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Report to Congressional Requesters:

February 2004:

FINANCIAL MANAGEMENT:

Some DOD Contractors Abuse the Federal Tax System with Little 
Consequence:

GAO-04-95:

GAO Highlights:

Highlights of GAO-04-95, a report to congressional requesters

Why GAO Did This Study:

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. 

What GAO Found:

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.

What GAO Recommends:

GAO makes recommendations to DOD for complying with statutory guidance 
and supporting IRS efforts in collecting unpaid taxes, to IRS for 
improving the effectiveness of collection activities, and to the 
Office of Management and Budget (OMB) to develop options for 
prohibiting federal contract awards to businesses and individuals that 
abuse the federal tax system. DOD and IRS partially agreed; OMB did 
not agree. DOD and OMB also did not agree with GAO’s matters for 
congressional consideration that DOD report on its collections through 
TOP and OMB report on policy options developed and actions taken 
against contractors that abuse the federal tax system. GAO reiterated 
support for its recommendations as well as for its suggestions to 
Congress. 

www.gao.gov/cgi-bin/getrpt?GAO-04-95

To view the full product, including the scope and methodology, click 
on the link above. For more information, contact Gregory D. Kutz at 
(202) 512-9095 or kutzg@gao.gov, or Steven J. Sebastian at (202) 
512-3406.

[End of section]

Contents:

Letter: 

Results in Brief: 

Background: 

DOD Contractors Owe Billions in Unpaid Federal Taxes: 

DOD and IRS Are Not Collecting Millions in Unpaid Federal Taxes from 
Contractors: 

DOD Contractors Involved in Abusive or Potentially Criminal Activity 
Related to the Federal Tax System: 

Contractors with Unpaid Taxes Are Not Prohibited by Law from Receiving 
Contracts from the Federal Government: 

Conclusions: 

Matters for Congressional Consideration: 

Recommendations for Executive Action: 

Agency Comments and Our Evaluation: 

Appendixes:

Appendix I: Scope and Methodology: 

Appendix II: DOD Contractors with Unpaid Federal Taxes: 

Appendix III: Comments from the Department of Defense: 

Appendix IV: Comments from the Internal Revenue Service: 

Appendix V: GAO Contacts and Staff Acknowledgments: 

GAO Contacts: 

Acknowledgments: 

Tables: 

Table 1: Types of Goods and Services Provided by DOD Contractors in Case 
Studies: 

Table 2: DOD Contractors with Unpaid Federal Taxes--Business: 

Table 3: DOD Contractors with Unpaid Federal Taxes--Individual: 

Table 4: DOD Contractors with Unpaid Federal Taxes--Business: 

Table 5: DOD Contractors with Unpaid Federal Taxes--Individual: 

Figures: 

Figure 1: Fiscal Year 2002 Federal Contract Award Amounts by Agency: 

Figure 2: DOD Contractor Unpaid Taxes by Tax Type: 

Figure 3: DOD Contractor Unpaid Taxes by Fiscal Year: 

Abbreviations: 

ACS: Automated Collection System:

CAPS: Computerized Accounts Payable System:

CCR: Central Contractor Registration:

DCIA: Debt Collection Improvement Act of 1996:

DCMA: Defense Contract Management Agency:

DFAS: Defense Finance and Accounting Service:

DLIS: Defense Logistics Information Service:

DOD: Department of Defense:

DOE: Department of Energy:

EIN: employer identification number:

FAR: Federal Acquisition Regulation:

FICA: Federal Insurance Contribution Act:

FMS: Financial Management Service:

FPLP: Federal Payment Levy Program:

GSA: General Services Administration:

IAPS: Integrated Accounts Payable System:

IRS: Internal Revenue Service:

MOCAS: Mechanization of Contract Administration Services:

NASA: National Aeronautics and Space Administration:

OMB: Office of Management and Budget:

OSI: Office of Special Investigations:

SSA: Social Security Administration:

SSN: Social Security number:

TFRP: trust fund recovery penalty:

TIN: tax identification number:

TOP: Treasury Offset Program:

Letter February 12, 2004:

The Honorable Norm Coleman: 
Chairman: 
The Honorable Carl Levin: 
Ranking Minority Member: 
Permanent Subcommittee on Investigations: 
Committee on Governmental Affairs: 
United States Senate:

The Honorable Janice D. Schakowsky: 
House of Representatives:

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,[Footnote 1] 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)[Footnote 2] and Federal Payment Levy Program 
(FPLP)[Footnote 3] 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.

Results in Brief:

Some DOD contractors abuse the federal tax system with little 
consequence.[Footnote 4] DOD and IRS records showed that about 27,100 
contractors registered in DOD's Central Contractor Registration (CCR) 
system had nearly $3 billion in unpaid federal taxes as of September 
30, 2002, of which 78 percent was over a year old. Of these 
contractors, over 25,600 were businesses[Footnote 5] that primarily 
owed unpaid payroll taxes. These 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. The other approximately 
1,500 contractors were primarily individuals who owed but had not paid 
income taxes on their business profits or individual income.

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 had fully assisted IRS in 
effectively levying contractor payments. In the 6 years since passage 
of the Taxpayer Relief Act of 1997, DOD has collected only about 
$687,000. DOD collections to date relate to its recently implemented 
TOP payment reporting process for its contract payment system, which, 
according to DOD records, disbursed over $86 billion to contractors in 
fiscal year 2002. DOD did not, however, have formal plans or a schedule 
at the completion of our work for reporting payment information to TOP 
for its 15 vendor payment systems, which disbursed another $97 billion 
to contractors in fiscal year 2002. DOD officials contend it would be 
difficult to implement a TOP reporting process for vendor payments 
because the systems are decentralized in 22 different payment 
locations. In addition, DOD did not have an organizational structure in 
place to implement a TOP reporting process. Unless DOD establishes 
processes to assist IRS in identifying payments from DOD systems that 
IRS could levy for unpaid federal taxes, the federal government will 
miss opportunities to collect hundreds of millions of dollars in unpaid 
taxes owed by DOD contractors.

IRS faces a number of high-risk challenges. Due to resource and 
workload management constraints, IRS established policies that either 
exclude or delay putting a significant number of cases into the levy 
program. In addition to policy constraints, inaccurate or outdated 
information in IRS systems prevent cases from entering the levy 
program. Our review of IRS collection efforts against DOD contractors 
selected for audit and investigation indicated that IRS attempts to 
work with the businesses and individuals to achieve voluntary 
compliance, pursuing enforcement actions such as levies of federal 
contract payments later rather than earlier in the collection process. 
For many of our case study contractors, this resulted in businesses and 
individuals continuing to receive federal contract payments without 
making any payments on their unpaid federal taxes.

We also found numerous instances of abusive or potentially 
criminal[Footnote 6] activity related to the federal tax system during 
our audit and investigation of 47 DOD contractor case studies. The 34 
case studies involving businesses with employees had primarily unpaid 
payroll taxes, some dating to the early 1990s and some for as many as 
62 tax periods.[Footnote 7] 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 their businesses. The 
other 13 case studies involved individuals who had unpaid income taxes 
dating as far back as the 1980s. These 47 DOD contractors provided a 
wide variety of goods and services, including building maintenance, 
construction, consulting, catering, dentistry, and funeral services. 
Several of these contractors provided parts or services supporting 
weapons and other sensitive military programs.

Federal law does not prohibit a contractor with unpaid federal taxes 
from receiving contracts from the federal government. At this juncture, 
the criteria calling for federal agencies to do business only with 
responsible contractors do not require contracting officers to consider 
a contractor's tax noncompliance, unless the contractor has been 
suspended or debarred for tax evasion. Further, the federal government 
has no coordinated process for identifying and determining the 
businesses and individuals that abuse the federal tax system and for 
conveying that information to contracting officers for use before 
awarding contracts. The Office of Federal Procurement Policy in the 
Office of Management and Budget (OMB) is responsible for providing 
overall direction to governmentwide procurement policies, regulations, 
and procedures and may be in the best position to facilitate 
discussions between DOD, IRS, and other affected agencies. 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 are making recommendations to DOD to immediately provide its 
contractor payment information to TOP and to IRS to use the levy 
program as one of the first steps in the collection process. We are 
making a recommendation to OMB to develop and pursue policy options for 
prohibiting contract awards to contractors that abuse the federal tax 
system, including any necessary legislation. We also suggest that 
Congress consider requiring DOD to periodically report to Congress on 
its progress in implementing the Debt Collection Improvement Act of 
1996 (DCIA) and providing its payment information for each of its 
contract and vendor payment systems to TOP, including 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 
require that OMB report to Congress on progress in developing and 
pursuing options for prohibiting federal contract awards to businesses 
and individuals that abuse the federal tax system, including periodic 
reporting of actions taken against contractors.

