Financial Management: Some DOD Contractors Abuse the Federal Tax 
System with Little Consequence (12-FEB-04, GAO-04-414T).	 
                                                                 
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.				 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-04-414T					        
    ACCNO:   A09236						        
  TITLE:     Financial Management: Some DOD Contractors Abuse the     
Federal Tax System with Little Consequence			 
     DATE:   02/12/2004 
  SUBJECT:   Collection procedures				 
	     Crimes or offenses 				 
	     Delinquent taxes					 
	     Department of Defense contractors			 
	     Financial management				 
	     Government collections				 
	     Income taxes					 
	     Interagency relations				 
	     Internal controls					 
	     Fraud						 
	     Risk management					 
	     Treasury Offset Program				 
	     IRS Federal Payment Levy Program			 

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GAO-04-414T

United States General Accounting Office

                                 GAO Testimony

Before the Permanent Subcommittee on Investigations, Committee on
Governmental Affairs, U.S. Senate

For Release on Delivery Expected at 9:30 a.m. EST Thursday, February 12,
2004

FINANCIAL MANAGEMENT

Some DOD Contractors Abuse the Federal Tax System with Little Consequence

Statement of

Gregory D. Kutz
Director, Financial Management and Assurance

Steven J. Sebastian
Director, Financial Management and Assurance

John J. Ryan
Assistant Director, Office of Special Investigations

                                       A

GAO-04-414T

Highlights of GAO-04-414T, a testimony before the Permanent Subcommittee
on Investigations, Committee on Governmental Affairs, U.S. Senate

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, GAO made 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 awards to contractors that abuse the 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
for contractors that abuse the tax system. GAO reiterated support for its
recommendations as well as its suggestions to Congress.

www.gao.gov/cgi-bin/getrpt?GAO-04-414T

To view the full product, click on the link above. For more information,
contact Gregory D. Kutz at (202) 512-9095 or [email protected], or Steven J.
Sebastian at (202) 512-3406.

February 12, 2004

FINANCIAL MANAGEMENT

Some DOD Contractors Abuse the Federal Tax System with Little Consequence

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.

Mr. Chairman, Members of the Subcommittee, and Representative Schakowsky:

Thank you for the opportunity to discuss payments to Department of Defense
(DOD) contractors that abuse the federal tax system. Our related report,1
released today and developed at the request of this Subcommittee and
Representative Schakowsky, addresses issues related to three high-risk
areas: DOD and Internal Revenue Service (IRS) financial management and IRS
collection of unpaid taxes. 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. As a result of the fraud and
abuse identified in our series of testimonies and reports on DOD's
purchase card program, you requested more comprehensive audits and
investigations of controls over payments to DOD contractors.

DOD and 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 program
high-risk areas, has weaknesses, including 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.

Today, we will summarize our work on DOD payments to contractors that
abuse the federal tax system. Our testimony will provide a perspective on
(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) and Federal Payment Levy Program (FPLP)
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

1 U.S. General Accounting Office, Financial Management: Some DOD
Contractors Abuse the Federal Tax System with Little Consequence,
GAO-04-95 (Washington, D.C.: Feb. 12, 2004).

contractors with unpaid federal taxes are prohibited by law from receiving
federal contracts.

Summary	The federal government will continue to miss opportunities to
collect on hundreds of millions of dollars in unpaid federal taxes owed by
DOD contractors until DOD begins to fulfill its responsibilities under the
Debt Collection Improvement Act of 1996 (DCIA) by fully assisting IRS in
its attempts to levy DOD contractor payments, and IRS fully utilizes its
authority under FPLP. Based on DOD and IRS records, over 27,000
contractors registered in DOD's automated registration system had nearly
$3 billion in unpaid federal taxes as of September 30, 2002. DOD
contractors receiving fiscal year 2002 payments from five of the largest
Defense Finance and Accounting Service (DFAS) contract and vendor payment
systems owed at least $1.7 billion of this nearly $3 billion.

