Financial Management: Thousands of GSA Contractors Abuse the	 
Federal Tax System (14-MAR-06, GAO-06-492T).			 
                                                                 
In February 2004 and again in June 2005, GAO testified that some 
Department of Defense (DOD) and civilian agency federal 	 
contractors abused the federal tax system with little		 
consequence. Previous problems we identified with contractors	 
with unpaid taxes have led to concerns over whether any 	 
interagency contractors, such as those on the General Services	 
Administration's (GSA) federal supply schedule, failed to pay	 
their taxes. GSA, through its federal supply schedule and other  
interagency contracts, arranges for federal agencies to purchase 
billions of dollars of goods and services directly from private  
vendors. GAO was asked to determine if GSA contractors, including
both contractors that were paid by GSA and GSA interagency	 
contractors, have unpaid federal taxes, and if so, to (1)	 
determine the magnitude of tax debts owed by GSA contractors; (2)
identify examples of GSA contractors that have tax debts and are 
also engaged in potentially abusive, fraudulent, or criminal	 
activities; and (3) determine whether GSA screens contractors for
tax debts and criminal activities prior to awarding contracts and
at the exercise of any government contract options.		 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-06-492T					        
    ACCNO:   A49042						        
  TITLE:     Financial Management: Thousands of GSA Contractors Abuse 
the Federal Tax System						 
     DATE:   03/14/2006 
  SUBJECT:   Contractor violations				 
	     Contractors					 
	     Delinquent taxes					 
	     Federal taxes					 
	     Tax law						 
	     Tax nonpayment					 
	     Tax violations					 
	     White collar crime 				 
	     Tax debt						 

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GAO-06-492T

     

     * Summary
     * Magnitude of Unpaid Taxes of GSA Contractors
          * Characteristics of Contractors' Unpaid Federal Taxes
     * GSA Contractors Involved in Abusive and Potentially Criminal
     * Tax Debts Are Generally Not Considered When Awarding Contrac
          * Contractors with Federal Tax Debts Are Not Explicitly Prohib
          * Restrictions on Tax Data Hamper Making Contractor Responsibi
          * GSA Contractors Not Required to Undergo Further Determinatio
     * Contractors with Tax Debts Have Unfair Cost Advantage in Con
     * Concluding Comments
          * Data Reliability Assessment
     * GAO's Mission
     * Obtaining Copies of GAO Reports and Testimony
          * Order by Mail or Phone
     * To Report Fraud, Waste, and Abuse in Federal Programs
     * Congressional Relations
     * Public Affairs

Testimony

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

United States Government Accountability Office

GAO

For Release on Delivery Expected at 9:30 a.m. EST

Tuesday, March 14, 2006

FINANCIAL MANAGEMENT

Thousands of GSA Contractors Abuse the Federal Tax System

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

GAO-06-492T

Mr. Chairman and Members of the Subcommittee:

Thank you for the opportunity to discuss General Services Administration
(GSA) contractors that have abused the federal tax system while doing
business with the federal government. In hearings held by this
subcommittee in February 2004 and again in June 2005,1 we testified that
some Department of Defense (DOD) and civilian agency federal contractors
abused the federal tax system with little consequence. In 2005, we
designated interagency contracting, in which GSA plays a prominent role,
as a new high-risk area.2 This designation is partly based on the fact
that interagency contracting3 tends to create an incentive for the agency
awarding the contracts to focus more on increasing contracting volume that
generate fees than on compliance with sound contracting policy and
required procedures (see app. II for further details on GSA's contracting
role).

This testimony continues a body of work which has identified federal
contractors with unpaid taxes. Our prior work gave rise to concerns over
whether GSA interagency contractors, such as those on GSA's federal supply
schedule, have also failed to pay their fair share of taxes.4 As a result,
you asked us to determine if GSA contractors have unpaid federal taxes,5
and if so, to (1) determine the magnitude of tax debts owed by GSA
contractors; (2) identify examples of GSA contractors that have tax debts
and are also engaged in potentially abusive, fraudulent, or criminal
activities; and (3) determine whether GSA screens contractors for tax
debts and criminal activities prior to awarding contracts and at the
exercise of any government contract options.

1 GAO, Financial Management: Some DOD Contractors Abuse the Federal Tax
System with Little Consequence, GAO-04-414T (Washington, D.C.: Feb. 12,
2004), and Financial Management: Thousands of Civilian Agency Contractors
Abuse the Federal Tax System with Little Consequence, GAO-05-683T
(Washington, D.C.: June 16, 2005).

2 See GAO, High-Risk Series, An Update, GAO-05-207 (Washington, D.C.:
January 2005).

3 Interagency contracts are those in which one federal agency (typically
GSA) awards the contract, such as a federal supply schedule contract, and
other federal agencies use the contracts, frequently paying a fee to do
so.