DOD and IRS partially agreed with our recommendations while OMB did not 
agree. In addition, DOD and OMB disagreed with our matters for 
congressional consideration. DOD did not agree that a requirement is 
necessary for DOD to report to Congress on its progress in implementing 
the DCIA. We believe that such reporting to Congress is necessary to 
facilitate oversight since DOD, until recently, had taken little action 
to implement the offset provisions of DCIA since its passage more than 
7 years ago. We continue to believe that Congress may wish to consider 
such oversight as the federal government is missing opportunities to 
collect hundreds of millions of dollars in unpaid taxes owed by DOD 
contractors. In oral comments, OMB questioned the need for developing 
or pursuing additional mechanisms to prohibit federal contract awards 
to "tax abusers." OMB's comments provide us no basis to change our 
recommendation. We believe that OMB should assume a leadership role in 
ensuring that contractors that abuse the tax system are prohibited from 
receiving federal contracts. See the "Agency Comments and Our 
Evaluation" section of this report for a more detailed discussion of 
agency comments. We have reprinted the DOD and IRS written comments in 
appendixes III and IV.

Background:

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.

Figure 1: Fiscal Year 2002 Federal Contract Award Amounts by Agency:

[See PDF for image]

[End of figure]

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[Footnote 8] 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[Footnote 9] used in contract 
pay disbursed over $86 billion to contractors in fiscal year 2002. 
While somewhat of a misnomer, vendor pay[Footnote 10] 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,[Footnote 11] including interest and penalties, 
totaling $249 billion, of which $112 billion has some collection 
potential and thus is at risk.[Footnote 12]

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.[Footnote 13] 
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[Footnote 14] 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.[Footnote 
15] 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.[Footnote 16] 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.[Footnote 17] 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.[Footnote 18]

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.[Footnote 19] 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.[Footnote 20] 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).[Footnote 21] Once a notice of impending levy is received, the 
delinquent taxpayer has several options for action and a minimum of 30 
days to respond.[Footnote 22] 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.[Footnote 23] 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,[Footnote 24] we estimated that 
IRS could use the levy program to potentially recover hundreds of 
millions of dollars in tax debt.

DOD Contractors Owe Billions in Unpaid Federal Taxes:

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.

Magnitude of Unpaid Federal Taxes Owed by DOD Contractors:

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.[Footnote 25] 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.

Figure 2: DOD Contractor Unpaid Taxes by Tax Type:

[See PDF for image]

[End of figure]

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.[Footnote 26] 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).[Footnote 27] Failure to 
remit payroll taxes can also be a criminal felony offense[Footnote 28] 
punishable by imprisonment of more than a year, while the failure to 
properly segregate payroll taxes can be a criminal misdemeanor 
offense[Footnote 29] 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.[Footnote 30] 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.[Footnote 31]

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.

Figure 3: DOD Contractor Unpaid Taxes by Fiscal Year:

[See PDF for image]

[End of figure]

Our previous work[Footnote 32] 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.

DOD Contractor Unpaid Taxes Are Likely Understated:

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[Footnote 33] 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.[Footnote 34] Our examination 
also identified some invalid TINs[Footnote 35] 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.[Footnote 36] 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.[Footnote 37]

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[Footnote 38] 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[Footnote 39] 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,[Footnote 40] 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.

DOD and IRS Are Not Collecting Millions in Unpaid Federal Taxes from 
Contractors:

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.

DOD Is Not Fully Assisting in the Collection of Unpaid Taxes Owed by 
Its Contractors:

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.[Footnote 41] 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.[Footnote 42] 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.[Footnote 43] 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.[Footnote 44]

IRS Policies Exclude Cases from the Levy Program:

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.[Footnote 45]

* 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.[Footnote 46] 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.[Footnote 47] 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.[Footnote 48]

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.

IRS Delays in Processing and Inaccurate Records Exclude Cases from the 
Levy Program:

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[Footnote 49] 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.[Footnote 50] 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.[Footnote 51] 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.[Footnote 52] 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.

IRS Subordinates Use of the Levy Program to Other Collection Efforts:

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.[Footnote 53] 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.

Challenges for IRS Collections:

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.[Footnote 54] 
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.[Footnote 55] 
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.

DOD Contractors Involved in Abusive or Potentially Criminal Activity 
Related to the Federal Tax System:

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,"[Footnote 56] 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.

Nature of Business for Case Study Contractors:

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.

Table 1: Types of Goods and Services Provided by DOD Contractors in 
Case Studies:

Type of business: Maintenance/construction services; Number: 8.

Type of business: Custodial services; Number: 4.

Type of business: Aircraft-related goods supplier; Number: 4.

Type of business: Research services; Number: 3.

Type of business: Consulting services; Number: 3.

Type of business: Music services; Number: 2.

Type of business: Dentist; Number: 2.

Type of business: Training services; Number: 2.

Type of business: Information technology personnel services; Number: 2.

Type of business: Other[A]; Number: 17.

Total; Number: 47.

Source: GAO analysis of DOD and public records.

[A] Includes goods and services such as uniform manufacturing, courier 
services, medical personnel services, funeral services, weapon parts, 
and computer equipment.

[End of table]

Examples of Abusive or Potentially Criminal Activity Related to the 
Federal Tax System by Businesses:

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[Footnote 57] 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.[Footnote 58] Additionally, the failure to comply with certain 
requirements for the separate accounting and deposit of withheld income 
and employment taxes is a misdemeanor.[Footnote 59]

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.

Table 2: DOD Contractors with Unpaid Federal Taxes--Business:

Case study: 1; 
Goods or service and nature of DOD work: Base support and custodial 
services: provides dining, trash removal, security, cleaning, and 
recycling programs on military bases; 
Unpaid federal tax amount[A]: Nearly $10 million; 
Estimated fiscal year 2002 collections under effective tax levy[B]: 
$527,000; 
Fiscal year 2002 DOD payments[C]: $3.5 million; 
Comments: State tax authorities levied the business bank account. The 
owner borrowed nearly $1 million from the business. The owner bought a 
boat, several cars, and a home outside the United States. The business 
was dissolved in 2003 and transferred its employees to a relative's 
business, where it submitted invoices and received payments from DOD 
on a previous contract through August 2003.

Case study: 2; 
Goods or service and nature of DOD work: Engineering research 
services: conducts studies for DOD; 
Unpaid federal tax amount[A]: Over $1 million; 
Estimated fiscal year 2002 collections under effective tax levy[B]: 
$58,000; 
Fiscal year 2002 DOD payments[C]: $390,000; 
Comments: The owner paid $1 million to purchase a house and 
furnishings in the mid-1990s. At around the same time, the owner 
borrowed nearly $1 million from the business, and the business stopped 
paying its taxes in full. DOD awarded the business contracts totaling 
over $600,000.

Case study: 3; 
Goods or service and nature of DOD work: Aircraft- related goods: 
manufactures structural parts for DOD aircraft; 
Unpaid federal tax amount[A]: Nearly $2 million; 
Estimated fiscal year 2002 collections under effective tax levy[B]: 
$50,000; 
Fiscal year 2002 DOD payments[C]: $336,000; 
Comments: The business received over 30 DOD contracts from 1997 
through 2002 totaling nearly $2 million.

Case study: 4; 
Goods or service and nature of DOD work: Research services: provides 
research for DOD; 
Unpaid federal tax amount[A]: Over $700,000; 
Estimated fiscal year 2002 collections under effective tax levy[B]: 
$13,000; 
Fiscal year 2002 DOD payments[C]: $86,000; 
Comments: DOD awarded the business a contract in 2002 for nearly 
$800,000. Owner has over $1 million in loans related to cars, real 
estate, and recreational activities, and owner also has a high-
performance airplane.

Case study: 5; 
Goods or service and nature of DOD work: Janitorial services;  
provides custodial services at a DOD facility; 
Unpaid federal tax amount[A]: Over $3 million; 
Estimated fiscal year 2002 collections under effective tax levy[B]: 
$108,000; 
Fiscal year 2002 DOD payments[C]: $719,000; 
Comments: The business did not make tax payments after early 2001, and 
it made only partial payments prior to that dating back to the mid-
1990s. The business also did not file corporate tax returns for 8 
years.

