Financial Management: Thousands of Civilian Agency Contractors	 
Abuse the Federal Tax Systems with Little Consequence (16-JUN-05,
GAO-05-683T).							 
                                                                 
Tax abuses by contractors working for the Department of Defense, 
which GAO previously reported on, have led to concerns about	 
similar abuses by those hired by civilian agencies. GAO was asked
to determine if similar problems exist at civilian agencies and, 
if so, to (1) quantify the amount of unpaid federal taxes owed by
civilian agency contractors paid through the Financial Management
Service (FMS), (2) determine whether there are indications of	 
abusive or potential criminal activity by contractors with unpaid
tax debts, and (3) identify any statutory or policy impediments  
and control weaknesses that impede tax collections under the	 
Federal Payment Levy Program (FPLP).				 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-05-683T					        
    ACCNO:   A26758						        
  TITLE:     Financial Management: Thousands of Civilian Agency       
Contractors Abuse the Federal Tax Systems with Little Consequence
     DATE:   06/16/2005 
  SUBJECT:   Federal taxes					 
	     Internal controls					 
	     Tax administration 				 
	     Tax nonpayment					 
	     Civilian employees 				 
	     Delinquent taxes					 
	     Department of Defense contractors			 
	     Tax administration systems 			 
	     Tax violations					 
	     Taxpayers						 
	     Tax law						 
	     Federal Payment Levy Program			 

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GAO-05-683T

United States Government Accountability Office

GAO Testimony

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

For Release on Delivery Expected at 9:30 a.m. EDT Thursday, June 16, 2005

FINANCIAL MANAGEMENT

Thousands of Civilian Agency Contractors Abuse the Federal Tax System with
                               Little Consequence

Statement of

Gregory D. Kutz
Managing Director, Forensic Audits and Special
Investigations

Steven J. Sebastian
Director, Financial Management and Assurance

John J. Ryan
Assistant Director, Forensic Audits and Special
Investigations

                                       A

GAO-05-683T

[IMG]

June 16, 2005

FINANCIAL MANAGEMENT

Thousands of Civilian Agency Contractors Abuse the Federal Tax System with
Little Consequence

                                 What GAO Found

FMS and IRS records showed that about 33,000 civilian agency contractors
owed over $3 billion in unpaid federal taxes as of September 30, 2004. GAO
investigated 50 civilian agency contractors with abusive and potentially
criminal activity. For example, businesses did not forward payroll taxes
withheld from their employees to IRS. Willful failure to remit payroll
taxes is a felony under U.S. law. Furthermore, several individuals owed
multiple businesses with unpaid federal taxes-one owned about 20
businesses that did not fully pay taxes on over 300 returns. Some diverted
payroll taxes for personal gain or to fund their businesses, such as
building a house, purchasing other real property, and increasing the
salary of the company's officer/owner. These contractors worked for a
number of federal agencies including the Departments of Justice and
Homeland Security, and the National Aeronautics and Space Administration.

             Examples of Abusive and Potentially Criminal Activity

                           Unpaid tax  Fiscal year 
                                              2004 
                 Business      amount FMS payments        Contractor activity 
                                                                    Purchased 
                                                          multimillion-dollar 
                                                                   properties 
              Health care $18 million     $300,000  while not paying millions 
                                                             in payroll taxes 

Doubled salary of one officer/owner to over $750,000 while not remitting
payroll taxes

                         Consulting $1 million $200,000

A pattern of over 20 years of closing businesses with tax debts, opening
new ones, and incurring more tax debts

                       Temporary help $900,000 $1 million

Diverted payroll taxes to a foreign bank Security $400,000 $200,000
account to build a house overseas

Source: GAO's analysis of civilian agency, IRS, FMS, public, and other
records.

If all tax debts owed by, and all payments made to, the 33,000 contractors
were included in the FPLP, FMS could have collected hundreds of millions
of dollars in fiscal year 2004. However, because only a fraction of all
unpaid taxes and a portion of FMS payments were included in the levy
program, FMS collected only $16 million. For example, about $171 billion
of unpaid federal taxes was not sent to the levy program to be offset
against payments because of statutory requirements or IRS policy
exclusions such as claims of financial hardship or bankruptcy.

Tens of billions of dollars in federal payments were not matched against
tax debts for potential levy because FMS did not proactively manage and
oversee the levy program. Until GAO brought it to FMS's attention, FMS was
unaware that $40 billion of contractor payments had not been submitted for
potential levy. FMS also did not identify payment files that lacked
contractor taxpayer identification numbers, names, or both, resulting in
another $21 billion that could not be levied. FMS also excluded billions
of dollars from levy because of what it considered limitations in its
automated systems without taking steps to overcome those limitations.
Furthermore, civilian agency purchase card payments to contractors
totaling nearly $10 billion could not be levied.

                 United States Government Accountability Office

Mr. Chairman, Members of the Subcommittee, Senator Collins, Senator
Lieberman, and Senator Akaka:

Thank you for the opportunity to discuss payments to civilian agency
contractors that abuse the federal tax system. Our related report,
released today and developed at the request of this Subcommittee, and
Senators Collins, Lieberman, and Akaka, describes problems we identified
in the management of the Federal Payment Levy Program (FPLP), in
particular the program's collection of levies from civilian agency
contractors with unpaid taxes.1 These problems illustrate the overall
challenges the federal government experiences in managing the federal tax
system in a way that contributes to taxpayers' perception of the tax
system's fairness, i.e., their perception that their friends, neighbors,
and business competitors are complying with the tax laws and actually
paying their taxes. These challenges are exacerbated by our
identification, in our testimony at a hearing on February 12, 2004, of
fraud, waste, and abuse among certain Department of Defense (DOD)
contractors that owed billions of dollars in unpaid taxes. Because of
these problems, you asked us to perform an audit and related investigation
of civilian agency contractors to determine whether, and to what extent,
civilian agency contractors also have unpaid federal taxes.

With some exceptions, civilian agency contractors receive disbursements
from the Department of Treasury's Financial Management Service (FMS).2 FMS
is also the federal government's central debt collection agency. Since
July 2000, FMS has operated the FPLP in conjunction with the Internal
Revenue Service (IRS) to collect unpaid federal taxes, including tax debt
owed by businesses and individuals who contract with civilian agencies.
Under the FPLP, specified payments to federal contractors are compared
with tax debt data-updated on a weekly basis by IRS-using the Treasury
Offset Program (TOP), a centralized debt collection program operated by
FMS. When payment data are sent to TOP, it electronically compares the

1 GAO, Financial Management: Thousands of Civilian Agency Contractors
Abuse the Federal Tax System with Little Consequence, GAO-05-637
(Washington, D.C.: June 16, 2005).

2 A few civilian agencies, such as the U.S. Postal Service, have their own
disbursing authority and do their own disbursements. Although DOD has its
own disbursement authority, some DOD payments are made through FMS.

names and taxpayer identification numbers (TINs)3 on the payment files
with the control names (first four characters of the names) and TINs of
the debtors listed in TOP. If there is a match on a debt for which IRS has
completed all legal notification requirements for levy, the federal
payment is reduced (levied) to help satisfy the unpaid federal taxes. In
fiscal year 2004, FMS collected $16 million from levying payments to
civilian agency contractors.