4 See GAO, Financial Management: Some DOD Contractors Abuse the Federal
Tax System with Little Consequence, GAO-04-95 (Washington, D.C.: Feb. 12,
2004), and Financial Management: Thousands of Civilian Agency Contractors
Abuse the Federal Tax System with Little Consequence, GAO-05-637
(Washington, D.C.: June 16, 2005).

5 For purposes of this report, GSA contractors include both contractors
that were paid by GSA and GSA interagency contractors. GSA-paid
contractors are contractors paid by GSA finance centers for goods and
services. These goods and services may be used by GSA internally or may be
purchased by GSA for the benefit of other agencies (such as GSA global
supply purchases of commercial items for sale to federal agencies). GSA
interagency contractors are contractors awarded contracts by GSA (such as
federal supply schedule and governmentwide acquisition contracts) from
which agencies routinely acquire services and products for their
procurement needs.

To identify GSA contractors with unpaid federal taxes, we obtained and
analyzed the Internal Revenue Service (IRS) tax debt data as of June 30,
2005. We matched the identities of contractors with IRS tax debts to
federal contractors that were either paid or awarded contracts by GSA to
contract with federal agencies during fiscal year 2004 and the first 9
months of fiscal year 2005. To illustrate indications of abuse or
potentially criminal activity, based on our data mining, we selected 25
GSA contractors for a detailed audit and investigation. For these 25
contractors, we reviewed copies of automated tax transcripts and other tax
records (for example, revenue officer's notes) and performed additional
searches of criminal, financial, and public records. To determine whether
GSA contracting officers are required to consider tax debts or other
criminal activities, we examined the Federal Acquisition Regulation (FAR)
and GSA regulations, policies and procedures for conducting responsibility
determinations on prospective contractors. We also discussed acquisition
policies and procedures used to award contracts with GSA officials and, as
part of these discussions, we determined whether contracting officers
specifically consider tax debts or perform background investigations in
determining whether a prospective contractor is a responsible source
before the contract is awarded and before the option to extend the
contract is exercised. For details on our scope and methodology, see
appendix I.

We conducted our audit work from June 2005 through January 2006 in
accordance with U.S. generally accepted government auditing standards. We
performed our investigative work in accordance with standards prescribed
by the President's Council on Integrity and Efficiency.

                                    Summary

During fiscal year 2004 and the first 9 months of fiscal year 2005,
thousands of GSA contractors abused the federal tax system with little
consequence.6 Specifically, our analysis of data provided by the
Department of Treasury's Financial Management Service (FMS), GSA, and the
IRS indicates that over 3,800 GSA contractors, or about 10 percent of all
GSA contractors, had tax debts totaling about $1.4 billion as of June 30,
2005.7 The unpaid taxes included corporate income, payroll,8 excise, and
unemployment taxes.

6 We considered activity to be abusive when a contractor's actions or
inactions, though not illegal, took advantage of the existing tax
enforcement and administration system to avoid fulfilling federal tax
obligations and were deficient or improper when compared with behavior
that a prudent person would consider reasonable.

We found instances of abusive or potentially criminal activity related to
the federal tax system through our audit and investigation of 25 GSA
contractor case studies. These 25 contractors provided a variety of goods
and services, including building maintenance, security services, and
computer services. During fiscal year 2004 and the first 9 months of
fiscal year 2005, the contractors were tasked by multiple agencies,
including the departments of Defense, Justice, Homeland Security, and
Veterans Affairs to perform work under a GSA contract.

The 25 contractors owed primarily payroll taxes, with some dating back to
the mid-1990s. These payroll taxes included amounts withheld from employee
wages for Social Security, Medicare, and individual income taxes. However,
rather than fulfilling their role as "trustees" and forwarding these
amounts to IRS, many of these GSA contractors diverted the money for
personal gain or to fund the business. Willful failure to remit payroll
taxes is a criminal felony offense9 while the failure to properly
segregate payroll taxes can be a criminal misdemeanor offense.10 In one
case study, the contractor did not pay its tax liability at the time the
company was making a loan to a company officer for hundreds of thousands
of dollars in the 1990s. The company subsequently filed for bankruptcy.
After the company's bankruptcy was discharged in the late 1990s, the
company failed again to remit all of its payroll taxes. At the same time
of owing payroll taxes, the company officer who received the loan acquired
a luxury vehicle and purchased a residential property currently valued in
the millions of dollars. Similarly, a number of owners or officers in the
other 24 case studies had significant personal assets, including
commercial properties, houses worth over $1 million, and luxury vehicles.
Despite owning significant assets, the owners or officers did not pay the
delinquent taxes of their businesses, and sometimes did not pay hundreds
of thousands of dollars of their own individual income taxes. Several
owners also gambled hundreds of thousands of dollars at the same time they
were not paying the taxes that their businesses owed.