As the largest purchaser of goods and services in the federal government,
DOD payments to contractors totaled about $183 billion in fiscal year
2002. 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. However, in the 6 years since passage of the
Taxpayer Relief Act of 1997,2 DOD has collected only about $687,000. DOD
recently implemented a TOP payment reporting process for its contract
payment system, which disbursed over $86 billion to contractors in fiscal
year 2002. However, DOD did not have formal plans or a schedule at the
completion of our work for reporting payment information from its 15
vendor payment systems, which disbursed another $97 billion to contractors
in fiscal year 2002. 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. DOD did not have an organizational
structure in place to implement a TOP reporting process at the remaining
payment systems.

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

2 The act 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.

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
activity related to the federal tax system during our audit and
investigation of 47 DOD contractor case studies. The 34 case studies
involving businesses3 with employees had primarily unpaid payroll taxes,
some dating to the early 1990s and some for as many as 62 tax periods.4
These payroll taxes included amounts withheld from employees 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 their
businesses. The other 13 case studies involved individuals who had unpaid
income taxes dating as far back as the 1980s. Several contractors in our
study 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. DOD contract awards of
nearly $165 billion represented nearly two-thirds of the federal
government's contracting activity during fiscal year 2002. 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

3 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 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.

4 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.

for tax evasion as explained later in our statement. Presently, 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.

As discussed in the report released today, we made recommendations to DOD
for complying with DCIA and supporting IRS efforts under the Taxpayer
Relief Act of 1997 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, and OMB did not agree with our
recommendations. DOD and OMB also did not agree with our matters for
congressional consideration that DOD report on its collections through the
TOP, and OMB report on policy options developed and actions taken against
contractors that abuse the federal tax system. We reiterated support for
our recommendations as well as our suggestions to Congress.

  DOD Contractors Owe Billions in Unpaid Federal Taxes

The nearly $3 billion in unpaid federal taxes owed by over 27,000
contractors registered in DOD's Central Contractor Registration system
(CCR) represented almost 14 percent of the registered contractors as of
February 2003. In addition, DOD contractors receiving fiscal year 2002
payments from five of the largest DFAS contract and vendor payment systems
represented at least $1.7 billion of the nearly $3 billion in unpaid
federal taxes shown on IRS records. Data reliability issues with respect
to DOD and IRS records prevented us from identifying an exact amount of
unpaid federal taxes. Consequently, the total amount of unpaid federal
taxes owed by DOD contractors is not known.

The type of unpaid taxes owed by these DOD contractors varied and
consisted of payroll, corporate income, excise, unemployment, individual
income, and other types of 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. As shown in figure 1,
about 42 percent of the total tax amount owed by DOD contractors was for
unpaid payroll taxes.

Figure 1: DOD Contractor Unpaid Taxes by Tax Type

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. 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 contributions for Social Security and Medicare.
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).
Failure to remit payroll taxes can also be a criminal felony offense
punishable by imprisonment of more than a year, while the failure to
properly segregate payroll taxes can be a criminal misdemeanor offense
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.5 Over time, the amount of this subsidy
is significant. As of September 1998, 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.

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 2, 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 2: DOD Contractor Unpaid Taxes by Fiscal Year

5 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).

Our previous work6 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 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. Additionally, IRS's current implementation strategy appears
to make the levy program one of the last collection tools IRS uses.
Changing the IRS collection 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 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. DOD
collections to date relate to DFAS payment reporting associated with
implementation of the TOP process in December 2002 for its contract
payment system,7 which disbursed over $86 billion to DOD contractors in
fiscal year 2002.

6 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.

7 Mechanization of Contract Administration Services (MOCAS).

Although it has been more than 7 years since the passage of DCIA,8 DOD has
not fully assisted IRS in using its continuous levy authority for the
collection of unpaid taxes by providing Treasury's Financial Management
Service (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. All disbursing agencies are to
compare their payment records with the TOP database. Since DOD has its own
disbursing authority, once DFAS is notified by FMS of the amount to be
levied, DOD 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 as described in figure 3.

