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. 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. 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. 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. Withholding up  to 15 percent of these payments is an effective collection method and is  authorized by law. 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. 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. Table 1 shows a breakdown for our 47 contractor case studies by the type  of goods and services provided to DOD. The owner allegedly has now relocated his cars and boat outside the  United States. 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. 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. 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.
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.