7 Because many GSA contractors are interagency contractors, some of the
approximately 3,800 contractors described in this report may also have
been included in our reports concerning DOD and civilian federal
contractors that abuse the federal tax system.

8 Payroll taxes are amounts that employers withheld from employees' wages
for federal income taxes, Social Security, and Medicare but failed to
remit to IRS, as well as the related employer matching contributions for
Social Security and Medicare taxes. Employers are responsible for
remitting payroll taxes to IRS and are liable for any outstanding balance.

9 26 U.S.C. S: 7202.

10 26 U.S.C. S: 7215 and 26 U.S.C. S:7512 (b).

The Federal Acquisition Regulation (FAR) limits awards of contracts to
responsible prospective contractors. A responsible prospective contractor
is a contractor that meets seven specific criteria,11 including adequate
financial resources and a satisfactory record of integrity and business
ethics. However, neither federal law, as implemented by the FAR, nor GSA
implementing policy specifically require contracting officers to take into
account a contractor's tax debt when assessing whether a prospective
contractor is responsible. In policies issued to implement the FAR, GSA's
guidance does not discuss whether or how tax debts should be considered
when making a determination of responsibility. We also found that the FAR
does not require, and GSA has not issued a policy on, assessing a current
contractor's tax debts at the time the government exercises an option to
extend a contract. As a result, no review is systematically performed by
GSA to determine if such contractors have unpaid taxes at the time a
contract is awarded or when an option to extend a contract is exercised by
the government.

Due to the lack of specific responsibility criteria related to tax debts,
limited GSA access to tax information, and lack of other procedures to
assess contractor tax debts, GSA ultimately awarded contracts, including
supply schedule contracts that other federal agencies may use to acquire
services and products for their procurement needs, to businesses with
significant tax debts. Federal law generally prohibits the disclosure of
taxpayer data, and consequently contracting officers have no access to tax
data directly from the IRS. Contracting officers can obtain some tax debt
information by checking publicly available data sources to determine if
IRS or state agencies have filed tax liens against a tax debtor's assets.
However, liens that IRS places on the company and/or its officers are not
available at a single publicly available database, and IRS does not always
file liens against tax debtors.

11 FAR 2.101; 9.104-1.

Finally, in wage-based businesses that provide homogeneous goods and
services, GSA contractors that owe tax debts have an unfair advantage in
price competition because they do not bear the same costs, such as payroll
taxes, that tax compliant contractors do on government contracts.

                  Magnitude of Unpaid Taxes of GSA Contractors

Over 3,800 GSA contractors had about $1.4 billion in unpaid federal taxes
as of June 30, 2005.12 This represents approximately 10 percent of GSA
contractors during fiscal year 2004 and the first 9 months of fiscal year
2005. We took a conservative approach to identifying the amount of tax
debt owed by GSA contractors, and therefore the amount is likely
understated.

Characteristics of Contractors' Unpaid Federal Taxes

As shown in figure 1, 85 percent of the approximately $1.4 billion in
unpaid taxes owed by GSA contractors was comprised of corporate income and
payroll taxes. The other 15 percent of taxes included excise,
unemployment, individual income, and other types of taxes. Unlike our
previous reports on contractors with tax debts, a larger percentage of
taxes owed by GSA contractors was comprised of corporate income taxes,
which are unpaid amounts that corporations owe on the income of their
business. This was due to a handful of GSA contractors that owed a
significant amount of corporate income tax debts as of June 2005.
Excluding this handful of cases, payroll taxes make up about 40 percent of
the outstanding taxes owed by GSA contractors.

12 Our estimate of GSA contractors with tax debt as of June 30, 2005, (1)
excluded tax debts that have not been agreed to by the tax debtor or
affirmed by the court, (2) tax debts from calendar year 2005, and (3) tax
debts of $100 or less.

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

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.

The amount of unpaid federal taxes we identified among GSA
contractors-$1.4 billion-is likely understated. First, to avoid
overestimating the amount owed by government contractors, we intentionally
limited our scope to tax debts that were affirmed by either the contractor
or a tax court for tax periods prior to 2005.13 We did not include the
most current tax year because recently assessed tax debts that appear as
unpaid taxes may involve matters that are routinely resolved between the
taxpayer and IRS, with the taxes paid, abated,14 or both within a short
period. We eliminated these types of debt by focusing on unpaid federal
taxes for tax periods prior to calendar year 2005 and eliminating tax debt
of $100 or less.15

13 We eliminated from our analysis all tax debt coded by IRS as not having
been agreed to by the taxpayer (for example, by filing a balance due
return) or a tax court. For financial reporting, those cases are referred
to as compliance assessments.

14 Abatements are reductions in the amount of taxes owed and can occur for
a variety of reasons, such as to correct errors made by IRS or taxpayers
or to provide relief from interest and penalties. 26 U.S.C. S: 6404.