Today, we will summarize our work on why substantial payments that FMS
made on behalf of civilian agencies to contractors with tax debt were not
levied. Our testimony will provide a perspective on (1) the magnitude of
unpaid federal taxes owed by civilian agency contractors, (2) the
statutory and policy impediments and control weaknesses that impeded tax
collections under the FPLP, and (3) abusive or criminal activity by
civilian agency contractors related to the federal tax system. In
addition, we will summarize our work covered in a separate draft report,
which we have transmitted to FMS and IRS for their comments, on the
progress FMS has made on obtaining reciprocal agreements with states so
that payments to contractors made by the states could be levied for unpaid
federal taxes.

Summary	Our analysis of FMS and IRS records showed that about 33,000
civilian agency contractors who owed over $3.3 billion in unpaid federal
taxes received payments from numerous federal agencies during fiscal year
2004. During the same period, the federal government missed many
opportunities to collect some of the unpaid federal taxes owed by these
civilian agency contractors. We estimate that if there were no legal or
administrative provisions that excluded a significant amount of tax debt
from the levy program, and if all contractor payments for which FMS
maintains detailed information were subjected to a 15 percent levy to
satisfy all the unpaid taxes of those civilian contractors, IRS and FMS
could

3 A TIN is a unique nine-digit identifier assigned to each business and
individual that files a tax return. For businesses, the employer
identification number assigned by IRS serves as the TIN. For individuals,
the Social Security Number, assigned by the Social Security
Administration, serves as the TIN.

collect hundreds of millions of dollars annually.4 However, during fiscal
year 2004, FMS collected only $16 million from the FPLP, leaving a tax
levy collection gap totaling hundreds of millions of dollars.

A significant portion of the levy collection gap arises because only a
fraction of unpaid tax debts is included in the levy program and matched
against payments. Specifically, because of legal requirements and IRS
policy provisions, only 37 percent of the unpaid tax debts are included in
the FPLP. In addition, only about 30 percent of the debt included in the
FPLP is actually ready for immediate levy. While the exclusion of unpaid
federal taxes from the levy program is justified in some circumstances, it
nevertheless results in significant losses in the collection of revenue
from levies. In a later report, we will examine the accuracy and
reasonableness of the IRS exclusions.

The remaining levy collection gap exists because of a lack of proactive
oversight and management of the levy program by FMS. For example, FMS was
not aware that it did not submit tens of billions of dollars in payments
to the levy program for matching against tax debts. These included
payments without payment type code and payments from certain agency paying
units. Even when FMS was aware that many payments from agency payment
files did not contain TINs, without which a match could not be made
between the payment file and the tax debts, FMS did not address this
deficiency. Consequently, these payments had no possibility of being
levied. Furthermore, FMS decided to exclude tens of billions of dollars in
payments from the levy program without determining whether the cost of
making changes to its automated systems and other efforts necessary to
include them in the levy program would exceed the potential benefits,
specifically increased tax collections and improved compliance. We
estimate that if FMS addresses its control and related weaknesses, it
could collect an estimated $50 million more from the FPLP annually.
Furthermore, FMS has not addressed other challenges in the levy program
that further limit its effectiveness at collecting unpaid taxes. These
challenges include levying contractors paid with government purchase

4 Our estimate was derived by analyzing data from FMS's Payments, Claims,
and Enhanced Reconciliation (PACER) system, which maintains detailed data
on payments made via checks and Automated Clearing House. PACER payment
data for fiscal year 2004 contained about 12.9 million contractor payments
valued at $247 billion. As will be discussed later, PACER does not
maintain detailed information related to $191 billion in payments made via
Fedwire-payments requiring same-day settlement.

cards and fully implementing, with IRS, the increased 100 percent levy
provision authorized in 2004.5 Furthermore, as will be communicated in a
separate report, a draft of which was transmitted to FMS and IRS for
comment on June 7, 2005, FMS and the states are not collecting debt,
including unpaid taxes, on behalf of one another through the offset of
contractor payments.6 These mutually beneficial tax collection activities
are not occurring because FMS has not actively pursued avenues to
encourage states to enter into reciprocal agreements with the federal
government to collect each other's taxes. Officials at the 17 states we
contacted informed us that they were not aware that such a debt collection
opportunity exists, but all expressed interest in pursuing this
opportunity.

We also found numerous instances of abusive or potentially criminal
activity related to the federal tax system during our audit and
investigation of 50 civilian agency contractor case studies.7 The 50 case
studies involved mostly small companies-many of them closely held by the
owners and officers-with unpaid payroll taxes. These payroll taxes
included Social Security, Medicare, and individual income taxes withheld
from employees' paychecks. We found that these contractors did not fulfill
their role as "trustees" and forward these amounts to IRS. Rather, by
diverting the money for personal gain or to fund their business, these
contractors potentially committed a criminal felony. For example, one of
the contractors used the payroll taxes not remitted to IRS to build a
house overseas. A few contractors were involved in more than one business,
all of which had unpaid tax debts. One case study contractor is one of a
group of

5 The American Jobs Creation Act of 2004 contains a provision authorizing
the federal government to levy up to 100 percent-up from a maximum of 15
percent-of specified payments for goods and services provided by
contractors with unpaid federal taxes. Pub. L. No. 108-357, S: 887(a), 118
Stat. 1418, October 22, 2004, to be codified at 26 U.S.C. S: 6331 (h)(3).

6 GAO, Debt Collection: State and Federal Governments Are Not Taking
Action to Collect Unpaid Tax Debt through Reciprocal Agreements,
GAO-05-697R (Washington, D.C.: to be issued).

7 A case study consists in some cases of multiple related entities, some
or all of which owe tax debts. When our audit and investigative work
indicated that the 50 contractors we originally selected were related to
other entities-defined as entities sharing the same owner or officer or
common addresses-we performed work to determine whether the related
entities and the owners owed tax debts as of September 30, 2004, and
received other federal payments during fiscal year 2004.

20 businesses that owed $13 million in unpaid taxes covering over 300 tax
periods.8 Another case study contractor had a 20-year history of opening a
business, failing to remit to IRS the taxes withheld from employees, and
then closing the business, only to repeat the cycle again and incur
additional tax debts almost immediately.

As discussed in our report released today, we are making 18
recommendations to FMS to improve collections under the FPLP and 1
recommendation to IRS to review the 50 case study companies and determine
whether additional collection action or criminal investigation is
warranted. IRS agreed and FMS partially agreed with our recommendations.
FMS did not agree with our recommendations that it should withhold
payments to contractors without a name or work with IRS to explore options
to levy or otherwise collect from purchase card payments. FMS also
disagreed with our characterization of its management of the levy program
but did not dispute the factual basis on which we based our findings and
recommendations. We disagree with FMS's assessment and reiterate support
for our recommendations. In our related report on state participation in
the levy program, a draft of which has been sent to FMS and IRS for
comment, we are also making three additional recommendations to FMS to
increase state participation in the collection of unpaid federal and state
taxes.