8 Congress passed DCIA to maximize the collection of delinquent nontax
debts owed to federal agencies. 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. If a match occurs, the
disbursing agency must offset the payment, thereby reducing or eliminating
the nontax debt.

Figure 3: DOD Contractor Payment Levy Process

Source: GAO.

The TOP database includes federal tax and nontax debt, state tax debt, and
child support debt. 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
decentralized payment systems disbursed almost $97 billion to DOD
contractors from 22 different payment locations in fiscal year 2002. 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. As we have previously reported, DOD's business systems environment
is stovepiped and not well integrated.9 DOD recently reported that its
current business operations were supported by approximately 2,300 systems
in operation or under development, and requested approximately

9 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); 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).

$18 billion in fiscal year 2003 for the operation, maintenance, and
modernization of DOD business systems. 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.

IRS Policies Exclude Cases from the Levy Program

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. Also, 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 case studies
also showed 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. 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.10 The study was not completed at the time of our audit. In
earlier reviews,11 we estimated IRS could use the levy program to
potentially recover hundreds of millions of dollars in tax debt.

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

10 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).

11 U.S. General Accounting Office, Tax Administration: IRS' Levy of
Federal Payments Could Generate Millions of Dollars, GAO/GGD-00-65
(Washington, D.C.: Apr. 7, 2000), GAO03-356, and GAO-01-711.

the collection phases listed below, IRS policy either excludes or severely
delays putting cases into the levy program.

o 	Phase 1: Notify taxpayer of unpaid taxes, including a demand for
payment letter.

o 	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.

o 	Phase 3: Move the case into a queue of cases awaiting assignment to a
field collection revenue officer.

o 	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.12 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.
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 that
work on

12 GAO-03-356.

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
limited to 10 years from the date of the assessment, these long delays
greatly decrease the potential for IRS to collect the unpaid taxes.

We identified specific examples of IRS not actively pursuing collection in
our review of 47 selected cases involving DOD contractors. In one case,
IRS cited resource and workload management considerations. IRS is not
currently seeking collection of about $14.9 billion of unpaid taxes citing
these considerations-about 5 percent of its overall inventory of unpaid
assessments as of September 30, 2002. In another case, IRS cited financial
hardship where the taxpayer was unable to pay. This puts collection
activities on hold until the taxpayer's adjusted gross income (per
subsequent tax return filings) exceeds a certain threshold. Some cases
repeatedly entered the queue awaiting assignment to a field collection
revenue officer and remained there for long periods.

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 take 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. Our review 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. For
example, 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. We also
found that inaccurate coding at times prevented both IRS collection action
and cases from entering the levy program. For example, 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.

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 and investigated, IRS
subordinated the use of the levy program in favor of negotiating voluntary
tax compliance with the DOD contractors, which often resulted in minimal
or no actual collections.

  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. 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 that
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. 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 our related report to IRS for
evaluation and additional collection action or criminal investigation.

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. In
table 1, 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 businesses 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 1: DOD Contractors with Unpaid Federal Taxes-Business

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

Engineering research    Over    $58,000 $390,000 The owner paid $1 million 
                                           to purchase a                      
    services: conducts  $1 million               house and furnishings in the 
                                                                mid-1990s. At 
     studies for DOD                          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.           

Aircraft-related goods: Nearly $50,000 $336,000 The business received over
30 DOD manufactures structural $2 million contracts from 1997 through 2002
totaling parts for DOD aircraft nearly $2 million.

Research services:   Over   $13,000 $86,000   DOD awarded the business a   
                                                        contract in           
provides research  $700,000                   2002 for nearly $800,000.    
          for                                          Owner has over         
          DOD                                  $1 million in loans related to 
                                                           cars, real estate, 
                                                and recreational activities,  
                                                       and owner also         
                                                   has a high-performance     
                                                         airplane.            

Janitorial services:    Over    $108,000 $719,000 The business did not     
                                            make tax payments                 
    provides custodial  $3 million              after early 2001, and it made 
                                                                 only partial 
      services at a DOD                         payments prior to that dating 
               facility                                      back to the mid- 
                                            1990s. The business also did not  
                                                          file                
                                               corporate tax returns for 8    
                                                         years.               