Case study: 6; 
Goods or service and nature of DOD work: Private security services: 
provides security guards at military bases; 
Unpaid federal tax amount[A]: Nearly $6 million; 
Estimated fiscal year 2002 collections under effective tax levy[B]: 
$3,000; 
Fiscal year 2002 DOD payments[C]: $21,000; 
Comments: One of the business's officers, who owns a large boat, paid 
off a recreation-related loan in 1999. The business paid taxes while 
in bankruptcy, but largely stopped paying after emerging from 
bankruptcy.

Case study: 7; 
Goods or service and nature of DOD work: Furniture sales and 
construction services;  
sells and installs office furniture at military installations; 
Unpaid federal tax amount[A]: Over $150,000; 
Estimated fiscal year 2002 collections under effective tax levy[B]: 
$6,000; 
Fiscal year 2002 DOD payments[C]: $38,000; 
Comments: The owners used the business to pay personal expenses, such 
as house mortgage and credit cards. One owner is a retired military 
officer.

Case study: 8; 
Goods or service and nature of DOD work: Custodial services;  
provides janitorial and housekeeping services at military 
installations; 
Unpaid federal tax amount[A]: Over $800,000; 
Estimated fiscal year 2002 collections under effective tax levy[B]: 
$219,000; 
Fiscal year 2002 DOD payments[C]: $1.5 million; 
Comments: The business received numerous DOD contracts from 1998 
through 2001 totaling nearly $12 million. The business is linked to 
potential check fraud.

Case study: 9; 
Goods or service and nature of DOD work: Construction services;  
provides housing management services including maintenance, repairs, 
and renovations, on military bases; 
Unpaid federal tax amount[A]: Over $1 million; 
Estimated fiscal year 2002 collections under effective tax levy[B]: 
$357,000; 
Fiscal year 2002 DOD payments[C]: $2.4 million; 
Comments: The business owes DOD tens of thousands of dollars for an 
overpayment in early 2000.

Case study: 10; 
Goods or service and nature of DOD work: Base support services;  
provides landscaping and snow removal at a military base; 
Unpaid federal tax amount[A]: Nearly; 
$1 million; 
Estimated fiscal year 2002 collections under effective tax levy[B]: 
$33,000; 
Fiscal year 2002 DOD payments[C]: $217,000; 
Comments: The business was awarded contracts from 1999 through 2000 
worth over $1 million. The business owes taxes dating back to the 
early 1990s.

Case study: 11; 
Goods or service and nature of DOD work: Construction services: 
provides repairs to aircraft hangars at a military base; 
Unpaid federal tax amount[A]: Over $700,000; 
Estimated fiscal year 2002 collections under effective tax levy[B]: 
$422,000; 
Fiscal year 2002 DOD payments[C]: $2.8 million; 
Comments: [Empty].

Case study: 12; 
Goods or service and nature of DOD work: Medical personnel services: 
provides; 
nursing, pharmacy, physical therapy, and other skilled medical 
personnel in DOD facilities; 
Unpaid federal tax amount[A]: Nearly $6 million; 
Estimated fiscal year 2002 collections under effective tax levy[B]: 
$698,000; 
Fiscal year 2002 DOD payments[C]: $4.7 million; 
Comments: Several federal and state tax liens have been placed against 
the owner.

Case study: 13; 
Goods or service and nature of DOD work: Aircraft- related goods: 
manufactures aircraft components for several DOD and civilian 
programs; 
Unpaid federal tax amount[A]: Over $400,000; 
Estimated fiscal year 2002 collections under effective tax levy[B]: 
$29,000; 
Fiscal year 2002 DOD payments[C]: $194,000; 
Comments: The business was awarded numerous DOD contracts in a recent 
4-year period totaling over $300,000. 

Source: GAO analysis of DOD, IRS, FMS, public, and other records.

Notes: Dollar amounts are rounded. The nature of unpaid taxes for 
businesses was primarily due to unpaid payroll taxes. A contractor 
registers in the CCR database with either an EIN or an SSN. In our 
report, any contractor registering with an EIN is referred to as a 
business, and any contractor registering with an SSN is referred to as 
an individual. An individual in CCR could be a business owner (i.e., 
sole proprietorship).

[A] Unpaid tax amount as of September 30, 2002.

[B] The estimated collections under an effective tax levy use the 
assumptions that all unpaid federal taxes are referred to TOP at 
Treasury FMS and all fiscal year 2002 DOD payment information is 
provided to TOP. The collection amount is calculated on 15 percent of 
the payment amount up to the amount of unpaid taxes.

[C] DOD payments from MOCAS, One Bill Pay, Integrated Accounts Payable 
System (IAPS), Computerized Accounts Payable System (CAPS) Clipper, and 
CAPS Windows automated systems identified by GAO.

[End of table]

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.

Examples of Abuse of the Federal Tax System by Individuals:

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.

Table 3: DOD Contractors with Unpaid Federal Taxes--Individual:

Case study: 14; 
Goods or service and nature of DOD work: Vehicle repair services: 
provides repair and painting for military vehicles; 
Unpaid federal tax amount[A]: Over $100,000; 
Estimated fiscal year 2002 collections under effective tax levy[B]: 
$22,000; 
Fiscal year 2002 DOD payments[C]: $147,000; 
Comments: The business was investigated for paying employee wages in 
cash. Despite a substantial tax liability, the owner recently 
purchased a home valued at over $1 million as well as a luxury sports 
car. The owner also owes a federal agency for child support.

Case study: 15; 
Goods or service and nature of DOD work: Dentist: provides; 
dental services at a military facility; 
Unpaid federal tax amount[A]: Over $100,000; 
Estimated fiscal year 2002 collections under effective tax levy[B]: 
$12,000; 
Fiscal year 2002 DOD payments[C]: $78,000; 
Comments: DOD recently increased the individual's contract by over 
$80,000. The dentist's credit history included several credit card 
accounts that were identified for collection action.

Case study: 16; 
Goods or service and nature of DOD work: Dentist: provides; 
dental services at a military facility; 
Unpaid federal tax amount[A]: Over $200,000; 
Estimated fiscal year 2002 collections under effective tax levy[B]: 
$11,000; 
Fiscal year 2002 DOD payments[C]: $76,000; 
Comments: DOD awarded the individual a multiyear contract for over 
$400,000. This individual paid income tax for only 1 year since 1993. 
The individual previously had a business that owes over $100,000 in 
unpaid payroll and unemployment taxes going back to the early 1990s.

Case study: 17; 
Goods or service and nature of DOD work: Training services; 
 conducts management and leadership courses; 
Unpaid federal tax amount[A]: Over $100,000; 
Estimated fiscal year 2002 collections under effective tax levy[B]: 
$2,000; 
Fiscal year 2002 DOD payments[C]: $12,000; 
Comments: This individual has not paid income taxes for 5 years. 

Source: GAO analysis of DOD, IRS, FMS, public, and other records.

Notes: Dollar amounts are rounded. Nature of unpaid taxes for 
individuals was primarily due to unpaid income taxes. A contractor 
registers in the CCR database with either an EIN or an SSN. In our 
report, any contractor registering with an EIN is referred to as a 
business, and any contractor registering with an SSN is referred to as 
an individual. An individual in CCR could be a business owner (i.e., 
sole proprietorship). For cases selected as individuals, we reviewed 
both the owner and related business information, if it could be 
identified.

[A] Unpaid tax amount as of September 30, 2002.

[B] The estimated collections under an effective tax levy use the 
assumptions that all unpaid federal taxes are referred to TOP at 
Treasury FMS and all fiscal year 2002 DOD payment information is 
provided to TOP. The collection amount is calculated on 15 percent of 
the payment amount up to the amount of unpaid taxes.

[C] DOD payments from MOCAS, One Bill Pay, IAPS, and CAPS automated 
systems identified by GAO.

[End of table]

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.

Contractors with Unpaid Taxes Are Not Prohibited by Law from Receiving 
Contracts from the Federal Government:

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.[Footnote 60] 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.[Footnote 61] 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.[Footnote 62] This statutory requirement is implemented in the 
FAR, which requires that government purchases be made from, and 
government contracts awarded to, responsible contractors 
only.[Footnote 63] 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,[Footnote 64] as well as to review a prospective 
contractor's certification[Footnote 65] on debarment, suspension, and 
other responsibility matters. Among the causes for debarment and 
suspension is tax evasion.[Footnote 66] 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.[Footnote 67]

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.[Footnote 68] As we found in November 
2002,[Footnote 69] 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.[Footnote 70]

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.