  Civilian Contractors Owe Billions of Dollars in Unpaid Federal Taxes

As was the case at the Department of Defense, thousands of civilian agency
contractors throughout the federal government abused the federal tax
system with little consequence. Our analysis of FMS and IRS records
indicated that during fiscal year 2004, FMS made payments on behalf of
civilian agencies to about 33,000 federal contractors with over $3.3
billion in unpaid federal taxes as of September 30, 2004. This amount is
likely understated because, first, we intentionally limited the population
of contractors with unpaid tax debts to debts and payments that were

8 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.

significant and agreed upon, 9 and second, because the disbursement files
we received from FMS were not complete, i.e., they did not always contain
the information we needed to determine whether the contractors owed
federal taxes. For example, contractors receiving $17 billion in payments
from FMS could not be identified because of blank or obviously erroneous
TINs in the payment files submitted to FMS by the civilian agencies.
Without an accurate TIN, we could not determine whether the contractor had
unpaid federal taxes and, if so, the amount of unpaid taxes owed by the
contractor. Similarly, as we have seen from our annual audits of IRS's
financial statements, the taxpayer account database we received from IRS
reflects only the amount of unpaid taxes either reported by the taxpayer
on a tax return or assessed by IRS through its various enforcement
programs.10 The IRS database does not reflect the amounts owed by
businesses and individuals that have not filed tax returns and for which
IRS has not assessed the tax amounts due.

The over $3.3 billion in unpaid taxes owed by these civilian agency
contractors ranged from a small amount owed by an individual for a single
tax period to a group of related businesses owing about $13 million for
over 300 tax periods. The type of unpaid taxes varied and consisted of
payroll, corporate income, individual income, and other types of taxes. As
shown in figure 1, over a third of the total tax amount owed by civilian
contractors was for unpaid payroll taxes, and over 40 percent was for
corporate income taxes.

9 Our initial matches of civilian contractor payments made during fiscal
year 2004 with IRS tax debt as of September 30, 2004, identified about
63,000 contractors that had tax debt totaling $5.4 billion. We excluded
from our preliminary estimates tax debts that had not been agreed to by
the tax debtor or affirmed by the court, tax debts from calendar year
2004, tax debts of $100 or less, and fiscal year 2004 FMS payments of $100
or less to arrive at our estimate of about 33,000 contractors with $3.3
billion in tax debts.

10 GAO, Financial Audit: IRS's Fiscal Years 2004 and 2003 Financial
Statements, GAO-05103 (Washington, D.C.: Nov. 10, 2004).

Figure 1: Type of Federal Tax Debt Owed by Civilian Contractors

Other tax $0.4 billion

Individual income tax $0.2 billion

Corporate income tax $1.5 billion

Payroll taxes $1.2 billion

Source: GAO analysis of IRS and FMS data as of September 30, 2004.

Unpaid payroll taxes include amounts that an employer withholds from an
employee's wages for federal income taxes, Social Security, and
Medicare-but does not remit to IRS-and the related matching contributions
of the employer for Social Security and Medicare. Employers who do not
remit payroll taxes to the federal government are subject to civil and
criminal penalties. Because employers are responsible for holding payroll
taxes withheld from employees "in trust" for the federal government and
making a federal tax deposit in that amount,11 the employer is liable for
the amounts not forwarded to the federal government, as well as the
employer's matching Social Security and Medicare contributions. Willful
failure to remit payroll taxes is a criminal felony offense punishable by
imprisonment of not more than 5 years,12

11 The law further provides that withheld income and employment taxes are
to be held in a separate bank account considered to be a special fund in
trust for the federal government. 26 U.S.C. S: 7512(b).

12 26 U.S.C. S: 7202.

while the failure to properly segregate payroll taxes can be a criminal
misdemeanor offense punishable by imprisonment of up to a year.13 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. However, individuals may be held personally liable for
the withheld amounts not remitted to IRS and assessed a civil monetary
penalty known as a trust fund recovery penalty (TFRP).14

A substantial amount of the unpaid federal taxes shown in IRS records as
owed by civilian contractors has been outstanding for several years. As
reflected in figure 2, over half of the unpaid taxes owed by civilian
contractors was for tax periods prior to calendar year 2000.15

13 26 U.S.C. S: 7215 and 26 U.S.C. S:7512 (b).

14 26 U.S.C. S: 6672.

15 The tax period may not always correspond to the age of the tax debt, as
when a tax form is filed years after the due date or when IRS assesses
additional taxes to earlier tax periods.

Figure 2: Civilian Contractors' Unpaid Federal Taxes by Tax Periods
through 2003

Prior to 1990 $0.2 billion

2003 $0.5 billion

2000-2002 $1.1 billion

1990-1999 $1.5 billion

Source: GAO analysis of IRS and FMS data as of September 30, 2004.

Prompt collection of unpaid taxes is vital because, as our previous work
has shown, as unpaid taxes age, the likelihood of collecting all or a
portion of the amount owed decreases.16 This is due, in part, to the
continued accrual of interest and penalties on the outstanding federal
taxes, which, over time, can dwarf the original tax obligation.
Furthermore, there is generally a 10-year statutory collection period
beyond which IRS is prohibited from attempting to collect tax debt.17
Consequently, if the contractors owed federal taxes beyond the 10-year
statutory collection period, the older tax debt typically would not be
available for collection

16 GAO, Unpaid Payroll Taxes: Billions in Delinquent Taxes and Penalty
Assessments Are Owed, GAO/AIMD/GGD-99-211 (Washington, D.C.: Aug. 2,
1999).

17 The 10-year time period may be suspended, including for periods during
which the taxpayer is involved in a collection due process appeal, a
litigation, a pending offer in compromise or an installment agreement.
Accordingly, figure 2 includes unpaid federal taxes that are for tax
periods prior to 1995.

because the debt would have been removed from IRS's records. We were
unable to determine the amount of unpaid tax debts of federal contractors
that had been removed because of the statutory collection period's
expiration.

  Millions in Unpaid Federal Taxes Are Not Collected

A large levy collection gap exists between the potential levy amount we
estimated and the amount FMS actually collected under the FPLP. According
to our estimate, if there were no legal or administrative provisions that
removed a substantial amount of tax debt from the levy program, and if all
contractor payments for which FMS maintained detailed information were
subjected to a 15 percent levy to satisfy all the unpaid taxes of those
civilian contractors, FMS could have collected as much as $350 million in
fiscal year 2004. However, during fiscal year 2004, FMS collected about
$16 million from civilian contractors-or about 4 percent of the maximum
levy collection we estimated. Because almost two-thirds of unpaid federal
taxes are excluded from the FPLP because of statutory requirements and IRS
policies, FMS and IRS will never be able to completely close the levy
collection gap. Additionally, FMS's lack of oversight and proactive
management of the levy program further impeded the government's ability to
close the levy collection gap, leading to at least $50 million in lost
levy collections from civilian agency contractors during fiscal year 2004.
Until FMS corrects the deficiencies in its oversight and management of the
levy program, the federal government will continue to miss opportunities
to collect unpaid taxes through the FPLP.

Billions of Dollars in Unpaid Taxes Excluded from Levy Program

According to IRS records, as of April 2005, IRS had coded about $71
billion of unpaid federal taxes as being legally excluded from the levy
program and $100 billion as being excluded because of policy decisions. As
shown in figure 3, this leaves only 37 percent ($98 billion out of $269
billion) in unpaid taxes that IRS sent to FMS to be included in the FPLP
for potential collection. Furthermore, IRS had completed all legal
notification requirements for immediate levy on only 30 percent the amount
of unpaid tax debts in the FPLP as of September 30, 2004. Consequently, 70
percent of those tax debts sent over for levy were still not eligible to
have payments levied.

                 Figure 3: Levy Status of Unpaid Federal Taxes

Statutory exclusions $71 billion

Policy exclusions $100 billion

In levy program $98 billion

          Source: GAO analysis of unaudited IRS data as of April 2005.