Also limiting the completeness of our estimate of the unpaid federal taxes
of GSA contractors is the fact that the IRS tax database reflects only the
amount of unpaid taxes either reported by the contractor on a tax return
or assessed by IRS through its various enforcement programs. The IRS
database does not reflect amounts owed by businesses and individuals that
have not filed tax returns and for which IRS has not assessed tax amounts
due. During our review, we identified instances from our case studies in
which GSA contractors failed to file tax returns for a particular tax
period and, therefore, were listed in IRS records as having no unpaid
taxes for that period. Further, our analysis did not attempt to account
for businesses or individuals that purposely underreported income and were
not specifically identified by IRS. According to IRS, underreporting of
income is the largest component of the estimated $345 billion annual gross
tax gap. IRS estimates that underreporting accounts for more than 80
percent of the total gross tax gap. Consequently, the true extent of
unpaid taxes for these businesses and individuals is not known.

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

As discussed previously, businesses with employees are required by law to
collect, account for, and transfer income and employment taxes withheld
from employees' wages to IRS. Businesses that fail to remit payroll taxes
to the federal government are liable for the amounts withheld from
employees, and IRS can assess a trust fund recovery penalty (TFRP) equal
to the total amount of taxes not collected or not accounted for and paid
against individuals who are determined by IRS to be "willful and
responsible" for the nonpayment of withheld payroll taxes.16 In addition
to civil penalties, criminal penalties exist for an employer's failure to
turn over withheld employee payroll taxes to IRS. Willful failure to remit
payroll taxes is a criminal felony offense punishable by imprisonment of
not more than 5 years,17 while the failure to properly segregate payroll
taxes can be a criminal misdemeanor offense punishable by imprisonment of
up to a year.18

15 A "tax period" varies by tax type. For example, the tax period for
payroll and excise taxes is generally 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.

16 26 U.S.C. S: 6672.

17 26 U.S.C. S: 7202.

Our audit and investigation of the 25 case-study business contractors
showed substantial abuse or potential criminal activity as all had unpaid
payroll taxes and have diverted those funds for personal or business use.
The 25 case-study contractors typically operate in wage-based industries,
providing security, building maintenance, computer services, and personnel
services for GSA and the departments of Defense, Homeland Security,
Justice, and Veterans Affairs. The types of contracts that were awarded to
these contractors included products and/or services related to law
enforcement, disaster relief, and national security. The amount of unpaid
taxes associated with these case studies ranged from approximately
$100,000 to over $9 million. Furthermore, we determined that several of
the case studies had unpaid state and local taxes where state and local
taxing authorities had filed multiple tax liens against them. Subsequent
to the award of the most recent contract by GSA, one case study company
and its owner were debarred from future federal contracts for illegal
activity unrelated to their failure to pay their payroll taxes.

Table 1 highlights 10 case studies with unpaid taxes. Our investigations
revealed that, despite their companies owing substantial amounts of taxes
to the IRS, some owners had substantial personal assets-including
commercial real estate, interest in a chain store, or multiple luxury
vehicles. Further, several owners owned homes worth over $1 million.

See appendix III for the details on the other 15 GSA contractor case
studies. We are referring the 25 cases detailed in our report to IRS so
that it can determine whether additional collection action or criminal
investigation is warranted.

18 26 U.S.C. S: 7215 and 26 U.S.C. S: 7512 (b).

Table 1: GSA Contractors with Unpaid Federal Taxes

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

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

           o  Case 1: This contractor provides emergency supplies for
           civilian agencies. At the same time the company was not paying its
           taxes, the company made a loan to a company officer for hundreds
           of thousands of dollars. The company subsequently filed for
           bankruptcy owing a substantial amount of federal and state taxes.
           After the company came out of bankruptcy, the company again failed
           to remit all of its taxes, including payroll taxes. IRS assessed a
           trust fund recovery penalty against the company and the owner for
           willful failure to remit payroll taxes.
           o  Case 2: The company provided security services for a civilian
           agency. Our investigative work indicates that an owner of the
           company made multiple cash withdrawals, totaling close to $1
           million, while the contractor owed payroll taxes. The company's
           owner used the cash withdrawals to fund an unrelated business and
           purchase a men's gold bracelet worth over $25,000. The company's
           owner has been investigated for fraud.
           o  Case 4: The company provides security services for a civilian
           agency. Our investigative work indicates that the owner of the
           company did not make tax deposits because the company did not have
           the funds to pay employee costs or other business expenses.
           However, we found that the company owner owns multiple properties
           worth over $1 million. The owner also owes IRS approximately
           $200,000 for personal income taxes.