Conclusions:

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.

Matters for Congressional Consideration:

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.

Recommendations for Executive Action:

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 process,

* 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 
information; and:

* address any necessary exceptions, such as when the goods or services 
cannot be obtained from other sources or for national security.

Agency Comments and Our Evaluation:

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,[Footnote 
71] 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 [Hyperlink, http://www.gao.gov].

Please contact Gregory D. Kutz at (202) 512-9095 or [Hyperlink, 
kutzg@gao.gov], John J. Ryan at (202) 512-9587 or 
[Hyperlink, ryanj@gao.gov], or Steven J. Sebastian at 
(202) 512-3406 or [Hyperlink, sebastians@gao.gov] if you or your staff 
have any questions concerning this report.

Signed by:

Gregory D. Kutz: 
Director: 
Financial Management and Assurance:

Signed by:

Robert J. Cramer: 
Managing Director: 
Office of Special Investigations:

Signed by:

Steven J. Sebastian: 
Director: 
Financial Management and Assurance:

[End of section]

Appendixes: 

Appendix I: Scope and Methodology:

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.[Footnote 72] 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.

[End of section]

Appendix II: DOD Contractors with Unpaid Federal Taxes:

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.

Table 4: DOD Contractors with Unpaid Federal Taxes--Business:

Case study: 18; 
Goods or service and nature of DOD work: 
Television repair services: 
provides repairs at military hospital; 
Unpaid federal tax amount[A]: Over $160,000; 
Estimated fiscal year 2002 collections under effective tax levy[B]: 

$5,000; 
Fiscal year 2002 DOD payments[C]: $32,000; 
Comments: 
* Contract for over $180,000 in late 1990s; 
* Long history of not remitting tax withholdings; 
* Several federal tax liens filed against the owner.

Case study: 19; 
Goods or service and nature of DOD work: 
Clothing manufacturer: provides military uniforms for DOD agency; 
Unpaid federal tax amount[A]: Over $1 million; 
Estimated fiscal year 2002 collections under effective tax levy[B]: 
$137,000; 
Fiscal year 2002 DOD payments[C]: $914,000; 
Comments: 
* Numerous DOD contract awards totaling over $10 million; 
* Offer in compromise, subsequently withdrawn.

Case study: 20; 
Goods or service and nature of DOD work: 
Courier service; 
Unpaid federal tax amount[A]: Over $300,000; 
Estimated fiscal year 2002 collections under effective tax levy[B]: 
$5,000; 
Fiscal year 2002 DOD payments[C]: $34,000; 
Comments: 
* DOD contract of over $30,000; 
* Bankruptcy filed; 
* Several tax liens filed against the business.

Case study: 21; 
Goods or service and nature of DOD work: 
Construction services: provides fencing installation, maintenance and 
renovations on military bases; 
Unpaid federal tax amount[A]: Nearly $60,000; 
Estimated fiscal year 2002 collections under effective tax levy[B]: 
Nearly $60,000; 
Fiscal year 2002 DOD payments[C]: $1.1 million; 
Comments: 
* Business cooperated with IRS only after being placed in Federal 
Payment Levy Program and being levied on payments from a participating 
federal agency; 
IRS received almost $25,000 from levied payments; 
* Has unpaid child support debt; 
* Two tax liens filed against business.

Case study: 22; 
Goods or service and nature of DOD work: 
Weapon parts manufacturer: supplies weapons parts and tools to various 
military organizations; 
Unpaid federal tax amount[A]: Over $400,000; 
Estimated fiscal year 2002 collections under effective tax levy[B]: 
$54,000; 
Fiscal year 2002 DOD payments[C]: $363,000; 
Comments: 
* Nearly $1.9 million in DOD contracts; 
* IRS tax liens filed against business.

Case study: 23; 
Goods or service and nature of DOD work: 
Cleaning services: provides cleaning and inspections of fire 
suppression systems; 
Unpaid federal tax amount[A]: Over $250,000; 
Estimated fiscal year 2002 collections under effective tax levy[B]: 
$6,000; 
Fiscal year 2002 DOD payments[C]: $40,000; 
Comments: 
* Awarded over $200,000 in DOD contracts; 
* Several tax liens filed against business and its owner.

Case study: 24; 
Goods or service and nature of DOD work: 
Computer equipment supplier: supplies; 
computer-related hardware to military services; 
Unpaid federal tax amount[A]: Over $500,000; 
Estimated fiscal year 2002 collections under effective tax levy[B]: 
$7,000; 
Fiscal year 2002 DOD payments[C]: $45,000; 
Comments: 
* Over $1.3 million in DOD contracts; 
* Owes tens of thousands of dollars to a federal agency for a civil 
penalty for failing to meet its fiduciary duties under the employee 
retirement plan; 
* Several federal, state, and county tax liens filed against business.

Case study: 25; 
Goods or service and nature of DOD work: 
Information technology personnel services: provides support for 
various military organizations; 
Unpaid federal tax amount[A]: Nearly $1 million; 
Estimated fiscal year 2002 collections under effective tax levy[B]: 
$140,000; 
Fiscal year 2002 DOD payments[C]: $932,000; 
Comments: 
* Federal payments received from three other federal agencies; 
* Multiple DOD contracts valued up to approximately $13 million; 
* Potential money laundering activities; 
* Defaulted on installment agreements.

Case study: 26; 
Goods or service and nature of DOD work: 
Aircraft- related goods: supplies aircraft maintenance equipment; 
Unpaid federal tax amount[A]: Over $1.5 million; 
Estimated fiscal year 2002 collections under effective tax levy[B]: 
$33,000; 
Fiscal year 2002 DOD payments[C]: $221,000; 
Comments: 
* Nearly $2 million in DOD contracts; 
* Several federal and state tax liens filed against this business; 
* Several judgments were made against this contractor.

Case study: 27; 
Goods or service and nature of DOD work: 
Aircraft- related goods: supplies instruments to military services; 
Unpaid federal tax amount[A]: Nearly $300,000; 
Estimated fiscal year 2002 collections under effective tax levy[B]: 
$7,000; 
Fiscal year 2002 DOD payments[C]: $48,000; 
Comments: 
* Numerous DOD contracts totaling over $350,000.

Case study: 28; 
Goods or service and nature of DOD work: 
Research services: provides research for military service programs; 
Unpaid federal tax amount[A]: Over $400,000; 
Estimated fiscal year 2002 collections under effective tax levy[B]: 
$4,000; 
Fiscal year 2002 DOD payments[C]: $30,000; 
Comments: 
* DOD contract for over $100,000; 
* Federal tax liens filed against business.

Case study: 29; 
Goods or service and nature of DOD work: 
Catering services; 
Unpaid federal tax amount[A]: Over $60,000; 
Estimated fiscal year 2002 collections under effective tax levy[B]: 
$4,000; 
Fiscal year 2002 DOD payments[C]: $29,000; 
Comments: 
* Several IRS tax liens and state tax liens filed against this 
business.

Case study: 30; 
Goods or service and nature of DOD work: 
Ammunition: manufactures ammunition; 
Unpaid federal tax amount[A]: Over $2 million; 
Estimated fiscal year 2002 collections under effective tax levy[B]: 
$100; 
Fiscal year 2002 DOD payments[C]: $1,000; 
Comments: 
* Over $8 million in DOD contracts; 
* Currently involved in a criminal investigation on product quality.

Case study: 31; 
Goods or service and nature of DOD work: 
Consulting services: provides technical support services for military 
installations; 
Unpaid federal tax amount[A]: Nearly $2 million; 
Estimated fiscal year 2002 collections under effective tax levy[B]: 
$410,000; 
Fiscal year 2002 DOD payments[C]: $2.7 million; 
Comments: 
* Nearly $30 million in DOD contracts; 
* Bankruptcy filed; 
* Federal and state tax liens filed.

Case study: 32; 
Goods or service and nature of DOD work: 
Moving services: provides furniture and office equipment for military 
installations; 
Unpaid federal tax amount[A]: Over $50,000; 
Estimated fiscal year 2002 collections under effective tax levy[B]: 
Over $50,000; 
Fiscal year 2002 DOD payments[C]: $399,000; 
Comments: 
* Over $200,000 in DOD contracts; 
* Several federal and state tax liens filed.

