Data reliability issues with respect to  DOD and IRS records prevented us from identifying an exact amount of  unpaid federal taxes. Unpaid payroll taxes include amounts  that a business withholds from an employee’s wages for federal income  taxes, Social Security, Medicare, and the related matching contributions of  the employer for Social Security and Medicare. DOD and IRS Are Not Collecting Millions in Unpaid Federal Taxes from Contractors

Until DOD establishes processes to provide information from all payment  systems to TOP, the federal government will continue missing  opportunities to collect hundreds of millions of dollars in tax debt owed by  DOD contractors. DOD Is Not Fully Assisting in the Collection of Unpaid Taxes Owed by Its Contractors

We estimate that DOD, which functions as its own disbursing agent, could  have offset payments and collected at least $100 million in unpaid taxes in  fiscal year 2002 if it and IRS had worked together to effectively levy  contractor payments. However, in the 6 years since the passage of the  Taxpayer Relief Act of 1997, DOD has collected only about $687,000. 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. In  response to our draft report, DOD developed a schedule to provide  payment information to TOP for all of its additional payment systems by  March 2005. In addition, DFAS did not have  an organizational structure in place to implement the TOP payment  reporting process. In one case,  IRS cited resource and workload management considerations. DOD Contractors Involved in Abusive or Potentially Criminal Activity Related to the Federal Tax System

We selected for case study 47 businesses and individuals that had unpaid  taxes and were receiving DOD contractor payments in fiscal year 2002. 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. Examples of Abusive or Potentially Criminal Activity Related to the Federal Tax System by Businesses

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. The business also made a down payment for the  owner’s boat and bought several cars and a home outside the country. 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. In 1996, the owner bought a home and furnishings  worth approximately $1 million and borrowed nearly $1 million from the  business. The tax problems of this business date back to the mid-1990s. 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. This  contractor received over $200,000 from DOD during 2002. See our related report 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. 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.
Why GAO Did This Study

GAO addressed issues related to three high-risk areas including the Department of Defense (DOD) and the Internal Revenue Service (IRS) financial management and IRS collection of unpaid taxes. This testimony provides a perspective on (1) the magnitude of unpaid federal taxes owed by DOD contractors, (2) whether indications exist of abuse or criminal activity by DOD contractors related to the federal tax system, (3) whether DOD and 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 taxes are prohibited by law from receiving federal contracts. In a companion report issued today.

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. In response to our draft report, DOD developed a schedule to provide payment information to TOP for all of its additional payment systems by March 2005. Furthermore, we found abusive or potentially criminal activity related to the federal tax system through our audit and investigation of 47 DOD contractor case studies. The 47 contractors provided a variety of goods and services, including building maintenance, catering, dentistry, funeral services, and 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 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 contracts to contractors that abuse the tax system.