           Federal law implemented in the FAR, and GSA internal policies do
           not require GSA contracting officers to examine tax debt when
           awarding contracts, nor do they provide guidance as to what role,
           if any, tax debt should play in determining whether prospective
           contractors meet the general criteria of responsible contractors.
           Also, due to a statutory restriction on disclosure of taxpayer
           information, even if tax debts specifically were to be considered
           in the awarding of contracts, no coordinated or independent
           mechanism exists for contracting officers to obtain complete
           information on contractors that have unpaid tax debt. Therefore,
           GSA does not screen contractors for tax debts prior to awarding
           contracts to GSA-paid contractors and GSA interagency contractors,
           and ultimately, contractors with unpaid federal taxes receive
           contracts from the federal government.

           Federal law implemented in the FAR and GSA internal policies do
           not expressly prohibit a contractor with unpaid federal taxes from
           being awarded contracts from the federal government. Although the
           FAR requires that federal agencies only do business with
           responsible contractors, it does not specifically require federal
           agencies to deny the award of contracts to businesses and
           individuals that have unpaid taxes, unless the contractor was
           specifically debarred or suspended by a debarring official for
           specific actions, such as conviction for tax evasion.

           As part of the contractor responsibility determination for
           prospective contractors, the FAR requires contracting officers to
           determine whether a prospective contractor meets several specified
           standards, including adequate financial resources and a
           satisfactory record of integrity and business ethics. However, the
           FAR does not require contracting officers to consider tax debt in
           making this determination.19 Similarly, GSA policies in
           implementing the FAR do not provide any additional guidance to GSA
           contracting officers on whether or how tax debts should be
           considered when making a determination of financial
           responsibility.20 According to GSA officials, contracting officers
           may consider delinquent tax debts as part of their overall
           determination of a prospective contractor's financial capability;
           however, the focus of such evaluation is on determining whether
           the contractor has the financial capability to deliver the
           products and services. Thus, there is no expectation that the
           contracting officer will consider tax compliance when evaluating
           whether companies have the integrity or ethics to perform the
           contract. In addition, according to GSA officials, the
           determination for financial capability of the contract is only
           applicable when awarding new contracts.21 Thus, if the contractor
           does not pay its tax debts after the contract award, no
           consideration of this will be made by GSA contracting officers for
           the duration of the contract or at the subsequent exercise of any
           options to extend, which for certain GSA Supply Schedule contracts
           can last up to 20 years.

           The FAR specifies that unless compelling reasons exist, agencies
           are prohibited from soliciting offers from, or awarding contracts
           to, contractors that are debarred, suspended, or proposed for
           debarment for various reasons, including tax evasion.22 Conviction
           for tax evasion is cited as one of the causes for debarment, while
           commission, i.e., indictment, for tax evasion is cited as a cause
           for suspension. However, the deliberate failure to remit taxes, in
           particular payroll taxes, while a felony offense, will likely not
           result in a company being debarred or suspended unless the
           contractor was indicted or convicted of the crime. During our
           work, we found that none of the contractors described in this
           testimony, nor the 97 contractors we reported in our previous
           work, have been charged with tax evasion,23 despite having abusive
           and potentially criminal activities related to the tax system.

           Current law restricts contracting officers' access to tax debt
           information unless reported by prospective contractors themselves
           or disclosed in public records. Consequently, contracting officers
           do not have ready access to information on unpaid tax debts to
           assist in making contractor responsibility determinations with
           respect to financial capability, ethics, and integrity.

           Contracting officers do not have a coordinated and independent
           mechanism to obtain accurate tax debt information on contractors
           that abuse the tax system. Federal law does not permit IRS to
           disclose taxpayer information, including tax debts.24 Thus, unless
           the taxpayer provides consent,25 certain tax debt information can
           only be discovered from public records when IRS files a federal
           tax lien against the property of a tax debtor.26 However,
           contracting officers are not required to obtain credit reports,
           which provides public record information, and when credit reports
           are obtained, GSA contracting officers generally focus on the
           contractor's credit score and not necessarily any liens or other
           public information. In addition, public record information is
           limited because IRS does not file tax liens on all tax debtors,
           and, while IRS has a central repository of tax liens, contracting
           officers do not have access to that information. Further, the
           listing of a federal tax lien in the credit reports of businesses
           or individuals may not be a reliable indicator of a contractor's
           tax indebtedness because of deficiencies in IRS's internal
           controls that have resulted in IRS not always releasing tax liens
           from property when the tax debt has been satisfied.27

           Unless reported by prospective contractors themselves, contracting
           officers face significant difficulties obtaining or verifying tax
           compliance information on prospective contractors. For example, in
           one contractor file we reviewed, a GSA official did inquire about
           a federal tax lien with a prospective contractor. The prospective
           contractor provided documentation to GSA demonstrating the
           satisfaction of the tax liability covered by that lien. However,
           because the GSA official could not obtain information from the IRS
           on tax debts, this official was not aware that the contractor had
           other unresolved tax debts unrelated to this particular tax lien.