Case study: 33; 
Goods or service and nature of DOD work: 
Power equipment: manufactures power supplies and regulators for 
various military organizations; 
Unpaid federal tax amount[A]: Over $200,000; 
Estimated fiscal year 2002 collections under effective tax levy[B]: 
$86,000; 
Fiscal year 2002 DOD payments[C]: $571,000; 
Comments: 
* Over $3 million in DOD contracts; 
* Tax lien filed against this business; 
* Several judgments filed against the business and its owner in the 
mid-1990s.

Case study: 34; 
Goods or service and nature of DOD work: 
Custodial services: provides janitorial and housekeeping services at 
military installations; 
Unpaid federal tax amount[A]: Over $5 million; 
Estimated fiscal year 2002 collections under effective tax levy[B]: 
$188,000; 
Fiscal year 2002 DOD payments[C]: $1.3 million; 
Comments: 
* About $4 million in DOD contracts; 
* Multiple bankruptcies filed; 
* Several federal and state tax liens filed against business.

Case study: 35; 
Goods or service and nature of DOD work: 
Construction services: provides construction services at military 
installations; 
Unpaid federal tax amount[A]: Nearly $150,000; 
Estimated fiscal year 2002 collections under effective tax levy[B]: 
$23,000; 
Fiscal year 2002 DOD payments[C]: $152,000; 
Comments: 
* Bankruptcy filed in late 1990s; 
* IRS received over $70,000 from levied payments from agencies other 
than DOD.

Case study: 36; 
Goods or service and nature of DOD work: 
Funeral home: provides funeral services; 
Unpaid federal tax amount[A]: Over $360,000; 
Estimated fiscal year 2002 collections under effective tax levy[B]: 
$2,000; 
Fiscal year 2002 DOD payments[C]: $14,000; 
Comments: 
* Continued to incur delinquent taxes after emerging from bankruptcy.

Case study: 37; 
Goods or service and nature of DOD work: 
Procurement services; 
obtains parts and equipment for various military organizations; 
Unpaid federal tax amount[A]: Over $100,000; 
Estimated fiscal year 2002 collections under effective tax levy[B]: 
$12,000; 
Fiscal year 2002 DOD payments[C]: $81,000; 
Comments: 
* Several federal and state tax liens filed against this business and 
its owner.

Case study: 38; 
Goods or service and nature of DOD work: 
Information technology personnel services: provides information 
technology support to military organizations; 
Unpaid federal tax amount[A]: Over $1 million; 
Estimated fiscal year 2002 collections under effective tax levy[B]: 
$289,000; 
Fiscal year 2002 DOD payments[C]: $1.9 million; 
Comments: 
* Corporate officer assessed a trust fund recovery penalty.

Source: GAO analysis of DOD, IRS, FMS, public, and other records.

Notes: Dollar amounts are rounded. Nature of unpaid taxes for 
businesses was primarily due to unpaid payroll taxes. A contractor 
registers in the CCR database with either an EIN or an SSN. In our 
report, any contractor registering with an EIN is referred to as a 
business, and any contractor registering with an SSN is referred to as 
an individual. An individual in CCR could be a business owner (i.e., 
sole proprietorship).

[A] Unpaid tax amount as of September 30, 2002.

[B] The estimated collections under an effective tax levy use the 
assumptions that all unpaid federal taxes are referred to TOP at 
Treasury FMS and all fiscal year 2002 DOD payment information is 
provided to TOP. The collection amount is calculated on 15 percent of 
the payment amount up to the amount of unpaid taxes.

[C] DOD payments from MOCAS, One Bill Pay, IAPS, and CAPS automated 
systems identified by GAO.

[End of table]

Table 5: DOD Contractors with Unpaid Federal Taxes--Individual:

Case study: 39; 
Goods or service and nature of DOD work: 
Music services: provides musicians and music services; 
Unpaid federal tax amount[A]: Over $30,000; 
Estimated fiscal year 2002 collections under effective tax levy[B]: 
$2,000; 
Fiscal year 2002 DOD payments[C]: $16,000; 
Comments: 
* Over $50,000 in DOD contracts; 
* Debt for unpaid child support; 
* Individual has personal debt that has been turned over for 
collection action.

Case study: 40; 
Goods or service and nature of DOD work: 
Maintenance services; 
repairs shielded doors for secure areas; 
Unpaid federal tax amount[A]: Over $50,000; 
Estimated fiscal year 2002 collections under effective tax levy[B]: 
$4,000; 
Fiscal year 2002 DOD payments[C]: $28,000; 
Comments: 
* Over $100,000 in DOD contracts; 
* Bankruptcies filed in mid-1990s; 
* Several court judgments filed against the contractor in the mid-to 
late 1990s.

Case study: 41; 
Goods or service and nature of DOD work: 
Music services: provides musicians for religious services; 
Unpaid federal tax amount[A]: Over $160,000; 
Estimated fiscal year 2002 collections under effective tax levy[B]: 
$33,000; 
Fiscal year 2002 DOD payments[C]: $217,000; 
Comments: 
* Individual has not filed an income tax return since 1997; 
* Defaulted on installment agreement in the late 1990s.

Case study: 42; 
Goods or service and nature of DOD work: 
Construction services; 
provides general carpentry, electrical, painting, and building 
repairs; 
Unpaid federal tax amount[A]: Nearly $70,000; 
Estimated fiscal year 2002 collections under effective tax levy[B]: 
$19,000; 
Fiscal year 2002 DOD payments[C]: $130,000; 
Comments: 
* Over $100,000 in DOD contracts; 
* Federal tax lien filed against this individual.

Case study: 43; 
Goods or service and nature of DOD work: 
Consulting services: provides software development services; 
Unpaid federal tax amount[A]: Over $50,000; 
Estimated fiscal year 2002 collections under effective tax levy[B]: 
$8,000; 
Fiscal year 2002 DOD payments[C]: $56,000; 
Comments: 
* Individual has personal credit accounts in collection; 
* Federal tax lien filed against this individual.

Case study: 44; 
Goods or service and nature of DOD work: 
Training services; 
provides diversity and sexual harassment training; 
Unpaid federal tax amount[A]: Over $60,000; 
Estimated fiscal year 2002 collections under effective tax levy[B]: 
$13,000; 
Fiscal year 2002 DOD payments[C]: $89,000; 
Comments: 
* Over $90,000 in DOD contracts; 
* Student loan debt; 
* Individual owes over $10,000 in past due debt; 
* Several civil judgments and state tax liens filed against contractor.

Case study: 45; 
Goods or service and nature of DOD work: 
Equipment maintenance: provides maintenance and repair of boilers, 
generators, and compressors; 
Unpaid federal tax amount[A]: Nearly $260,000; 
Estimated fiscal year 2002 collections under effective tax levy[B]: 
$17,000; 
Fiscal year 2002 DOD payments[C]: $113,000; 
Comments: 
* Individual owes over $10,000 in past due debt; 
* Defaulted on installment agreement; 
* One judgment against individual.

Case study: 46; 
Goods or service and nature of DOD work: 
Environmental engineering: prepares environmental reports; 
Unpaid federal tax amount[A]: Over $10,000; 
Estimated fiscal year 2002 collections under effective tax levy[B]: 
Over $10,000; 
Fiscal year 2002 DOD payments[C]: $286,000; 
Comments: 
* Owner is federal employee and reserve military officer.

Case study: 47; 
Goods or service and nature of DOD work: 
Consulting services; provides advice to a military medical command; 
Unpaid federal tax amount[A]: Nearly $140,000; 
Estimated fiscal year 2002 collections under effective tax levy[B]: 
$13,000; 
Fiscal year 2002 DOD payments[C]: $89,000; 
Comments: 
* Nearly $300,000 in DOD contracts; 
* Student loan debt with a federal agency; 
* Individual has several accounts with collection agency; 
* Federal tax lien filed against individual. 

Source: GAO analysis of DOD, IRS, FMS, public, and other records.

Notes: Dollar amounts are rounded. Nature of unpaid taxes for 
individuals was primarily due to unpaid income taxes. A contractor 
registers in the CCR database with either an EIN or an SSN. In our 
report, any contractor registering with an EIN is referred to as a 
business, and any contractor registering with an SSN is referred to as 
an individual. An individual in CCR could be a business owner (i.e., 
sole proprietorship). For cases selected as individuals, we reviewed 
both the owner and related business information, if it could be 
identified.

