Financial Management: Some DOD Contractors Abuse the Federal Tax System with Little Consequence
GAO-04-95
Published: Feb 12, 2004. Publicly Released: Feb 12, 2004.
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Highlights
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.
Recommendations
Matter for Congressional Consideration
| Matter | Status | Comments |
|---|---|---|
| Until such time as DOD is able to demonstrate that it is meeting its responsibilities under the Debt Collection Improvement Act of 1996 (DCIA), including providing payment information to the Treasury Offset Program (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. | On February 12, 2004, we testified and reported that DOD and IRS records showed that over 27,000 contractors owed about $3 billion in unpaid taxes as of September 30, 2002. We also pointed out that DOD has not fully implemented provisions of the Debt Collection Improvement Act of 1996 or the Taxpayer Relief Act of 1997. Those acts required federal agencies to assist IRS in levying up to 15 percent of each contract payment to offset federal tax debt owed by federal agency contractors, which would include those hired by DOD. We estimated that DOD could have helped IRS collect at least $100 million more 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 since passage of the legislation in 1996 in part because DOD subjected to potential levy contractor payment information from only 1 of its 16 payment systems. DOD had no formal plans as of February 2004 to subject payment information from its other 15 payment systems to potential levy. In commenting on our report, DOD either fully or partially concurred with all of our recommendations that focused on actions that DOD could take to levy payments made to its contractors that had unpaid taxes. Subsequent to that testimony and report, Congress passed and the President signed the fiscal year 2005 DOD appropriations act. That act reduced DOD's appropriation by $50,000,000 and instructed DOD to improve its process of offsetting payments made to contractors who have unpaid tax debt. Subsequent to reduction of DOD's appropriation, DFAS has added its payments systems to the levy program. Consequently, no further congressional action is necessary. | |
| 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. | On December 26, 2007, Congress passed legislation, public law 110-161, that requires prospective contractors for contracts greater than $5 million to certify in writing that they have not been notified of any unpaid federal tax assessment for which the liability remains unpaid. Consequently, no further action is necessary. |
Recommendations for Executive Action
| Agency Affected | Recommendation | Status |
|---|---|---|
| Department of Defense | To comply with the DCIA and support IRS efforts under the Taxpayer Relief Act of 1997 to collect unpaid federal taxes, the Secretary of Defense should direct the Under Secretary of Defense (Comptroller) to take four long- and short-term actions. For the long term, the Under Secretary should develop a formal plan to implement DCIA by providing payment information to TOP for all Defense Financing 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. |
The tax levy program was authorized by the Taxpayer Relief Act of 1997. The Treasury Offset Program (TOP), which is an automated systems based program, is used by Treasury to collect delinquent non-tax debts and to continuously levy federal payments to collect delinquent tax debts. In 2004, we reported that Department of Defense (DOD) was not levying millions of dollars in taxes because DOD had only incorporated one payment system into TOP and IRS policies and processes excluded millions of cases from potential levy. Defense Finance and Accounting Service (DFAS) has added all of its payment files into TOP for levy and offset. Further, DOD has implemented the 100 percent levy provision on all payment systems and centralized its locations to process levies issued by the IRS. Consequently, no further action is necessary.
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| Department of Defense | For the short term, the Under Secretary of Defense (Comptroller) should collaborate with Treasury's FMS to develop interim procedures for identifying active DOD contactors in TOP. |
The tax levy program was authorized by the Taxpayer Relief Act of 1997. The Treasury Offset Program (TOP), which is an automated systems based program, is used by Treasury to collect delinquent non-tax debts and to continuously levy federal payments to collect delinquent tax debts. In 2004, we reported that Department of Defense (DOD) was not levying millions of dollars in taxes because DOD had only incorporated one payment system into TOP and IRS policies and processes excluded millions of cases from potential levy. Defense Finance and Accounting Service (DFAS) has added all of its payment files into TOP for levy and offset. In addition, DOD has implemented the 100 percent levy provision on all payment systems and centralized its locations to process levies issued by the IRS. Consequently, no further action is necessary.