           GSA interagency contractors are not only approved to do business
           with GSA, but with all federal agencies. The FAR does not require
           agencies that use contracts awarded by other agencies to perform
           additional background or other investigation to validate the
           awarding agencies' determination that the contractors are
           responsible. Agency officials at the four agencies at which we
           inquired-the departments of Justice, State, and Veterans Affairs,
           and the National Aeronautics and Space Administration- generally
           stated that they did not perform additional background or other
           investigations when using contractors selected for interagency
           contracts. These officials informed us that they had assumed GSA
           performed all the screening necessary to ensure that the
           contractors were responsible contracting sources. Consequently,
           when GSA awards interagency contracts to contractors with tax
           debt, contractors with tax debts will be given an opportunity to
           do business with other federal agencies for the duration of the
           GSA contract.

           GSA contractors with tax debts have an unfair advantage in costs
           when competing with contractors that pay their taxes. This is
           particularly true for wage-based industries that provide
           relatively basic types of goods and services, such as security and
           moving services. The most egregious abuse, not remitting employee
           payroll taxes, saved these companies over 15 percent of the
           employee's wages. Clearly, contractors that do not pay their taxes
           do not bear the same costs that tax compliant contractors have
           when competing on contracts. As a result, when in direct
           competition for homogenous types of goods and services in
           wage-based businesses, these contractors could offer prices for
           their goods and services that are lower than their tax compliant
           competitors. Our investigations showed that some GSA contractors
           that did not fully pay their payroll taxes were issued task orders
           based solely on price over competing contractors that did not have
           any tax debts. The following provides information on these cases.

           Case 1: A GSA Schedule contractor was competitively awarded a task
           order from the GSA schedule in the late 1990s to provide temporary
           personnel services over another GSA contractor that was compliant
           with its taxes. The task order award was based solely on the
           hourly cost of the temporary employee. At the time, the contractor
           had owed taxes for at least 10 years. This contractor had a
           history of incurring payroll taxes on one company, then upon being
           assessed a trust fund recovery penalty on that company but making
           little or no payments, closing that company and starting another.
           The owner later renewed the contract under a new company name and
           Taxpayer Identification Number.

           Case 2: A GSA Schedule contractor was issued two competitive task
           orders for services related to moving office furniture and
           equipment. On both task orders, the contractor's offer for
           services was significantly less than three competing offers on the
           first order and two competing offers on the second order. The
           contractor owed about $700,000 in unpaid taxes (mostly payroll
           taxes) while its competitors did not owe any unpaid taxes. Because
           the contractor did not pay its payroll taxes, a significant cost
           in a wage-based business, the contractor's cost structure provided
           the contractor more flexibility in setting its price in the
           competition for federal contracts.

           There is widespread concern today about contractor fraud and
           related ethics problems in federal government contracting.
           However, except for contractors charged with or convicted of tax
           evasion, no laws or policies exist today that prevent GSA
           contractors with abusive and potentially criminal activity related
           to the federal tax system from being awarded contracts and doing
           business with federal agencies. Aside from any general concerns
           about the federal government doing business with contractors that
           do not pay their taxes, allowing these contractors to do business
           with the federal government while not paying their taxes could
           create an unfair competitive advantage for these contractors. In
           essence, the current contract award process fails to encourage
           contractors to pay these taxes. This causes a disincentive to
           contractors to pay their fair share of taxes, and could lead to
           further erosion in compliance with the nation's tax system.

           Our objectives were to (1) determine the magnitude of tax debts
           owed by GSA contractors; (2) identify examples of GSA contractors
           that have tax debts and are also engaged in potentially abusive,
           fraudulent, or criminal activities; and (3) determine whether GSA
           screens contractors for tax debts and criminal activities prior to
           awarding contracts and at the exercise of any government contract
           options.

           To identify the magnitude of unpaid taxes owed by GSA contractors,
           we first identified the federal contractors that were either GSA
           interagency contractors or that were paid by GSA. To identify
           GSA-paid contractors, we obtained from the Department of the
           Treasury's Financial Management Service (FMS) the Payments,
           Claims, and Enhanced Reconciliation (PACER) database containing
           all Automated Clearing House (ACH) and check payments made by FMS
           on behalf of GSA to federal contractors during fiscal year 2004
           and the first 9 months of fiscal year 2005.1 To identify
           contractors screened by GSA's Federal Supply Service (FSS), we
           obtained and analyzed GSA data on Multiple Award Schedule (MAS)
           contracts and other FSS award contracts as recorded in the Federal
           Supply Service Automated Supply System (FSS-19). To identify
           contractors screened by GSA's Public Buildings Service (PBS), we
           obtained and analyzed GSA data from its Pegasys and FPDS-NG
           systems. To identify contractors screened by GSA's Federal
           Technology Service, we obtained and analyzed GSA data from its
           Pegasys system.