According to IRS records, bankruptcy and taxpayer agreements, including
installment or offer in compromise agreements,18 each account for about a
quarter of the $71 billion in statutory exclusions. Another 38 percent-$27
billion-is due to IRS not having completed all initial taxpayer
notifications required by law before a tax debt could be referred to the
FPLP. These are cases that IRS refers to as being in notice status.

For tax debt in notice status-the first phase of IRS's collection process-
IRS sends a series of up to four separate notices to the tax debtor
demanding payment of the tax debt. Upon receipt of each notice, the
debtors have a minimum of 30 days to respond and have a number of
different options, including appealing the tax debt if they disagree with
the tax assessment, entering into a payment arrangement, applying for a
hardship determination,19 or paying the tax debt in full. Each time the
debtor responds to a notice, IRS must make a determination on how to

18 Installment agreements allow for payments on the debt in smaller, more
manageable amounts. An offer in compromise approved by IRS allows a tax
debtor to settle unpaid tax debt for less than the full amount due.

19 In these instances, the tax debtors demonstrate to IRS that making any
payments at all would result in a significant financial hardship.

dispose of the response, for example, whether to accept or reject an
installment agreement if one is offered, before proceeding further with
another notice or collection action. The process of notification,
response, disposition, and further notification could occur up to four
times. Until the series of notifications is complete, the tax debt is
excluded from the levy program.

In addition to legal restrictions, $100 billion in tax debts is excluded
because of IRS policy decisions. According to IRS data as of April 2005,
slightly over half ($51 billion) of all policy exclusions were due to
IRS's determination that the tax debtor was in financial hardship.20 Other
policy exclusions include debts belonging to debtors who are working with
IRS to voluntarily comply and debtors under active criminal investigation,
among others. The amount excluded for policy reasons remained substantial
even after IRS added more than $28 billion to the levy program by reducing
the number of policy exclusions in response to recommendations we made in
our previous report on DOD contractors.21

In addition to the above, our past financial audits have indicated that
IRS's records contain coding errors that affect the accuracy of taxpayers'
account information, resulting in lost opportunities to collect
outstanding taxes. The effective management of these codes is critical
because if the codes used to exclude tax debts from the levy program (such
as codes identifying a contractor as being in bankruptcy or having an
installment agreement) erroneously remain in the system for long periods,
tax debts may be needlessly excluded from the levy program.

Billions More in Tax Debts Referred to FMS Were Not Leviable

FMS's records indicate that as of September 30, 2004, about 70 percent of
the tax debt in the FPLP was still not immediately leviable because IRS
had not completed all the legal notification requirements necessary for
levying to begin. Before levying a payment or any other asset, IRS is
required to send the debtor an additional notice of intent to levy-known
as a collection due process notice-that notifies the debtor of the
impending levy. IRS gives the debtor up to 10 weeks to either resolve the
debt or file

20 According to IRS, financial hardship can be either a statutory
exclusion (under 26 U.S.C. 6343(e)) or policy exclusion, depending on when
and who makes the determination. For reporting on the FPLP, IRS
categorizes hardship cases as policy exclusions.

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

an appeal. The debtor has the same response options as in the initial
notice phase. In addition, the taxpayer can file a collection due process
appeal. Once IRS completes action on the response or if the tax debtor
does not respond, IRS codes the tax debt in the FPLP for immediate levy.
Payments cannot be levied until this process is complete.

Prior to 1998, IRS was authorized to levy a payment immediately upon
matching a tax debt with a federal payment as long as the collection due
process notice had been sent. However, the IRS Restructuring and Reform
Act of 1998 requires that debtors be afforded an opportunity for a
collection due process hearing before a levy action can take place. To
comply with this provision, IRS currently waits a minimum of 10 weeks for
the tax debtor to respond to the collection due process notice before it
proceeds with levy, thereby causing the federal government to miss levying
some contractor payments. The joint task force established after our
previous audit22 has supported making the due process for the federal
payment levy program a postlevy process.23 This would allow IRS to levy
payments when first identified and provide contractors with procedural due
process remedies afterward. To further reduce the payments lost to levy
because of the time required for the collection due process to run its
course, IRS officials stated that they had begun matching new DOD
contracts valued at over $25,000 against tax debt and sending out
collection due process notifications at that time rather than waiting
until payments are made. The task force is also exploring avenues to
combine the collection due process notice with the last of its initial
notification letters sent to tax debtors.

22 In response to recommendations made in our audit of DOD contractors
with unpaid federal tax debt, the Federal Contractor Tax Compliance Task
Force was established with representatives from DOD, the Defense Finance
and Accounting Service, IRS, FMS, the General Services Administration, the
Office of Management and Budget, and the Department of Justice. The joint
task force agreed to work together to ensure that federal contractors pay
their taxes and that appropriate enforcement actions, including levies,
are taken to collect delinquent tax accounts.

23 Federal Contractor Tax Compliance Task Force, Report to Senate
Committee on Governmental Affairs Permanent Subcommittee on Investigations
(Washington, D.C.: Oct. 26, 2004).

FMS's Management and Oversight of FPLP Resulted in Missed Opportunities to
Levy Billions in Contractor Payments

We found that FMS disbursed tens of billions of dollars in payments
without subjecting them to the levy process because of a lack of proactive
oversight. As shown in table 1, the reasons for payments not being
subjected to the levy process were that (1) agency payment station codes
were not loaded into TOP, (2) payments contained blank or obviously
inaccurate TINs, (3) payments contained blank or invalid names, and (4)
payments contained invalid payment types. In general, FMS was not aware of
these omissions until we brought them to its attention.

Table 1: Payments Submitted to TOP That Could Not be Levied

                              Dollars in billions

                            Types of payments Amount

Payments where the agency payment station has not been loaded in TOP $40
Payments containing blank or obviously inaccurate TINs

Payments containing blank or invalid names

Payment containing invalid payment types

Source: GAO's analysis of FMS data.

Notes: The categories above cannot be added together to derive the total
amount of excluded payments because many payments had multiple
deficiencies, each of which would have prevented the payment from being
levied. For example, some payments without TINs also have invalid names.

First, we found that FMS did not update the TOP database to accept $40
billion in payments from about 150 agency paying stations.24 If a paying
station is not in the TOP database, that location is excluded from the
levy program; thus payments from that location are not matched against
unpaid federal taxes for potential levy. Of the $40 billion not sent to
TOP, we determined that approximately $9 billion in payments was made to
civilian contractors with tax debts, none of which could be or were
levied.

24 These stations are generally referred to by their Treasury Agency
Location Codes (ALC). The ALC is used to identify transactions, documents,
and reports processed through the Treasury Department by a specific
accounting point or station within an agency or bureau of a federal
department or independent agency. Using the ALC enables Treasury to
reconcile deposits and disbursements.