[A] Unpaid tax amount as of September 30, 2002.

[B] The estimated collections under an effective tax levy use the 
assumptions that all unpaid federal taxes are referred to TOP at 
Treasury FMS and all fiscal year 2002 DOD payment information is 
provided to TOP. The collection amount is calculated on 15 percent of 
the payment amount up to the amount of unpaid taxes.

[C] DOD payments from MOCAS, One Bill Pay, IAPS, and CAPS automated 
systems identified by GAO.

[End of table]

[End of section]

Appendix III: Comments from the Department of Defense:

UNDER SECRETARY OF DEFENSE 
1100 DEFENSE PENTAGON 
WASHINGTON, DC 20301-1100:

COMPTROLLER:

JAN 15 2004:

Mr. Gregory D. Kutz:

Director, Financial Management and Assurance: 
U.S. General Accounting Office:

Washington, DC 20548:

Dear Mr. Kutz:

This is the Department of Defense (DoD) response to the General 
Accounting Office (GAO) Draft Report (04-95), "FINANCIAL MANAGEMENT: 
DoD Pays Billions of Dollars to Contractors That Abuse the Federal Tax 
System," dated December 8, 2003, (GAO: Code 192092). The DoD concurs 
with the four recommendations in the draft report and is already 
taking action to correct the noted deficiencies. 

The Department appreciates the opportunity to comment on the subject 
report.

Mr. Tom Summers will be available to help resolve the issues outlined 
in this report. He may be contacted by e-mail: tom.summers@osd.mil or 
by telephone at (703) 697-3193.

Sincerely,

Signed by: 

Dov S. Zakheim:

Enclosure: As stated:

GAO DRAFT REPORT - DATED DECEMBER 8, 2003 GAO CODE 192092/GAO-04-95:

"FINANCIAL MANAGEMENT: DOD PAYS BILLIONS OF DOLLARS TO CONTRACTORS THAT 
ABUSE THE FEDERAL TAX SYSTEM":

DEPARTMENT OF DEFENSE COMMENTS TO THE RECOMMENDATIONS:

RECOMMENDATION 1: The GAO recommended that the Secretary of Defense 
direct the Under Secretary of Defense (Comptroller) to develop a formal 
plan to implement the Debt Collection Improvement Act (DCIA) of 1996 by 
providing payment information to the U. S. Treasury's Offset Program 
(TOP) for all Defense Finance and Accounting Service (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.

DOD RESPONSE: Concur. The Defense Finance and Accounting Service (DFAS) 
Columbus implemented the Treasury Offset Plan (TOP) on December 16, 
2002, to offset/levy payments made to DoD contractors in the 
Mechanization of Contract Administration Services (MOCAS) system. To 
date, DFAS has collected approximately $1,150,292.21 in offsets/levies.

The following chart summarizes the plan status for 100 percent of the 
entitlement systems on which DFAS bases its contract and vendor 
payments. The implementation dates include the time that DFAS will need 
to establish procedures for withholding funds that Treasury identifies 
for offset/levy.

The completion date to implement the DoD's offset/levy program for the 
DFAS payment systems is August 2004. For the non-DFAS systems, DFAS has 
been requested to work with the appropriate system owners and the 
Treasury Financial Management Service (FMS) to develop an 
implementation plan by February 27, 2004. The target date for 
implementation of the offset/levy program for non-DFAS system owners is 
March 2005.

Enclosure:

Department of Defense Treasury Offset Program (TOP) Implementation 
Plan:

[See PDF for image]

[End of table]

RECOMMENDATION 2: The GAO recommended that the Secretary of Defense 
direct the Under Secretary of Defense (Comptroller) to collaborate with 
the U.S. Treasury's Financial Management Service to develop interim 
procedures for identifying active Defense contractors in the TOP.

DOD RESPONSE: Concur. Once the Department identifies the invoices 
available for offset, the process of identifying active Defense 
contractors in the TOP currently is reserved to FMS. The Department 
will partner with FMS and IRS to assess the possibility of developing 
more extensive matching logic with the objective of increasing the 
number of matches available.

The Department has been collaborating in other ways. In addition to 
providing FMS with the payment availability file on a weekly basis, FMS 
was provided with a list of the approximately 336,000 open 
Mechanization of Contract Administration Services (MOCAS) contracts 
that have Tax Identification Numbers (TINs) in order to predict 
possible future offset/levy opportunities. From this list, there were 
225 matches, which represents 0.067 percent of the open contracts in 
MOCAS. Additionally, FMS was provided a list of payable invoices from 
CAPS-W (Columbus), which resulted in one match, that is, 0.032 percent. 
The Department is also assessing the feasibility of providing payment 
availability files to FMS more frequently. The Department has been, and 
will continue to be, proactive in working with Treasury to generate as 
many collections as possible.

Estimated Completion Date: Ongoing.

RECOMMENDATION 3: The GAO recommended that the Secretary of Defense 
direct the Under Secretary of Defense (Comptroller) to develop manual 
procedures so that the offset of payments can be started immediately 
for all DoD payment systems.

DOD RESPONSE: Partially Concur. The Department's implementation plan 
has been accelerated to 6 months for most payment systems. We believe 
that our focus should remain on implementing a system-based process 
rather than temporary manual procedures.

Estimated Completion Date: Not applicable.

RECOMMENDATION 4: The GAO recommended that the Secretary of Defense 
direct the Under Secretary of Defense (Comptroller) to devote 
sufficient resources to implement all aspects of the TOP and the DoD 
plan (identified in recommendation 1).

DOD RESPONSE: Concur. The Department will devote the necessary 
resources to support the offset/levy program as it is implemented in 
each system in the plan identified in Recommendation 1. The level of 
resources will be revaluated as the program progresses.

Estimated Completion Date: Ongoing.

Matters for Congressional Consideration: Until such time as DoD is able 
to demonstrate it is meeting its responsibilities under the DCIA, 
including providing payment information to TOP for purposes of 
offsetting delinquent federal debt, and to facilitate action by the 
Department, Congress should consider requiring that DoD report 
periodically to the Congress on its progress in implementing the Act 
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.

DoD Response: Such a Congressional requirement is not necessary. As the 
implementation plan proceeds, the Department will report the progress 
of implementing the requirements of the Debt Collection Improvement Act 
within each of its contract and vendor payment systems to the GAO.

Appendix IV: Comments from the Internal Revenue Service:

DEPARTMENT OF THE TREASURY 
INTERNAL REVENUE SERVICE 
WASHINGTON. D.C. 20224:

January 12, 2004:

Mr. Steven J. Sebastian: 
Director, Financial Management and Assurance:  
United States General Accounting Office: 
Washington, D.C. 20548:

Dear Mr. Sebastian:

We have read your report entitled, "DOD Pays Billions of Dollars to 
Contractors Thatt Abuse the Federal Tax System" (GAO-04-95) and agree 
with the concerns you identified with contractors who abuse the federal 
tax system. We also agree that the Federal Payment Levy Program (FPLP) 
is one program that can become a more effective tool to collect 
delinquent federal taxes owed by businesses and individuals who receive 
federal payments, including Department of Defense (DOD) contractors.

The FPLP program provides an automated process for serving tax levies 
and collecting unpaid taxes through Treasury's Financial Management 
Service (FMS). The FMS uses its Treasury Offset Program to match 
certain types of federal payments against federal tax debt records. As 
a result the program applies a portion of these federal payments to the 
outstanding tax liabilities:

While FPLP is an effective tool to collect delinquent taxes, its use 
must be balanced against taxpayer rights. When taxpayers submit an 
Installment Agreement or Offer in Compromise, they are entitled, by 
statute, to have their request considered by the Internal Revenue 
Service. Taxpayers also have an absolute right to an independent appeal 
of proposed enforcement actions. In these situations, unless a jeopardy 
condition exists, the Service must delay any levy action, including the 
levy through FPLP.

To ensure that we take full advantage of FPLP and other enforcement 
tools, we have taken a number of sops to speed the collection of 
delinquent taxes. We have updated our Inventory Delivery System to 
identify many of the in-business trust fund taxpayers as high priority 
work for field collection. These cases now bypass the Automated 
Collection System (ACS) and are placed directly in the queue for 
assignment to a revenue officer.

We have also improved the cycle time of many of our processes including 
our Offer in Compromise program. Your report reflects the Fiscal Year 
2002 results where 65 percent of offers were resolved in excess of six 
months. In Fiscal Year 2003 reduced that number to 44 percent.