           To identify GSA contractors with unpaid federal taxes, we obtained
           and analyzed the Internal Revenue Service (IRS) unpaid assessment
           data as of June 30, 2005. We matched the GSA screened and/or paid
           contractor records to the IRS unpaid assessment data using the
           taxpayer identification number (TIN) field. We also matched data
           obtained from competing bidders (those who were not awarded the
           task order) to the IRS assessment database using the TIN field to
           determine whether they owed tax debt. To avoid overestimating the
           amount owed by contractors with unpaid tax debts and to capture
           only significant tax debts, we excluded from our analysis tax
           debts and payments meeting specific criteria to establish a
           minimum threshold in the amount of tax debt and in the amount of
           payments to be considered when determining whether a tax debt is
           significant. The criteria we used to exclude tax debts are as
           follows:

           o  tax debts that IRS classified as compliance assessments or memo
           accounts for financial reporting,2 
           o  tax debts from calendar year 2005 tax periods, and
           o  contractors with total unpaid taxes of $100 or less.

           The criteria above were used to exclude tax debts that might be
           under dispute or generally duplicative or invalid, and tax debts
           that are recently incurred. Specifically, compliance assessments
           or memo accounts were excluded because these taxes have neither
           been agreed to by the taxpayers nor affirmed by the court, or
           these taxes could be invalid or duplicative of other taxes already
           reported. We excluded tax debts from calendar year 2005 tax
           periods to eliminate tax debt that may involve matters that are
           routinely resolved between the taxpayer and IRS, with the taxes
           paid or abated within a short period. We further excluded tax
           debts of $100 or less because they are insignificant for the
           purpose of determining the extent of taxes owed by GSA
           contractors.

           To identify indications of abuse or potentially criminal activity,
           we selected 25 GSA contractors for a detailed audit and
           investigation. The 25 contractors were chosen using a
           non-representative selection approach based on our judgment, data
           mining, and a number of other criteria. Specifically, we narrowed
           the 25 contractors with unpaid taxes based on the amount of unpaid
           taxes, number of unpaid tax periods, amount of payments reported
           by GSA and FMS,3 indications that owner(s) might be involved in
           multiple companies with tax debts, and selection of contractors
           doing business with a variety of federal agencies.

           We obtained copies of automated tax transcripts and other tax
           records (for example, revenue officer's notes) from IRS as of June
           30, 2005, and reviewed these records to exclude contractors that
           had recently paid off their unpaid tax balances and considered
           other factors before reducing the number of businesses to 25 case
           studies. We performed additional searches of criminal, financial,
           and public records. In cases where record searches and IRS tax
           transcripts indicate that the owners or officers of a business are
           involved in other related entities4 that have unpaid federal
           taxes, we also reviewed the related entities and the owner(s) or
           officer(s), in addition to the original business we identified.
           For the selected 25 cases, our investigators also contacted some
           contractors, performed interviews, and reviewed contract files to
           determine the extent of price competition and to identify bidders
           on competitively awarded contracts.

           To determine the extent to which contracting officers are to
           consider tax debts or other criminal activities, we examined the
           Federal Acquisition Regulation (FAR) and GSA policies and
           procedures for conducting responsibility determinations on
           prospective contractors, including specific guidance on
           responsibility determinations and periodic reviews focusing on the
           quality of contract awards. We discussed acquisition policies and
           procedures used to award contracts with officials from the Office
           of Chief Acquisition, FSS, FTS, and PBS. As part of these
           discussions, we asked whether contracting officers specifically
           consider tax debts or perform background investigations to
           determine whether a prospective contractor is a responsible source
           before the contract is awarded. We also discussed with GSA
           officials whether any review is performed by the contracting
           officer at the option to extend the contract. Additionally, we
           interviewed an official from GSA's Kansas City Credit and Finance
           Center to determine how the center makes financial determination
           recommendations and the role, if any, that tax debts have on that
           recommendation.

           To obtain an understanding of what steps other federal agencies
           take to screen GSA supply schedule contractors for tax debts or
           other criminal activities, we interviewed procurement agency
           officials at selected civilian agencies (including the National
           Aeronautics and Space Administration and the departments of
           Justice, State, and Veterans Affairs). We selected these agencies
           based on a number of criteria, including national security
           concerns and amount of payments to contractors, especially those
           with tax debts. As part of these discussions, we determined the
           level of reliance agencies placed on GSA's contractor
           qualification determinations in awarding contracts, even for
           sensitive contracts such as security, to contractors that have
           been approved by GSA as responsible sources.

           We conducted our audit work from June 2005 through January 2006 in
           accordance with U.S. generally accepted government auditing
           standards, and we performed our investigative work in accordance
           with standards prescribed by the President's Council on Integrity
           and Efficiency.

