Presidential Executive Order 12764, “Principles of Ethical Conduct for Government Officers and Employees” (government code of ethics), provides ethical guidelines to be followed in the executive branch of the federal government. Among the ethical standards prescribed in the order is that “Employees shall satisfy in good faith their obligations as citizens, including all just financial obligations, especially those such as Federal, State, or local taxes that are imposed by law.” The executive order, which was recently emphasized by the current administration in January 2001, continues to stress the ethical importance of federal workers’ complying with their federal tax obligations. Noncompliance by federal workers and annuitants could adversely affect the public’s perception of tax administration, government effectiveness, and the federal workforce. If the general public perceives that federal workers and annuitants can successfully evade their tax obligations, voluntary compliance, the foundation of the U.S. tax system, could be eroded. In 1992, IRS initiated FERDI, a program to identify the degree of compliance with federal tax laws among federal workers and federal annuitants. IRS began this program as a means to improve information on potential levy sources and in response to the presidential executive order. Beginning in 1992, IRS began to periodically match its records of outstanding taxes and nonfiled tax returns against federal personnel records to identify federal workers and annuitants who either had outstanding taxes or had not filed their tax returns. IRS entered into agreements with the Defense Manpower Data Center, which receives personnel data files on many of the government’s active and retired civilian and military workers, and the U.S. Postal Service, which maintains and processes similar data for postal workers, to match these personnel records against a data file of outstanding taxes and unfiled tax returns monthly. Most agencies, accounting for over 95 percent of the federal workforce, participate in this matching process. For those federal agencies and entities that do not, including the National Security Agency, the Federal Bureau of Investigation, the Central Intelligence Agency, the Board of Governors of the Federal Reserve System, and legislative branch entities, IRS attempts to identify these employees through a separate matching of Wage and Earnings Statements (W-2s). However, this process has certain limitations. Agencies that participate in the matching process and agencies where IRS is able to perform a match using W-2 information annually receive a letter from IRS informing them of the number of employees with outstanding taxes or unfiled tax returns. These letters also contain IRS’ assessment of the agency’s rate of compliance. Because of restrictions imposed by confidentiality laws, these agencies do not receive information on the specific names of individual employees whom IRS has identified as not complying with the nation’s tax laws. The broad objectives of FERDI are to enhance the federal government’s tax administration process by improving the compliance of federal employees and annuitants with their responsibility for filing tax returns and paying taxes, thereby helping to ensure the public’s confidence in the tax system. The program combines reaching out to federal agencies to raise their awareness of this issue and prioritizing IRS’ efforts to reduce its unpaid tax cases. Because of the potential ethical concerns and public perceptions related to federal employees and annuitants who do not comply with their tax responsibilities, IRS until recently adopted what it referred to as a “zero tolerance” policy for these cases. Specifically, IRS’ policy until January 2001 has generally been to actively pursue all known noncompliance cases involving federal workers and annuitants, without prioritizing by amount involved or potential for collection. In January 2001, IRS changed its prioritization system for FERDI cases and these now receive the same priority as the general population cases. According to IRS records, as of October 1999, over 390,000 federal workers and annuitants, or 4.5 percent of the total 8.7 million on-roll federal worker and annuitant population, owed about $2.5 billion in unpaid federal taxes. IRS records indicate that another 65,000 federal workers and annuitants had not filed tax returns and were identified by IRS as potential nonfilers. In total, IRS records indicated that as of October 1999, over 5 percent of the federal population had outstanding taxes, had not met its tax filing responsibilities, or both. This percentage compared favorably with the general population: IRS’ records indicated that as of October 1999, over 8 percent of the general population owed amounts to the government for unpaid taxes, had not filed tax returns, or both. Information recently reported by IRS indicated that, as of October 2000, 340,000 federal workers and annuitants owed cumulative unpaid taxes of about $2.5 billion, and another 85,000 federal workers and annuitants had not filed tax returns. This information indicated that, as of October 2000, slightly less than 5 percent of the federal worker and annuitant population owed taxes or had not filed tax returns as required, compared to a little over 7 percent for the general population. Based on these percentages, federal workers and annuitants appear to be more compliant than the general taxpayer population