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

United States General Accounting Office (GAO) Report to Congressional Requesters / GAO-04-95 
12feb04

Results in Brief

Some DOD contractors abuse the federal tax system with little consequence.[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[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[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.[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 government wide 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 government wide 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.

Notes:

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.

source: http://www.gao.gov/new.items/d0495.pdf 12feb04