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| Department of Defense | For the short term, the Under Secretary of Defense (Comptroller) should develop manual procedures so that the levy of contractor payments can be started immediately for all DOD payment systems. |
The tax levy program was authorized by the Taxpayer Relief Act of 1997. The Treasury Offset Program (TOP), which is an automated systems based program, is used by Treasury to collect delinquent non-tax debts and to continuously levy federal payments to collect delinquent tax debts. In 2004, we reported that Department of Defense (DOD) was not levying millions of dollars in taxes because DOD had only incorporated one payment system into TOP and IRS policies and processes excluded millions of cases from potential levy. Defense Finance and Accounting Service (DFAS) has added all of its payment files into TOP for levy and offset. It has also implemented the 100 percent levy provision on all payment systems and centralized its locations to process levies issued by the IRS. Consequently, no further action is necessary.
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| Department of Defense | For both the long and short term, the Under Secretary of Defense (Comptroller) should devote sufficient resources to implementing all aspects of TOP and the DOD plan. |
The tax levy program was authorized by the Taxpayer Relief Act of 1997. The Treasury Offset Program (TOP), which is an automated systems based program, is used by Treasury to collect delinquent non-tax debts and to continuously levy federal payments to collect delinquent tax debts. In 2004, we reported that Department of Defense (DOD) was not levying millions of dollars in taxes because DOD had only incorporated one payment system into TOP and IRS policies and processes excluded millions of cases from potential levy. Defense Finance and Accounting Service (DFAS) has added all of its payment files into TOP for levy and offset. It has also implemented the 100 percent levy provision on all payment systems and centralized its locations to process levies issued by the IRS. Consequently, no further action is necessary.
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| Internal Revenue Service | To help improve the effectiveness of IRS collection activities, the Commissioner of Internal Revenue should capitalize on the potential of the FPLP by using the levy program as one of the first steps in the IRS collection process. |
In our review of Department of Defense (DOD) contractors who abuse the federal tax system, we found that the Internal Revenue Service (IRS) was excluding all cases in its Automated Collection System (ACS), one of the first steps in the IRS collection process, from the Financial Management Service's (FMS) automated Treasury Offset Program (TOP). FMS uses the TOP as the mechanism to collect tax levies through the Federal Payment Levy Program (FPLP). IRS was waiting a year before sending those cases to the Financial Management System's (FMS) automated Treasury Offset Program (TOP). By excluding those cases from the FPLP for a year, IRS did not consider about $13 billion in tax debt for levy through the FPLP. In response to our recommendation, IRS removed the one-year systemic block on both queue and deferred cases. Removing the block made those cases immediately available for matching with federal payments, which would make those payments subject to levy.
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| Internal Revenue Service | To help improve the effectiveness of IRS collection activities, the Commissioner of Internal Revenue should capitalize on the potential of the Federal Payment Levy Program (FPLP) by changing or eliminating policies that prevent businesses and individuals with federal contracts from entering the levy program. |
In our review of Department of Defense (DOD) contractors who abuse the federal tax system, we found that the Internal Revenue Service (IRS) was excluding cases from the Financial Management Service's (FMS) automated Treasury Offset Program (TOP). FMS uses the TOP as the mechanism to collect tax levies through the Federal Payment Levy Program (FPLP). Excluding cases prevented IRS from collecting taxes more efficiently. In response to our recommendations, IRS removed the Automated Collection System (ACS)exclusion for over $3.2 billion--nearly 50 percent--of the tax debt in its ACS inventory. By doing so, IRS made these billions of dollars in tax debt available for offest against federal payments, which made those payments subject to levy through the FPLP. Through this action, IRS made approximately $9 billion in tax debt available for offset against federal payments.
