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. 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. 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. 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.