Second, FMS disbursed over $17 billion to civilian agency contractors
without TINs or with obviously inaccurate TINs in the payment files
submitted to it by civilian agencies. Valid TIN information is critical to
the levy program because payments lacking this information cannot be
matched against tax debts. The Debt Collection Improvement Act of 199625
requires executive agencies to obtain TINs from contractors and to include
TINs on certified payment vouchers submitted to the Treasury Department
for payment.26 While Treasury has exempted as a matter of policy a limited
number of vendors from the TIN requirements, the exemptions are rare and
are generally limited to foreign companies providing goods and services
for federal agencies in a foreign country or companies performing
classified work. According to FMS officials, FMS tabulates certain payment
records with obviously inaccurate TINs by agency and encourages agencies
to send payment files with valid TINs in case of noncompliance.27 However,
FMS does not enforce the TIN requirement by rejecting agency payments with
blank or obviously inaccurate TINs or requiring the agencies to certify
that such payments meet one of the TIN exclusion criteria. As a result,
agencies continue to submit payment requests without TINs, and
consequently, these payments cannot be levied to collect unpaid federal
taxes.

Third, FMS disbursed nearly $3.8 billion in fiscal year 2004 to
contractors whose name was not properly contained in the agency-submitted
payment files. Instead, the name field in the payment file was either
blank or contained numeric characters only.28 The lack of a proper name
could have been detected if FMS had conducted a cursory review of the
payment files

25 Pub. L. No. 104-134, 110 Stat. 1321-358, Apr. 26, 1996.

26 31 U.S.C. S:7701(c) and (d).

27 Tabulation is performed for the standard payment types sent through the
levy program, that is, payments known as type B. Type A and Fedwire
payments are not tabulated or monitored. Type A payments are payments
where the agency certifies the payment in the same file that contains
detailed payment information. For type B payments, agencies send FMS the
certification for the payment separately from the detailed payment
information. ACH-CTX payments (a specific kind of type B payment) are
payments whereby agencies can pay multiple invoices to a single contractor
using a single ACH-CTX payment. Fedwire is a processing system designed
for high-dollar, low-volume payments that must be received by payees the
same day as originated by the agency.

28 In addition, we identified numerous payee names that contained only a
single alphabetic character in the name field. We did not include these in
our analysis of payments with improper name fields.

submitted by the agencies. For example, our review readily identified that
most of the payment files submitted by the Department of State (State) did
not contain valid contractor names. About $3.2 billion of the nearly $3.8
billion we identified as payments made to contractors without names in the
payment files were made on behalf of State. According to a State
Department official, State likely had names on its payment files since the
1980s, but a programming error had resulted in the names not being in the
disbursement file sent to FMS. While disbursements could be made without a
name-as disbursements are made electronically via direct deposit into the
contractor's bank account-valid name information is critical because the
levy program requires a match between both the name and TIN for a levy to
occur.

Last, during fiscal year 2004, FMS disbursed about $5 billion via checks
to civilian agency contractors on the basis of agency-submitted payment
files that did not contain data in the payment-type field. FMS uses the
payment-type field to determine if the payment is subject to the levy
program. If the payment-type field is blank, FMS does not attempt to match
the payment to unpaid tax debts for potential levy. As a result, none of
the $5 billion in payments we identified as having a blank payment-type
field could have been levied to collect the contractors' unpaid federal
taxes. After we brought this to FMS's attention, an official stated that
FMS planned to establish a new centralized program to monitor the
completeness of agency information.

Management Decisions Excluded Tens of Billions More in Payments from the
Levy Program

In addition to payments not included in the levy program because oversight
was lacking, FMS and IRS also made decisions that caused tens of billions
of dollars more in contractor payments not to be subject to potential levy
collection. Specifically, we found that while FMS disbursed funds using a
number of payment mechanisms-including payments known as type A, type B
(including ACH-CTX), and Fedwire-FMS has taken actions to include only
disbursements made via type B in the levy program. Even then, ACH-CTX-a
specialized type B payment-is excluded from the levy program. We also
found that FMS does not levy payments to collect the unpaid federal taxes
owed by individuals because a small possibility exists that an individual
TIN and name may be the same as the TIN and name of an unrelated business.
Consequently, IRS instructed FMS not to levy contractor payments to
individuals because it did not want to mistakenly levy payments of
individuals to pay the debt of an unrelated business.

Although it is responsible for administering the levy program, FMS could
not quantify the magnitude of federal contractor payments excluded from
the levy program, nor could FMS estimate the amount of levy collections it
was missing because it had not included all payment categories in the
program. Our work, based on limited data, indicates that at a minimum, $26
billion in payments was made via type A and ACH-CTX that were not subject
to the levy process. The $26 billion, although likely understated,
represents almost 11 percent of all contractor disbursements recorded in
FMS's PACER database. In addition, FMS disbursed approximately $191
billion in Fedwire payments,29 but was not able to identify the value of
payments made to contractors via Fedwire that it did not send to the levy
program.

FMS excluded these payments from the levy program because including them
would require programming changes to its automated systems or other
efforts. Although FMS had performed some preliminary studies in 2001
regarding how to send type A payments to TOP, officials were unable to
provide information regarding the cost of making system corrections.30 At
that time, FMS was developing a new payment system that it estimated would
be completed as early as 2003 and therefore decided not to make the system
changes. However, at the time of our audit, the new system was still not
fully deployed. Consequently, over the last 4 years, the federal
government has lost an unknown amount of collections that could have been
levied from those payments. FMS officials stated that FMS is continuing to
focus on completing the deployment of a new disbursement system, which it
now estimates will be fully operational in 2006, rather than including
type A payments in its current system. FMS tentatively plans to
incorporate type A payments into TOP in calendar year 2006 when its new
system is scheduled to be operational.

29 This amount does not include $66 billion in certain benefit payments.

30 FMS officials stated that it could take additional programming time to
prepare TOP to receive type A payment information from other systems. For
example, FMS conducted a study in 2001 and estimated that it would take
about 6 hours of programming and 1 to 3 days of testing to make the system
changes necessary to one system to include type A payments in TOP for
levy.

FMS Faces Challenges in Addressing Other Program Limitations

FMS faces other management challenges in matching TINs and names, levying
purchase cards, and implementing the 100 percent levy provision of the
American Jobs Creation Act of 2004. Specifically, almost $2 billion of
contractor payments could not be levied because the TIN and payee name in
the payment files did not match with the TIN and "control name" with which
IRS provided TOP. In general, the control name is the first four
characters of an individual's last name or the first four characters of
the business name. If TOP finds a TIN match between the payment file and
the file provided by IRS, but cannot find the control name (first four
characters of the IRS name) anywhere within the name field of the payment
file, TOP reports only the mismatch to IRS, but does not levy payments to
collect delinquent tax debts. After we brought this to FMS's and IRS's
attention, IRS began working with FMS to increase the number of control
names-up to 10 additional control names per business-it sends to TOP. IRS
officials believed that this should increase the number of matches
available under the levy program. IRS is also evaluating additional
changes to increase the number of name controls that it sends to FMS for
matching with payments to individuals.

We also found that nearly $10 billion in federal payments made via
purchase cards to contractors in fiscal year 2004 are not subject to levy
because the government payment is made to the bank that issues the
purchase card instead of the contractor doing business with the
government. FMS officials have acknowledged the need to address this
challenge but stated that FMS faces both operational and legal issues to
incorporate such payments into TOP and that the process of paying the
purchase-card-issuing bank may prevent FMS from using TOP to collect from
contractors paid with a purchase card. In the meantime, the use of
purchase cards for federal acquisition purposes continues to increase.
Until this challenge is thoroughly examined by FMS and IRS and until
solutions are identified, the federal government will continue to be
unable to levy or otherwise collect from tens of billions of dollars in
payments made to civilian contractors through this mechanism.