in meeting their tax obligations. However, these percentages and the amounts reported as owed to the federal government are affected by several factors. Not all taxpayers, including federal workers and annuitants, pay the amounts they owe the federal government. Some do not provide payments on their tax liability when they file their tax returns. Others underreport, either mistakenly or deliberately, the amounts they owe the government. Still others do not report the amounts they owe. To the extent that underreporting or nonreporting by taxpayers is not detected and corrected by IRS, the amount of unpaid taxes IRS identifies is understated. Conversely, not all amounts IRS identifies as unpaid taxes are actually owed by taxpayers; thus, the amount of unpaid taxes IRS identifies could be overstated. This is particularly true for cases in which IRS assesses additional taxes based on third-party-provided information, or when a taxpayer has not filed a tax return for a given period and IRS constructs a return for the individual based on third-party information. Erroneous third-party information can result in IRS’ erroneously assessing a taxpayer for amounts that are not owed. Also, when IRS assesses taxes based on third-party payment information, the assessed tax may be overstated because IRS cannot consider legitimate deductions that may apply and that could reduce or even eliminate the identified tax liability. In addition, if IRS errs in applying taxpayer payments, its records could reflect a tax liability that has already been paid. In other instances, IRS unpaid assessments include amounts being contested by taxpayers. In some cases, the taxpayers may even be due a refund. It is also important to note that, for both the federal and the general populations, the percentages noted above and the reported amounts of unpaid taxes include balances taxpayers owe that are being paid under installment agreements. The amount of unpaid taxes owed by the federal population as of October 1999 and October 2000 included about $660 million and about $650 million, respectively, owed by taxpayers who were in installment agreements with IRS. If these federal workers and annuitants were excluded from the population of federal workers and annuitants who were considered to be noncompliant, the percentages of the federal worker and annuitant population who owed taxes or had not filed tax returns as required as of October 1999 and October 2000 would decline to 3.3 percent and 3 percent, respectively. IRS’ difficulty in better determining noncompliance is affected by a number of issues including significant deficiencies in its systems and processes leading to delays in identifying noncompliant taxpayers and errors in taxpayer accounts, and resource allocation decisions and limitations. These issues are discussed later in this report under “Impediments Exist in Collecting Amounts Owed and Promoting Compliance.” According to IRS records, as of October 1999, the taxes owed by the over 390,000 federal workers and annuitants predominantly stemmed from their income. Nearly one-half of the outstanding amounts IRS reported as owed by these federal workers were identified through IRS’ enforcement programs. About one-third of these individuals owed taxes for more than one tax period and owed for extended periods of time, and about 56 percent of the total outstanding amounts dated back to before 1995. Federal annuitants accounted for 54 percent of the total outstanding amounts owed by federal workers and annuitants, while constituting 40 percent of the number of individuals with tax delinquencies. IRS employees were more compliant than the rest of the federal population; however, they are subject to special monitoring by IRS and can face substantial disciplinary actions for willful noncompliance. Our work indicates that a significant portion of the outstanding amounts owed by federal workers and annuitants is potentially uncollectible. The vast majority of federal workers and annuitants owe taxes stemming from the income they earn. According to IRS records, as of October 1999, over 99 percent of the accounts owed by federal workers and annuitants was attributable to individual income taxes owed. It is important to note that such income taxes are not necessarily solely attributable to federal salaries or pensions. Some income may be attributable to other sources such as secondary nonfederal income, a spouse’s nonfederal income, or gains on sale of property. Among the less than one percent of federal workers and annuitants with outstanding taxes as of October 1999 that were not related to their income, approximately 2,300 individuals owed the government penalty assessments totaling $155 million resulting from IRS’ finding them to be willful and responsible for the failure to remit amounts withheld from employee salaries for payroll taxes. In some instances, these individuals were assessed for multiple periods of withheld but nonremitted payroll taxes—the 2,300 individuals owe outstanding penalties on 3,019 separate tax accounts. In one case we reviewed, we found that IRS had assessed a retired federal employee for withholding and not forwarding to the government payroll taxes he withheld from employees of two businesses he started after retiring. In each of these two businesses, the individual had withheld taxes from his employees’ salaries for 17 separate periods without forwarding the withheld funds to the federal government.