     Private security   Nearly   $3,000         $21,000 One of the business's 
            services:                                    officers, who owns a 
    provides security $6 million                       large boat, paid off a 
               guards                                 recreation-related loan 
at military bases                         in 1999. The business paid taxes 
                                                                     while in 
                                              bankruptcy, but largely stopped 
                                                                 paying after 
                                              emerging from bankruptcy.       

7  Furniture sales and    Over     $6,000      $38,000 The owners used the 
                                                            business to pay   
         construction                                      personal expenses, 
           services:       $150,000                             such as house 
                                                                     mortgage 
      sells and installs                                   and credit cards.  
            office                                          One owner is a    
                                                                retired       
     furniture at military                                 military officer.  
         installations                                    
                                                             The business     
8  Custodial services:    Over            $1.5 million  received numerous  
                                    $219,000                      DOD         
      provides janitorial                                 contracts from 1998 
              and          $800,000                          through 2001     
                                                               totaling       
     housekeeping services                                nearly $12 million. 
     at                                                   The business is     
                                                          linked to           
           military                                         potential check   
         installations                                          fraud.        

(Continued From Previous Page)

                                                 Estimated 
                                Unpaid    fiscal year 2002 Fiscal year        
Case  Goods or service  federal tax collections under   2002 DOD           
         and                                               
         nature of DOD         amounta                                        
study work                          effective tax levyb paymentsc Comments

      Construction       Over    $357,000 $2.4 million  The business owes DOD 
       services:                                            tens of thousands 
                                                            of dollars for an 
    provides housing  $1 million                         overpayment in early 
                                                                        2000. 
       management                                      
       services,                                       
       including                                       
      maintenance,                                     
         repairs, and                                  
         renovations,                                  
on military bases                                   

       Base support                                      The business was     
        services:         Nearly    $33,000     $217,000 awarded contracts    
                                                         from                 
provides landscaping                                   1999 through 2000   
                    and $1 million                          worth over $1     
                                                               million.       
      snow removal at a                                     The business owes 
               military                                  taxes dating back to 
                                                                          the 
           base                                              early 1990s.     
       Construction        Over             $2.8 million 
        services:                  $422,000              
    provides repairs to  $700,000                        
               aircraft                                  
           hangars at a                                  
          military base                                  

     Medical personnel     Nearly   $698,000 $4.7 million Several federal and 
                                                    state tax liens have been 
    services: provides   $6 million             placed against the owner.     
    nursing, pharmacy,                       
physical therapy, and                     
other skilled medical                     
     personnel in DOD                        
        facilities                           

Aircraft-related goods:   Over   $29,000 $194,000 The business was awarded 
                                                                 numerous DOD 
    manufactures aircraft  $400,000                  contracts in a recent    
                                                     4-year period totaling   
    components for several                                over $300,000.      
      DOD and civilian                               
          programs                                   

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).

aUnpaid tax amount as of September 30, 2002.

bThe 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.

cDOD 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.

The following provides illustrative detailed information on several of
these cases.

o 	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.

o 	Case # 2 -This engineering research contractor received nearly $400,000
from DOD during 2002. At the time of our audit, 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.

o 	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 the 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.

o 	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 audit, 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.

o 	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
audit, 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.

o 	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.

o 	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 Individuals are responsible for the payment of
income taxes, and our audit Federal Tax System by and investigation of 13
individuals showed significant abuse of the federal Individuals tax system
similar to what we found with our DOD business case studies.

In table 2, 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 2: DOD Contractors with Unpaid Federal Taxes-Individual

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

Dentist: provides    Over   $12,000 $78,000 DOD recently increased the     
                                       individual's                           
dental services at $100,000                  contract by over $80,000. The 
             military                                               dentist's 
        facility                       credit history included several credit 
                                                                         card 
                                            accounts that were identified for 
                                                                   collection 
                                                      action.                 

Dentist: provides    Over   $11,000 $76,000 DOD awarded the individual a   
                                       multiyear                              
dental services at $200,000               contract for over $400,000. This 
             military                                              individual 
        facility                        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.                 