Finally, FMS has not fully implemented a new provision, authorized by
Congress in October 2004, which increased the maximum levy percentage from
15 percent to 100 percent of payments to contractors with unpaid taxes.
Our analysis indicated that if no legal or procedural provisions excluded
tax debts from the levy program, a levy of up to 100 percent on all
contractor payments would result in FMS's collecting as much as

$800 million31 annually from civilian contractors. However, because the
provision provides for increasing the levy percentage on payments to
vendors for "goods and services" sold or leased to the government, IRS has
determined that the legal language excluded real estate, such as rent
payments, from the new levy requirement. This exclusion presents
significant implementation challenges for FMS because the civilian
agencies' payment systems at present do not separately identify real
estate transactions from other contractor payments. Without the ability to
distinguish between these payments, FMS could not implement the new law
for civilian payments in such a way as to exempt real estate transactions
from the 100 percent levy. FMS officials stated they had recently been
able to implement the 100 percent levy provision for certain DOD payments
but were unable to do so for disbursements made directly by FMS. According
to FMS and IRS officials, a specific legislative change is being sought to
subject real estate payments to the new 100 percent levy requirement.

FMS Has Not Taken Action to Establish Reciprocal Agreements with States

As discussed in a separate product,32 developed at the request of this
committee and transmitted to FMS for review and comment on June 7, 2005,
FMS has not pursued agreements with the states that could result in the
federal and state government's collecting-through the offset of contractor
payments-unpaid tax debts on behalf of each other. The Debt Collection
Improvement Act of 1996 authorizes these collections if a state enters
into a reciprocal agreement with FMS that allows the state and FMS to
collect unpaid debt from each other's payments, including payments to
their contractors. Despite the potential benefits, the federal government
has not yet established any reciprocal agreements with states to offset
contractor payments. According to FMS officials, states have not expressed
interest in executing such agreements. In fact, the state debt collection
officials we contacted,33 and officials at the Federation of Tax
Administrators and at the National Association of State Auditors,

31 This assumes that the tax debts and payment amount remain constant in
future years.

32 GAO-05-697R.

33 We contacted debt collection officials of the following 17 states:
California, Connecticut, Georgia, Illinois, Hawaii, Louisiana, Maine,
Maryland, Michigan, Minnesota, Missouri, New Jersey, New York, North
Carolina, Pennsylvania, South Carolina, and Virginia. Collectively, the 17
states received over 75 percent of FMS's collections from the federal tax
refund offset program as well as over 75 percent of the federal
collections from the State Income Tax Levy Program.

Comptrollers, and Treasurers, informed us that they had not pursued
reciprocal agreements because they were not aware that this debt
collection avenue exists. The state officials all expressed interest in
obtaining more information on potential agreements and in assessing the
potential benefits of such agreements.

Our review indicated that many federal contractors paid through FMS have
unpaid state tax debt. Our analysis of FMS's payment records found that
FMS disbursed a total of about $1.8 billion to over 4,600 federal
contractors with state tax debt-primarily tax debt owed by individuals-in
fiscal year 2004. These contractors owed approximately $17 million in
state tax debt. According to our analysis, if states had reciprocal
agreements with FMS, the states could have collected over half of the
outstanding state tax debt from these federal contractors in a single
year.

  Civilian Agency Contractors Involved in Abusive and Potentially Criminal
  Activity Related to the Federal Tax System

We found abusive and potentially criminal activity related to the federal
tax system for all 50 cases that we audited and investigated. The 50
case-study contractors typically operate in wage-based industries,
providing security, building maintenance, professional services, health
care, and personnel services for the Departments of Homeland Security,
Justice, and Veterans Affairs, and the National Aeronautics and Space
Administration, to name a few. The contractors are mostly small-many of
them, closely held by the owners and officers. In table 2, and on the
following pages, we summarize 10 of these businesses. The amount of unpaid
taxes associated with these 10 case studies ranged from nearly $400,000 to
over $18 million. We found that some case-study contractors had large
amounts of unpaid taxes because they were "multiple abusers," i.e., they
were one of a group of related companies that owed taxes. Several
"multiple abusers" among these 10 cases studies owed taxes for more than
50 tax periods; in one case, a group of about 20 related businesses owed
nearly $13 million over more than 300 tax periods. It was also not
surprising to find that a few of the business owners among these case
studies also owed individual income taxes. Furthermore, we determined that
9 of the 10 case studies had unpaid state and local taxes significant
enough that state and local tax taxing authorities had filed tax liens
against them.

Our investigations revealed that some owners had substantial personal
assets-including commercial real estate, a sports team, or multiple luxury
vehicles-yet their businesses failed to remit the payroll taxes withheld
from employees' salaries. Several owners owned homes worth over $1
million-one owner had over $3 million and another had over

$30 million in real estate holdings. Others informed our agents that they
diverted payroll taxes they had not remitted to IRS for personal gain or
to fund their business, while others were engaged in activities that also
indicated that they might have diverted payroll taxes for personal gain.
For example, one owner transferred the payroll taxes he withheld from
employees to a foreign bank account and was using the money to build a
home in that country, while another contractor doubled the salary of an
officer in a 5-year period to over $750,000 at the same time that the
business failed to remit payroll taxes and declared losses for income tax
purposes of more than $2 million. In one case, even though the business
owed IRS for unpaid payroll taxes withheld from employees' salaries, the
business was involved in a joint venture to spend millions on additional
facilities and new technologies, some of which will take place outside the
United States. In addition, we found that 3 of the 50 case studies
involved owners or officers who had been either convicted or indicted for
non-taxrelated criminal activities or were under IRS investigation. We are
referring the 50 cases detailed in our report to IRS so that it can
determine whether additional collection action or criminal investigation
is warranted.

         Table 2: Civilian Agency Contractors with Unpaid Federal Taxes

         Goods,                                  
         services,                               
         or nature of                            
         work                                    
         and agencies to Fiscal year      Unpaid 
Case  whom they were     2004 FMS federal tax 
study provided          paymentsa     amountb Comments 

                                               o  Business is affiliated with 
      Health-care-         Over        Over    many other health-care-related 
                                                        facilities, including 
related services to $300,000 $18 million  nursing and convalescent homes.  
     Departments of                         o  Taxes owed by related entities 
                                               cover over 80 tax periods.     
                                              o  Since failing to fully remit 
    Veterans' Affairs                             all the taxes withheld from 
                                                         employees' paychecks 
     and Health and                          starting in the late 1990s, the  
                                                     owner purchased          
        Human Services                           o  multimillion-dollar       
                                                       properties,            
                                              o  an unrelated business, and   
                                             o  a number of luxury vehicles.  
                                              o  Other real estate holdings   
                                                 include residential and      
                                                  commercial properties       
                                             valued in the tens of millions.  

                                                 o  Company and several other 
2 Waste collection     Over       Over  entities share the same address or 
                                                                  executives. 
                                           o  Taxes owed by related entities  
     services to the  $700,000 $2 million    cover over 40 tax periods and    
                                                        include               
      Department of                        individual income tax debt of one  
                                                        owner.                
                                           o  Since the late 1990s, about the 
         Justice                            same time that the company failed 
                                                                   to pay all 
                                           of its payroll taxes, the company  
                                           regularly withdrew cash from its   
                                                         bank                 
                                          accounts. These withdrawals totaled 
                                               several million dollars.       
                                          o  Since failing to fully remit all 
                                            the payroll taxes withheld from   
                                                      employees'              
                                             paychecks, one owner sold his    
                                          residence for more than $1 million. 