Finally, we have reviewed the systemic blocks in our FPLP procedures 
and information systems and found that some of these prevent certain 
cases from entering the levy program. We will be making changes to our 
information systems to modify a number of these blocks including 
current blocks on cases that are in the queue and certain Business 
Master File cases in ACS. As a result of this effort, more delinquent 
accounts will be included in the FPLP earlier in the collection 
process. While inclusion in the FPLP may appear cost beneficial, 
concerns for taxpayer rights and statutory requirements sometimes 
require us to remove a taxpayer from FPLP or prevent us from taking any 
enforcement action at at For that reason, we believe a balanced 
approach to the FPLP rather than a cost benefit analysis, is more 
appropriate. Therefore, we do not plan to evaluate the cost benefit of 
keeping these businesses and individuals in the levy program until the 
taxes are fully paid.

Your report also mentions problems with data quality in the Central 
Contractor Registration (CCR) database; particularly as it relates to 
inaccurate or bogus Taxpayer Identification Numbers (TINS) provided by 
registered taxpayers. As we stated in our response to your audit "More 
Can Be Done to Ensure Federal Agencies File Accurate Information 
returns," we will work with the DOD to ensure that the vendor TINS on 
the CCR are accurate. We will also work with the Office of Management 
and Budget and DOD to support changes they initiate with respect to 
Federal contacts and contractors.

We are working with your office to secure additional information on the 
47 businesses and individuals identified in your audit, with 
indications of abuse or potential criminal activity. We plan to review 
each of these case ties and refer them for additional action as 
appropriate. As part of our work with DOD we will also consider 
alternative uses of the information in the CCR to help identify these 
types of egregious cases.

If you have any questions please contact me, or Cheryl Sherwood, 
Director, Payment Compliance Policy, at (202) 283-7650.

Sincerely,

Signed for: 

Mark W. Everson: 

[End of section]

Appendix V: GAO Contacts and Staff Acknowledgments:

GAO Contacts:

Arthur W. Brouk, (214) 777-5633 
Lawrence Malenich, (202) 512-9399 
John J. Ryan, (202) 512-9587:

Acknowledgments:

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.

(192092):

FOOTNOTES

[1] U.S. General Accounting Office, Major Management Challenges and 
Program Risks: Department of the Treasury, GAO-03-109 (Washington, 
D.C.: January 2003).

[2] Treasury established TOP as part of implementing its 
responsibilities under the Debt Collection Improvement Act of 1996. 
Treasury created TOP to centralize the process by which certain federal 
payments are withheld or reduced to collect delinquent nontax debts 
owed to federal agencies.

[3] A provision in the Taxpayer Relief Act of 1997 authorized IRS to 
continuously levy up to 15 percent of certain federal payments made to 
delinquent taxpayers. IRS established its continuous levy program, now 
referred to as FPLP, to collect federal tax debt. In this report, we 
refer to FPLP as the levy program. Levy is the legal process by which 
IRS orders a third party to turn over property in its possession that 
belongs to the delinquent taxpayer named in a notice of levy.

[4] In this report, a DOD contractor abused the federal tax system when 
payroll taxes withheld from employee wages were not remitted to IRS for 
1 year or more. We considered activity to be abusive when a 
contractor's actions or inactions, though not illegal, took advantage 
of the existing tax enforcement and administration system to avoid 
fulfilling federal tax obligations and were deficient or improper when 
compared with behavior that a prudent person would consider reasonable.

[5] A tax identification number (TIN) is a unique nine-digit identifier 
assigned to each business and individual that files a tax return. For 
businesses, the employer identification number (EIN) assigned by IRS 
serves as the TIN. For individuals, the Social Security number (SSN) 
assigned by the Social Security Administration (SSA) serves as the TIN. 
Contractors register their TINs in the CCR database in either the TIN/
EIN field or the SSN field. In our report, a contractor completing the 
TIN/EIN field is referred to as a business, while a contractor 
completing the SSN field is referred to as an individual.

[6] We characterized as "potentially criminal" any activity related to 
federal tax liability that may be a crime under a specific provision of 
the Internal Revenue Code. Depending on the potential penalty provided 
by statute, the activity could be a felony (punishable by imprisonment 
of more than 1 year) or a misdemeanor (punishable by imprisonment of 1 
year or less). Some potential crimes under the Internal Revenue Code 
constitute fraud because of the presence of intent to defraud, 
intentional misrepresentation or deception, or other required legal 
elements. 

[7] A "tax period" varies by tax type. For example, the tax period for 
payroll and excise taxes is one quarter of a year. The taxpayer is 
required to file quarterly returns with IRS for these types of taxes, 
although payment of the taxes occurs throughout the quarter. In 
contrast, for income, corporate, and unemployment taxes, a tax period 
is 1 year.

[8] Federal Acquisition Regulation; Central Contractor Registration, 68 
Fed. Reg. 56,669 (2003) (to be codified at 48 C.F.R. pts. 1, 2, 4, 13, 
32, and 52).

[9] Mechanization of Contract Administration Services. 

[10] The vendor pay systems include payments for contracts not 
administered by DCMA, plus miscellaneous noncontractual payments such 
as utilities.

[11] As of September 2003, IRS had an inventory of known unpaid taxes 
totaling $246 billion of which $120 billion has some collection 
potential but only $20 billion of which is considered currently 
collectible. This inventory includes unpaid taxes that IRS is 
attempting to collect and unpaid taxes that IRS knows are due but for 
which it has decided not to pursue collection. Total unpaid taxes also 
include an unknown amount of unpaid taxes that IRS has not identified 
and are therefore not in the IRS inventory.

[12] GAO-03-109.

[13] U.S. General Accounting Office, Unpaid Payroll Taxes: Billions in 
Delinquent Taxes and Penalty Assessments Are Owed, GAO/AIMD/GGD-99-211 
(Washington, D.C.: Aug. 2, 1999).

[14] Taxpayer Relief Act of 1997 § 1024, 26 U.S.C. § 6331(h) (2000).

[15] Pub. L. No. 104-134, 110 Stat. 1321 (1996).

[16] 31 U.S.C. § 3716(c)(6) (2000).

[17] 31 C.F.R. § 285.5 (c)(2) (2003).

[18] U.S. General Accounting Office, Tax Administration: Millions of 
Dollars Could Be Collected If IRS Levied More Federal Payments, GAO-01-
711 (Washington, D.C.: July 20, 2001).

[19] 31 U.S.C. § 3716(c)(1)(A) (2000) and 31 C.F.R. § 285.5(c)(2) 
(2003).

[20] 31 U.S.C. § 3711(g)(1) (2000).

[21] IRS must give the taxpayer written notice 30 days before 
initiating a levy or seizure action. 26 U.S.C. § 6330(a) (2000).

[22] Before receiving a notice of intent to levy, a taxpayer typically 
receives several balance due notices as part of the IRS standard 
notification process.

[23] Installment agreements allow the full payment of the debt in 
smaller, more manageable amounts. An offer in compromise approved by 
IRS allows a delinquent taxpayer to settle unpaid debt for less than 
the full amount due.

[24] U.S. General Accounting Office, Tax Administration: Federal 
Payment Levy Program Measure, Performance, and Equity Can Be Improved, 
GAO-03-356 (Washington, D.C.: Mar. 6, 2003); Tax Administration: IRS' 
Levy of Federal Payments Could Generate Millions of Dollars, GAO/GGD-
00-65 (Washington, D.C.: Apr. 7, 2000); and GAO-01-711.

[25] Payroll taxes consist of income and employment taxes (i.e., 
Federal Insurance Contribution Act (FICA) contributions--Social 
Security and Medicare) withheld from an employee's wages, as well as 
the employer's matching FICA contributions.

[26] The law further provides that withheld income and employment taxes 
are to be held in a separate bank account considered to be a special 
fund in trust for the federal government. 26 U.S.C. § 7512(b) (2000).

[27] 26 U.S.C. § 6672 (2000).

[28] 26 U.S.C. § 7202 (2000).

[29] 26 U.S.C. § 7215 (2000).

[30] GAO/AIMD/GGD-99-211.

[31] The estimate includes both FICA and Self-Employment Contribution 
Act taxes, but does not include federal income tax withholdings. 
Accrued interest is included in this amount because assessments 
distributed to the trust funds earn interest at Treasury-based interest 
rates, similar to the rates used to develop IRS's interest accruals.