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| Internal Revenue Service | To help improve the effectiveness of IRS collection activities, the Commissioner of Internal Revenue should capitalize on the potential of the FPLP by 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. |
IRS changed its FPLP case exclusion and selection criteria to (1) retain tax debts in the FPLP until the IRS and the tax debtor have agreed on and finalized the terms of any Installment Agreements or Offers, (2) eliminate the FPLP exclusion on tax debts coded as criminal investigation cases except those under active investigation, (3) reduce the FPLP exclusion criteria for tax debts that are about to reach its statutory expiration date from three months to one month prior to expiration, (4) change the FPLP case selection criteria to make defaulted installment agreement cases with reversed financial hardship closing codes eligible for levy through the FPLP, and (5) exclude only the specific tax periods for which the tax debtor files a Collection Due Process Appeal, an amended return, or other claim rather than excluding the tax debtor's entire outstanding tax debt. These changes have resulted in making additional hundreds of millions of dollars and hundreds of thousands of tax debt accounts available for levy through the FPLP. Consequently, no further action is necessary.
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| Internal Revenue Service | The Commissioner of Internal Revenue should evaluate the 47 referred cases detailed in this report and consider whether additional collection action or criminal investigation is warranted. |
In our reviews of federal contractors who abuse the federal tax system, we identified Department of Defense, civilian, and GSA contractors with abusive and potentially criminal activity. Many of these businesses had not forwarded payroll taxes withheld from their employees and other taxes to IRS. Willful failure to remit payroll taxes is a felony under U.S. law. Furthermore, some company owners diverted payroll taxes for personal gain or to help fund their businesses. In 2004 and 2005, we referred 47 cases involving defense contractors, 50 cases involving civilian contractors, and 25 cases involving GSA contractors to the IRS. Susequently, IRS reported that of the total of 122 cases that were referred in 2004 and 2005, it had closed 62 cases (51 percent). Of these, 23 cases were full pay closures, and IRS determined that the remaining 39 cases were currently not collectible. These non-collectible cases involve defunct corporations or other taxpayers where it is judged that there is no potential, now or in the future, for collection. Of the 122 cases, IRS reported that it had closed 62 cases. Of those, 23 were closed because the taxpayer had full paid the debt and 39 were closed because IRS had determined them to be currently not collectible. An additional 17 cases were in IRS's active collection inventory. For the remaining cases, IRS reported that the taxpayer (1) was attempting to satisfy the debt by making payments through an installment agreement or has filed an offer-in-compromise, (2) had been determined by IRS to be in financial hardship and collection of the debt is in abeyance, (3) was in bankruptcy proceedings and IRS is prohibited from taking additional collection actions, or (4) was under criminal investigation.
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| Office of Management and Budget | 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), the Director of OMB should 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 (1) consider whether additional legislation is needed; (2) 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; (3) fully comply with the statutory restriction on disclosure of taxpayer information; and (4) address any necessary exceptions, such as when the goods or services cannot be obtained from other sources or for national security. |
One of the responsibilities of OMB--through its Office of Federal Procurement Policy (OFPP)--is to provide overall direction to shaping the government's procurement regulations. The OFPP, whose administrator is chair of the Federal Acquisition Regulation (FAR) Council; the Civilian Agency Acquisition Council; and the Defense Acquisition Regulations Council have responsibility for FAR changes. A final rule amending the FAR has been agreed to that will add conditions regarding delinquent Federal taxes to standards of contractor responsibility. Specifically, the FAR change--FAR 2006-011--will require the prospective contractor to self-certify that it has no civil tax judgment and/or convictions, no violation of Federal criminal tax laws, and no delinquent Federal taxes in an amount exceeding $3,000. As a result of this regulation change, federal contracts are to be awarded to only those contractors who are not delinquent on their federal taxes.
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Full Report
Topics
Delinquent taxesFinancial managementFraudInternal controlsProgram abusesRisk managementStrategic planningTaxesAccountabilityBudgetingDepartment of Defense contractors