(Continued From Previous Page)

         Goods,                                  
         services,                               
         or nature of                            
         work                                    
         and agencies to Fiscal year      Unpaid 
Case  whom they were     2004 FMS federal tax 
study provided          paymentsa     amountb Comments 

      Health-care-       Nearly Over $9 o  Business is affiliated with three  
                                              other related companies.        
                                        o  Taxes owed by related entities     
related services to $250,000 million cover over 60 tax periods and include 
                                        the                                   
     the Department of                   owner's individual income tax debt,  
                                           totaling hundreds of thousands.    
                                             o  One entity is under IRS       
    Veterans Affairs                      investigation. In addition, owner   
                                                    suspected of              
                                            fraudulent banking activity.      
                                            o  Since failing to pay taxes     
                                        o  officer spent tens of thousand of  
                                               dollars on gambling and        
                                            o  one of the three companies had 
                                            multiple withdrawals of cash from 
                                                                         bank 
                                           accounts-each totaling tens of     
                                                thousands of dollars.         

                                           o  Company is one of almost 20     
Waste collection    Over      Nearly  related entities, all of which owed  
                                                       unpaid                 
services to the  $10,000 $13 million    taxes-primarily payroll taxes.     
    Department of                         o  Taxes owed by related entities   
                                             cover over 300 tax periods.      
Veterans Affairs                            o  The owner also owns         
                                          o  a residential property located   
                                               near a golf course and         
                                            o  other commercial properties in 
                                        several states with an assessed value 
                                                                           of 
                                                  over $2 million.            

Payroll and temporary employment services to the Department of Housing and
Urban Development

Over Nearly  o  Business related to three other entities. $1 million
$900,000  o  Taxes owed by two related entities cover over 20 tax periods.

o  Some tax debts of remaining entities were not paid for so long that IRS
is now legally prohibited from seeking collection.

o  The owner's history of delinquency stretches nearly 20 years and
covered multiple businesses. Specifically, the owner typically

o  incurs payroll taxes for one company,

o  is assessed trust fund penalty on that company but makes no or little
payments,

o  closes company,

o  starts another company, and

o  repeats the same pattern.

o  For example, the owner filed for bankruptcy protection in the late
1990s. In the early 2000s, after the court denied the owner's request for
bankruptcy protection, the owner closed the company and immediately
established a new business with a similar name at the same address that
provides the same services.

o  The owner

o  rents office space in an expensive area of a major metropolitan city
and

o  purchased a luxury automobile at the same time the company had filed
for bankruptcy protection and was not remitting all of the payroll taxes.

                  6      Health-care-       Nearly        Over 
                     related services to  $300,000 $10 million 
                        Department of              
                       Veterans Affairs            

o  The company's delinquent taxes-primarily payroll taxes-cover 20 tax
periods from the late 1990s.

o  IRS is investigating the company for potential criminal activity.

o  Since failing to pay payroll taxes in the late 1990s, the officer who
had been assessed the trust fund violation purchased several vehicles
totaling nearly $200,000.

o  Since the late 1990s, the company reported cumulative losses on its tax
returns totaling about $5 million.

o  Despite these continued losses and accumulated tax debt, the company is
involved in a multimillion-dollar joint venture.

(Continued From Previous Page)

         Goods,                                  
         services,                               
         or nature of                            
         work                                    
         and agencies to Fiscal year      Unpaid 
Case  whom they were     2004 FMS federal tax 
study provided          paymentsa     amountb Comments 

                                         o  The company had not filed all     
    Security guard      Over     Over  required tax returns since the early   
                                                      2000s,                  
                                           and had been delinquent in payroll 
     services to    $200,000 $400,000     taxes almost continuously since the 
                                                                         late 
     Departments of                                   1990s.                  
       Homeland                        o  Delinquent tax debts cover over 25  
                                        tax periods and include the owner's   
     Security and                     individual income taxes totaling tens   
                                      of thousands. In addition, the owner    
Veterans Affairs                     repeatedly failed to file personal    
                                                income tax returns.           
                                         o  The owner diverted unpaid payroll 
                                           taxes to a foreign bank account to 
                                                                      build a 
                                                  house overseas.             

                                               Consulting     Over       Over 
                                          services to the $200,000 $1 million 
                                              Smithsonian          
                                              Institution          

o  The business's unpaid federal taxes are primarily payroll taxes
incurred in late 1990s and early 2000s.

o  Unpaid tax debt balance covers more than 20 tax periods and includes
hundreds of thousands of dollars in individual income tax debts owed by
two officers.

o  During the same period that tax debt was incurred, the company also
declared large losses but doubled the salary of one officer to over
$750,000.

o  Officers own several luxury vehicles and multimillion-dollar properties
in exclusive areas of a major metropolitan area.

o  The company is making payments on current installment agreement.

                                            o  Tax debt balance includes over 
    Armed security      About   Nearly     $200,000 in payroll taxes owed for 
                                                                       almost 
guard services to $500,000 $400,000            10 tax periods.             
several agencies,                   o  In the early 2000s, company did not 
                                              file income tax returns.        
     including the                     o  In the mid-2000s, an officer of the 
                                         company was convicted for stealing   
     Department of                     hundreds of thousands of dollars from  
                                                    the company.              
    Justice and the                    o  The owner is under indictment for   
                                       embezzlement and money laundering.     
     Environmental                     
Protection Agency                   

                                      o  This business did not make any       
       Building         Over   Nearly payroll tax deposits for several years  
                                      from                                    
     maintenance,   $300,000 $400,000 the late 1990s through the early 2000s. 
lawn and garden,                   o  Tax debt balance covers more than 30 
                                          tax periods and includes nearly     
     and sanitary                      $100,000 in personal tax debt of the   
                                                     officer.                 
     services to                      o  The company is a chronic nonpayer of 
                                          corporate tax debts and has not     
    Department of                     made any voluntary income tax payments  
                                               since the mid-1990s.           
                                             o  The officer is also a chronic 
    Transportation                          nonfiler of his individual income 
                                                             taxes. In one of 
                                        those years, the officer reported net 
                                         income of about $100,000 but paid no 
                                                      taxes.                  

Source: GAO's analysis of civilian agency, IRS, FMS, public, and other
records.

Notes: Dollar amounts are rounded for the tax debt, estimated maximum
levy, and government payments. The nature of unpaid taxes for businesses
was primarily due to unpaid payroll taxes.

a Civilian agency vendor payments provided by FMS from its PACER system.

b Unpaid tax amount as of September 30, 2004.

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

Case 1: This case includes many related companies that provide health care
services for the Department of Veterans Affairs, for which they received
over $300,000 in payments during fiscal year 2004. The related companies
have different names, operate in a number of different locations, and use
at least several other TINs. However, they share a common owner and
contact address. The businesses collectively owed more than $18 million in
tax debts-of which nearly $17 million is unpaid payroll taxes dating back
to the mid-1990s. IRS has assessed a multimillion-dollar trust fund
penalty for willful failure to remit payroll taxes on each of two
officers. During the early 2000s, at the time when the owner's business
and related companies were still incurring payroll tax debts, the owner
purchased a number of multimillion-dollar properties, an unrelated
business, and a number of luxury vehicles. Our investigation also
determined that real estate holdings registered to the owner totaled more
than $30 million.

