing a TFRP against the owners to make them  personally liable for the taxes the business owed.  The owners used the  business to pay their personal expenses, such as their home mortgage,  utilities, and credit cards.  The owners said they considered these  payments a loan from the business.  Under this arrangement, the owners  were not reporting this company benefit as income so they were not  paying income taxes, and the business was reporting inflated expenses.
Case # 9 - This family-owned and operated building contractor  provided a variety of products and services to DOD, and DOD provided  a substantial portion of the contractor’s revenues.  At the time of our  review, the business had unpaid payroll taxes dating back several years.   In addition to failing to remit the payroll taxes it withheld from  employees, the business had a history of filing tax returns late,  sometimes only after repeated IRS contact.  Additionally, DOD made an  overpayment to the contractor for tens of thousands of dollars.   Subsequently, DOD paid the contractor over $2 million without  offsetting the earlier overpayment.
Case # 10 - This base support services contractor has close to $1  million in unpaid payroll and unemployment taxes dating back to the  early 1990s, and the business has paid less than 50 percent of the taxes it  owed.  IRS assessed a TFRP against one of the corporate officers.  This  contractor received over $200,000 from DOD during 2002.
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 2, and on the following pages, we highlight four of the individual  case studies.  In all four cases, the individuals had unpaid income taxes.  In  one of the four cases, the individual operated a business as a sole  proprietorship with employees and had unpaid payroll taxes.  Taxes owed  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 our related report 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 with unpaid federal taxes from receiving  contracts.  Further, the government has no coordinated process for  identifying and determining the businesses and individuals with unpaid  taxes that should be prevented from receiving contracts and for conveying  that information to contracting officers before awarding contracts.
In previous work, we supported the concept of barring delinquent  taxpayers from receiving federal contracts, loans and loan guarantees, and  insurance.  In March 1992, we testified on the difficulties involved in using  tax compliance as a prerequisite for awarding federal contracts.  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 federal government before deciding whether to  award a contract to a business or individual.  Further, no coordinated and  independent mechanism exists for contracting officers to obtain accurate  information on contractors that abuse the tax system.  Such information is  not obtainable from IRS because of a statutory restriction on disclosure of  taxpayer information.  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: Concluding Comments
paragraphs: Thousands of DOD contractors that failed in their responsibility to pay  taxes continue to get federal contracts.  Allowing these contractors to do  substantial business with the federal government while not paying their  federal taxes creates an unfair competitive advantage for these businesses  and individuals at the expense of the vast majority of DOD contractors that  do pay their taxes.  DOD’s failure to fully comply with DCIA and IRS’s  continuing challenges in collecting unpaid taxes have contributed to this  unacceptable situation, and have resulted in the federal government  missing the opportunity to collect hundreds of millions of dollars in unpaid  taxes from DOD contractors.  Working closely with IRS and Treasury, DOD  needs to take immediate action to comply with DCIA and thus assist in  effectively implementing IRS’s legislative authority to levy contract  payments for unpaid federal taxes.  Also, IRS needs to better leverage its  ability to levy DOD contractor payments, moving quickly to use this  important collection tool.  Beyond DOD, the federal government needs a  coordinated process for dealing with contractors that abuse the federal tax  system, including taking actions to prevent these businesses and  individuals from receiving federal contracts.
Our related report on these issues released today includes nine  recommendations to DOD, IRS, and OMB.  Our DOD recommendations  address the need to comply with the DCIA by supporting IRS efforts under  the Taxpayer Relief Act of 1997 to collect unpaid federal taxes.  Our IRS  recommendations address improving the effectiveness of IRS collection  activities through earlier use of the Federal Payment Levy Program and  changing or eliminating policies that prevent businesses and individuals  with federal contracts from entering the levy program.  Our OMB  recommendation addresses developing and pursuing policy options for  prohibiting federal contract awards to businesses and individuals that  abuse the federal tax system.  In written comments on a draft of our report,  DOD and IRS officials partially agreed with our recommendations.  OMB  officials did not agree with our recommendation to develop policy options  for prohibiting federal contract awards to businesses and individuals that  abuse the federal tax system.
Our report also suggests that Congress consider requiring DOD to  periodically report to Congress on progress in providing its payment  information to TOP for each of its contract and vendor payment systems,  including details of the resulting collections by system and in total for all  contract and vendor payment systems during the reporting period.  In  addition, our report suggests that Congress consider requiring that OMB  report to Congress on progress in developing and pursuing options for  prohibiting federal government contract awards to businesses and  individuals that abuse the federal tax system, including periodic reporting  of actions taken.  DOD and OMB did not agree with our matters for  congressional consideration.
We continue to believe all of our recommendations and matters for  congressional consideration constitute valid and necessary courses of  action, especially in light of the identified weaknesses and the slow  progress of DOD to fully implement the offset provisions of the DCIA since  its passage more than 7 years ago.
Mr. Chairman, Members of the Subcommittee, and Ms. Schakowsky, this  concludes our prepared statement.  We would be pleased to answer any  questions you may have.
section_title: and Staff Acknowledgments
paragraphs: For future contacts regarding this testimony, please contact Gregory D.  Kutz at (202) 512-9095 or kutzg@gao.gov, Steven J. Sebastian at (202) 512- 3406 or sebastians@gao.gov, or John J. Ryan at (202) 512-9587 or  ryanj@gao.gov.  Individuals making key contributions to this testimony  included Tida Barakat, Gary Bianchi, Art Brouk, Ray Bush, William  Cordrey, Francine DelVecchio, K. Eric Essig, Kenneth Hill, Jeff Jacobson,  Shirley Jones, Jason Kelly, Rich Larsen, Tram Le, Malissa Livingston,  Christie Mackie, Julie Matta, Larry Malenich, Dave Shoemaker, Wayne  Turowski, Jim Ungvarsky, and Adam Vodraska.
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