Training services: Over $2,000 $12,000 This individual has not paid income
taxes for
conducts management $100,000 5 years.
and leadership courses

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.

aUnpaid tax amount as of September 30, 2002.

bThe 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.

cDOD payments from MOCAS, One Bill Pay, IAPS, and CAPS automated systems
identified by GAO.

The following provides illustrative detailed information on these four
cases.

o 	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.

o 	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.

o 	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.

o 	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 our related report13 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 with unpaid federal taxes from receiving contracts.
Further, the government has no coordinated process for identifying and
determining the businesses and individuals with unpaid taxes that should
be prevented from receiving contracts and for conveying that information
to contracting officers 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.14
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.15 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.

13 GAO-04-95.

14 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).

15 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).

Federal agencies are required by law to award contracts to responsible
sources.16 This statutory requirement is implemented in the FAR, which
requires that government purchases be made from, and government contracts
awarded to, responsible contractors only.17 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,18 as well as to review a prospective contractor's
certification19 on debarment, suspension, and other responsibility
matters. Among the causes for debarment and suspension is tax evasion.20
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.21

16 10 U.S.C. S: 2305 (b) and 41 U.S.C. S: 253b (2000).

17 48 C.F.R. S: 9.103 (a).

18 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.

19 Such certification is required only for contracts exceeding the
simplified acquisition threshold.

20 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.

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 federal government before deciding whether to award
a contract to a business or individual. 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.22 As we found in November 2002,23 unless reported
by prospective contractors themselves, contracting officers face
significant difficulties obtaining or verifying tax compliance information
on prospective contractors.

21 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.

22 26 U.S.C. S: 6103 (2000).

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

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.24

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.

Concluding Comments	Thousands of DOD contractors that failed in their
responsibility to pay taxes continue to get federal contracts. Allowing
these contractors to do substantial 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

24 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.

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.

Our related report on these issues released today includes nine
recommendations to DOD, IRS, and OMB. Our DOD recommendations address the
need to comply with the DCIA by supporting IRS efforts under the Taxpayer
Relief Act of 1997 to collect unpaid federal taxes. Our IRS
recommendations address improving the effectiveness of IRS collection
activities through earlier use of the Federal Payment Levy Program and
changing or eliminating policies that prevent businesses and individuals
with federal contracts from entering the levy program. Our OMB
recommendation addresses developing and pursuing policy options for
prohibiting federal contract awards to businesses and individuals that
abuse the federal tax system. In written comments on a draft of our
report, DOD and IRS officials partially agreed with our recommendations.
OMB officials did not agree with our recommendation to develop policy
options for prohibiting federal contract awards to businesses and
individuals that abuse the federal tax system.

Our report also suggests that Congress consider requiring DOD to
periodically report to Congress on progress in providing its payment
information to TOP for each of its contract and vendor payment systems,
including details of the resulting collections by system and in total for
all contract and vendor payment systems during the reporting period. In
addition, our report suggests that Congress 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. DOD and OMB did not agree with our matters for
congressional consideration.

We continue to believe all of our recommendations and matters for
congressional consideration constitute valid and necessary courses of

action, especially in light of the identified weaknesses and the slow
progress of DOD to fully implement the offset provisions of the DCIA since
its passage more than 7 years ago.

Mr. Chairman, Members of the Subcommittee, and Ms. Schakowsky, this
concludes our prepared statement. We would be pleased to answer any
questions you may have.

  GAO Contacts and Staff Acknowledgments

(192118)

For future contacts regarding this testimony, please contact Gregory D.
Kutz at (202) 512-9095 or [email protected], Steven J. Sebastian at (202)
5123406 or [email protected], or John J. Ryan at (202) 512-9587 or
[email protected]. Individuals making key contributions to this testimony
included Tida Barakat, Gary Bianchi, Art Brouk, 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, Larry Malenich, Dave Shoemaker, Wayne Turowski, Jim
Ungvarsky, and Adam Vodraska.

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