Case 2: This case comprises a number of related entities, all of which
provide waste collection and recycling services. These entities received
fiscal year 2004 payments from the Department of Justice totaling over
$700,000, about half of which is from purchase card payments, while owing
in aggregate over $2 million in tax debt. These taxes date to the late
1990s and consist primarily of payroll taxes. Despite the fact that the
company reportedly used legally available means to repeatedly block
federal efforts to file liens against the company, liens totaling more
than $1 million exist against the company. IRS has also assessed trust
fund penalties against the two officers. At the same time that the
entities were incurring the tax debt, cash withdrawals totaling millions
of dollars were made against the business's bank account. Furthermore,
since the company started owing taxes, the owner had sold real estate
valued at over $1 million. The executives of these entities drive
late-model luxury or antique automobiles. Recently, the company started to
make payments on its taxes.

Case 3: This case includes several nursing care facilities, three of which
owed taxes-primarily payroll-totaling nearly $9 million. In addition, the
owner's individual income tax debt totaled more than $400,000, bringing
the total tax debt of this case study contractor to over $9 million. One
business provides nursing care services for the Department of Veterans
Affairs, for which it was paid over $200,000 during fiscal year 2004. An
officer of the company has been assessed a multimillion-dollar trust fund

penalty for willful failure to remit payroll taxes and was recently
arrested on fraud charges. Our investigative work indicates that an owner
made multiple cash withdrawals, each valued at tens of thousands of
dollars, in the early 2000s while owing payroll taxes and that these cash
withdrawals were used for gambling. We further determined that cash
transfers totaling over $7 million were made in a 7-month period in the
early 2000s.

Case 7: This contractor provided guard and armed security services for the
Department of Homeland Security and the Department of Veterans Affairs,
for which it was paid over $200,000 during fiscal year 2004. This business
has a history of noncompliance with federal tax laws. Specifically, the
business was consistently delinquent in paying its taxes since the late
1990s and has not filed all its income and payroll tax returns for a
number of years in the late 1990s. In the last 1-year period that the
business made payroll tax deposits, the business reported that it owed
nearly $80,000 in payroll taxes but made payments totaling less than
$4,000- about one-twentieth of the taxes owed. At the same time that the
owner withheld but failed to remit payroll taxes, the owner diverted the
money into a foreign bank account to build a house overseas.

Case 8: During fiscal year 2004, this company provided consulting services
for the Smithsonian Institution, for which it received over $200,000.
Starting in the late 1990s, the company did not remit to the government
all the money it withheld from its employees' salaries. However, at about
the time the company was failing to remit the taxes, it nearly doubled one
officer's salary to over $750,000. IRS assessed a trust fund penalty on
the officers of this company for willfully failing to remit payroll taxes
withheld from their employees' salaries. Those officers own homes valued
at millions of dollars in exclusive neighborhoods in a large metropolitan
area and several late-model luxury vehicles.

Concluding Comments	In the current environment of federal deficits and
rising obligations, the federal government cannot afford to leave hundreds
of millions of dollars in taxes uncollected each year. However, this is
precisely what has been occurring with respect to the FPLP. The levy
program has thus far been inhibited from achieving its potential primarily
because substantial tax debt is not subject to levy and because FMS, the
nation's debt collector, has not exercised effective and proactive
oversight and management of the program. Overall, the problems we discuss
throughout our companion report issued today paint a picture of a program
badly in need of management overhaul. Until FMS takes decisive actions to
improve

oversight and management of the program, there will be a persistent loss
of collections and contractors will continue to be able to abuse the tax
system with little consequence.

Furthermore, by failing to pay taxes on their income or diverting the
payroll taxes withheld from their employee's salaries to fund business
operations or their own personal lifestyles, contractors with unpaid tax
debts effectively decrease their operating costs. The lower operating
costs provide these individuals and their companies with an unfair
competitive advantage over the vast majority of companies that pay their
fair share of taxes. Over time, this could lead to further erosion in
taxpayers' confidence in the fairness of the nation's tax system, leading
to increased rates of noncompliance with the nation's tax laws. Federal
contractors should be held to a high degree of responsibility to pay their
fair share of taxes owed because they are being paid by the government,
and the failure to effectively enforce the tax laws against them
encourages noncompliance among other contractors as well. The federal
government will continue to lose hundreds of millions of dollars in tax
collections annually until actions are taken to send all payments to the
levy program, ensure that all payments have the information necessary to
allow them to be levied, and establish a proactive approach toward
managing the levy program.

Our companion report includes 18 recommendations to FMS and one to IRS.
Our recommendations to FMS address the need to improve implementation of
the FPLP so that FMS can increase by tens of millions of dollars annually
the amount levied from payments to contractors with unpaid federal taxes,
including the need to identify and correct payments made to contractors
without valid taxpayer identification numbers and implement procedures to
provide reasonable assurance that all eligible payments are submitted for
levy. Our recommendation to IRS calls for it to investigate and, if
warranted, pursue collection or criminal investigation of the 50 case
study contractors identified in the report. In written comments on a draft
of the companion report, IRS agreed with our findings and recommendations,
and pointed to efforts that it has taken to deal with contractors who
abuse the federal tax system. FMS partially agreed with our
recommendations. However, while not disputing the substance of our
findings, FMS disagreed that its management of the program was
ineffective. FMS stated that it believed that it had provided excellent
leadership of the levy program, that the weaknesses we cited in the
companion report were the result of difficult management choices, and that
the responsibility for managing the levy program rests with IRS. FMS also
disagreed with our conclusion that it had not fully implemented the

100 percent levy provision. FMS also did not agree with two of our
recommendations, specifically, that it should withhold payments to vendors
without names in the agency payment files and that it work with IRS to
explore options to levy payments or otherwise collect outstanding tax debt
from contractors paid by purchase card vendors.

We continue to believe that the problems we discuss throughout the
companion report paint a picture of a program badly in need of management
overhaul. Although IRS has a key responsibility to refer tax debts, FMS
has an equally key responsibility to make all payments available for levy.
We continue to believe that all of our recommendations constitute valid
and necessary courses of action, especially in light of the identified
weaknesses and the slow progress that FMS has made to maximize collections
since the passage of the Debt Collection Improvement Act more than 8 years
ago.

Mr. Chairman; Members of the Subcommittee; and Senators Collins, Levin,
and Akaka, this concludes our prepared statement. We would be pleased to
answer any questions you may have.

  Contacts and Acknowledgment

(192168)

For future contacts regarding this testimony, please contact Gregory D.
Kutz at (202) 512-9095 or [email protected], Steven J. Sebastian at (202)
512-3406 or [email protected], or John J. Ryan at (202) 512-9587 or
[email protected]. Individuals making key contributions to this testimony
included, Ray Bush, Richard Cambosos, William Cordrey, Francine
Delvecchio, F. Abe Dymond, Paul Foderaro, Alison Heafitz, Kenneth Hill,
Aaron Holling, Jason Kelly, John Kelly, Rich Larsen, Tram Le, Mai Nguyen,
Kristen Plungas, Rick Riskie, David Shoemaker, Sid Schwartz, Esther
Tepper, Tuyet-Quan Thai, Wayne Turowski, Matt Valenta, Scott Wrightson,
and Mark Yoder.

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