[32] U.S. General Accounting Office, Internal Revenue Service: 
Recommendations to Improve Financial and Operational Management, GAO-
01-42 (Washington, D.C.: Nov. 17, 2000); Internal Revenue Service: 
Composition and Collectibility of Unpaid Assessments, GAO/AIMD-99-12 
(Washington, D.C.: Oct. 29, 1998); and GAO/AIMD/GGD-99-211.

[33] Contractors register their TINs in the CCR database into either 
the TIN/EIN field (business) or the SSN field (individual).

[34] IRS Master Files are data files that contain tax return filing 
histories for businesses and individuals.

[35] In this report, an invalid TIN refers to a missing TIN, a TIN with 
more or less than nine numeric characters, a TIN that includes an alpha 
character, or a TIN that does not match or cannot be found in IRS or 
SSA records.

[36] We referred this matter to our Office of Special Investigations 
because we were concerned that some contractors may be registering in 
CCR with invalid TINs to avoid federal taxes or debt collection.

[37] U.S. General Accounting Office, Tax Administration: More Can Be 
Done to Ensure Federal Agencies File Accurate Information Returns, GAO-
04-74 (Washington, D.C.: Dec. 5, 2003).

[38] One Bill Pay, formerly known as Standard Accounting and Reporting 
System.

[39] Abatements are reductions in the amount of taxes owed and can 
occur for a variety of reasons, such as to correct errors made by IRS 
or taxpayers or to provide relief from interest and penalties. 26 
U.S.C. § 6404 (2000).

[40] U.S. General Accounting Office, Financial Audit: IRS's Fiscal 
Years 2002 and 2001 Financial Statements, GAO-03-243 (Washington, D.C.: 
Nov. 15, 2002).

[41] 31 C.F.R. § 285.5(c)(2) (2003).

[42] U.S. General Accounting Office, DOD Business Systems 
Modernization: Continued Investment in Key Accounting Systems Needs to 
Be Justified, GAO-03-465 (Washington, D.C.: Mar. 28, 2003) and DOD 
Business Systems Modernization: Important Progress Made to Develop 
Business Enterprise Architecture, but Much Work Remains, GAO-03-1018 
(Washington, D.C.: Sept. 19, 2003).

[43] Although over $1 million was levied during this period, FMS 
refunded $353,500 to the contractors due to a processing error. FMS 
levied the DOD payments prior to IRS issuing a levy to FMS and prior to 
the statutory pre-levy notification letter to the taxpayer. 
Consequently, FMS was required to refund some collections. DFAS 
implemented the levy process near the beginning of our review; 
therefore, we did not test controls over the process.

[44] We estimated this potential collection amount using the 
assumptions that all unpaid federal taxes were referred to Treasury FMS 
for inclusion in the TOP database, and all fiscal year 2002 DFAS 
payment information was provided to FMS for matching against the TOP 
database. The collection amount was calculated on 15 percent of the 
payment amount up to the amount of unpaid taxes. Our analysis did not 
account for any exclusion allowed by the levy program, such as cases 
where the contractor had entered bankruptcy, made alternative 
arrangements to pay, or demonstrated to IRS that making payments on the 
outstanding tax debt would result in a financial hardship. However, 
although federal agencies are required to obtain contractor TINs by 31 
U.S.C. § 7701(c)(1), many DOD contractor payment transactions do not 
include TINs; therefore, the total amount of unpaid federal taxes owed 
by contractors and potential collections through FPLP is not known.

[45] Although cases may move through the phases sequentially, it is not 
necessary that they do so. Cases begin in the notice phase, but they 
move back and forth between various phases and may, for example, enter 
the queue or Automated Collection System phases repeatedly. There are 
also other status phases into which a case might enter that are not 
presented here.

[46] GAO-03-356.

[47] IRS sends tax debt notifications at least once each year. When IRS 
initiated the levy program, it blocked all cases entering the queue for 
1 year to ensure that at least one notice would be sent before the case 
entered the levy program. IRS officials stated that they intend to 
change this policy in early 2004.

[48] The 10-year period can be extended or suspended under a variety of 
circumstances, such as agreements by the taxpayer to extend the 
collection period, bankruptcy litigation, and court appeals. 
Consequently, some tax assessments can and do remain on IRS's records 
for decades.

[49] The Taxpayer Advocate Service is an IRS program that provides an 
independent system to ensure that tax problems that have not been 
resolved through normal channels are promptly and fairly handled. 

[50] U.S. General Accounting Office, Internal Revenue Service: 
Recommendations to Improve Financial and Operational Management, GAO-
01-42 (Washington, D.C.: Nov. 17, 2000).

[51] Review of the Offers in Compromise Program (Reference No. 091603, 
Dec. 7, 1998), performed by what is now the Office of the Treasury 
Inspector General for Tax Administration.

[52] GAO-01-42.

[53] GAO-03-356.

[54] GAO-03-356.

[55] GAO-03-356.

[56] For financial reporting, IRS classifies its unpaid tax debts as 
either (1) federal taxes receivable (taxes due from taxpayers for which 
IRS can support the existence of a receivable through taxpayer 
agreement or a favorable court ruling), (2) compliance assessments 
(where neither the taxpayer nor the court has affirmed that the amounts 
are owed), or (3) write-offs (which are unpaid assessments that IRS 
does not expect to collect because of factors such as taxpayer death, 
bankruptcy, or insolvency).

[57] 26 U.S.C. § 6672 (2000).

[58] 26 U.S.C. § 7202 (2000).

[59] 26 U.S.C. § 7215 (2000).

[60] U.S. General Accounting Office, Tax Administration: Federal 
Contractor Tax Delinquencies and Status of the 1992 Tax Return Filing 
Season, GAO/T-GGD-92-23 (Washington, D.C.: Mar. 17, 1992).

[61] U.S. General Accounting Office, Debt Collection: Barring 
Delinquent Taxpayers From Receiving Federal Contracts and Loan 
Assistance, GAO/T-GGD/AIMD-00-167 (Washington, D.C.: May 9, 2000).

[62] 10 U.S.C. § 2305 (b) and 41 U.S.C. § 253b (2000).

[63] 48 C.F.R. § 9.103 (a).

[64] Contractors included on the list as having been declared 
ineligible on the basis of statutory or regulatory procedures are 
excluded from receiving contracts under the conditions and for the 
period set forth in the statute or regulation. Agencies are prohibited 
from soliciting offers from, awarding contracts to, or consenting to 
subcontracts with these contractors under these conditions and for that 
period.

[65] Such certification is required only for contracts exceeding the 
simplified acquisition threshold.

[66] The government may suspend a contractor suspected of tax evasion, 
upon adequate evidence, and debar a contractor for a conviction or 
civil judgment for commission of tax evasion. Further, prospective 
contractors are required to certify in their bids or proposals whether 
they or their principals, within the preceding 3 years, were convicted 
or had civil judgments rendered against them for commission of tax 
evasion, and whether they or their principals are presently indicted or 
otherwise criminally or civilly charged with commission of tax evasion.

[67] In December 2000, a controversial revision to the FAR was issued 
that required contracting officers to consider a prospective 
contractor's compliance with several areas of law, including tax, in 
determining a satisfactory record of integrity and business ethics. 
This revision was revoked in December 2001 after having been 
effectively suspended for many federal agencies earlier in 2001. 

[68] 26 U.S.C. § 6103 (2000).

[69] U.S. General Accounting Office, Government Contracting: 
Adjudicated Violations of Certain Laws by Federal Contractors, GAO-03-
163 (Washington, D.C.: Nov. 15, 2002). 

[70] For example, if the prospective contractor is a small business, 
the nonresponsibility determination would be reviewed by the Small 
Business Administration, which could issue a Certificate of Competency 
stating that the prospective contractor is responsible for the purpose 
of receiving and performing a specific government contract. A 
determination of nonresponsibility could also be protested through the 
bid protest process.

[71] The Nonprocurement Common Rule is the procedure used by federal 
executive agencies to suspend, debar, or exclude individuals or 
entities from participation in nonprocurement transactions such as 
grants, cooperative agreements, scholarships, fellowships, contracts 
of assistance, loans, loan guarantees, subsidies, insurance, payments 
for specified use, and donation agreements.

[72] Because TINs were missing in some DOD payment records, we 
populated the five payment files with TINs by matching payment records 
to contractor records in the CCR database using the DOD Commercial and 
Government Entity code. This procedure identified additional payments 
made to DOD contractors with unpaid federal taxes.

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