           For the IRS unpaid assessments data, we relied on the work we
           performed during our annual audits of IRS's financial statements.
           While our financial statement audits have identified some data
           reliability problems associated with the coding of some of the
           fields in IRS's tax records, including errors and delays in
           recording taxpayer information and payments, we determined that
           the data was sufficiently reliable to address this report's
           objectives. Our financial audit procedures, including the
           reconciliation of the value of unpaid taxes recorded in IRS's
           masterfile to IRS's general ledger, identified no material
           differences.

           For Payments, Claims, and Enhanced Reconciliation (PACER)
           database, we interviewed FMS officials responsible for the
           database and reviewed documentation provided by FMS supporting
           quality reviews on its databases. In addition, we performed
           electronic testing of specific data elements in the database that
           we used to perform our work.

           To help ensure reliability of GSA-provided data, we interviewed
           GSA officials concerning the reliability of the data provided to
           us. In addition, we performed electronic testing of specific data
           elements in the databases that we used to perform our work and
           performed other procedures to ensure the completeness of the
           contract data provided by GSA. We also reviewed the results of the
           GSA Inspector General's audit of the system's internal controls
           completed in support of GSA's fiscal year 2004 consolidated and
           combined financial statements.

           Based on our discussions with agency officials, review of agency
           documents, and our own testing, we concluded that the data
           elements used for this testimony were sufficiently reliable for
           our purposes.

           As the federal government's principal business agent, General
           Services Administration's (GSA) activities and programs are
           diverse and have governmentwide implications. Through its supply
           schedules and governmentwide acquisition contracts, GSA arranges
           for federal agencies to purchase billions of dollars of goods and
           services directly from private vendors. In addition, its
           telecommunication and computer services and real estate activities
           involve huge sums of money and extensive interaction with the
           private sector.

           GSA provides goods and services and develops policy through a
           network of 11 regional offices and a central office in Washington,
           D.C. GSA's programs are generally run by its three service
           components-Federal Supply Service (FSS), Federal Technology
           Service (FTS), and Public Buildings Service (PBS).1

           FSS assists federal agencies in acquiring a full range of
           products-including over 4 million commonly used commercial items,
           ranging from furniture, computers, tools, equipment, and motor
           vehicles. FSS also supports agencies in acquiring services, such
           as professional consulting, travel, transportation, and property
           management. FSS has followed a self-service business model, using
           contracts, called supply schedule contracts, that are designed to
           be flexible, simple to use, and consistent with commercial buying
           practices. FSS negotiates master contracts with vendors, seeking
           discounts off commercial list prices that are at least as
           favorable as the discounts offered to those vendors' most favored
           customers. Federal agencies can then use these supply schedule
           contracts to issue task orders from which goods and services are
           acquired.

           FTS provides customers with telecommunications products and
           services-voice, data, and video-and a full range of IT products
           and services. Unlike FSS, FTS has followed a full-service business
           model, providing assisted procurement services to help agencies
           define and fill their IT and telecommunications requirements. FTS
           is a major user of the FSS supply schedule contracts as well as a
           range of contract vehicles FTS and other federal agencies have
           awarded-commonly known as governmentwide acquisition contracts.

           PBS is the primary property manager for the federal government,
           utilizing government buildings and privately owned leased
           facilities.2 In order to meet the office space needs for federal
           agencies, GSA hires and manages private sector professionals, such
           as architects, engineers, and contractors to design, renovate, and
           construct federal buildings. In addition, GSA leases space in
           cities and small towns when leasing is the practical answer to
           meeting federal space needs.

           From a financing standpoint, GSA is unusual among federal agencies
           in that most of its funding does not come from direct
           appropriations from Congress. Instead, GSA's funding comes from
           fees GSA charges agencies for the goods and services provided and
           the rents from its buildings. As such, GSA must encourage other
           agencies to acquire goods and services from the contracts GSA has
           awarded to help cover its operating costs. In fiscal year 2004,
           GSA reported revenues of approximately $20 billion to cover the
           costs of its operations.

           Table 1 in the main portion of this testimony provides data on 10
           detailed case studies. Table 2 shows the remaining case studies
           that we audited and investigated. As with the 10 cases discussed
           in the body of this testimony, we also found substantial abuse or
           potentially criminal activity related to the federal tax system
           during our review of these 15 case studies. The case studies
           involving businesses with employees primarily involved unpaid
           payroll taxes. Several of the companies negotiated an installment
           or repayment agreement with the Internal Revenue Service (IRS) but
           subsequently defaulted on that agreement.

         Tax Debts Are Generally Not Considered When Awarding Contracts

Contractors with Federal Tax Debts Are Not Explicitly Prohibited from Doing
Business with the Federal Government

19 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.

20 GSA provides guidance to GSA contracting officers in the General
Services Administration Acquisition Manual (GSAM), Acquisition Letters,
and Procurement Information Bulletins.

21 The FAR does not require a responsibility determination when an agency
exercises options to extend a contract. For one contract file we reviewed,
the contractor filed for bankruptcy prior to GSA's action to extend. GSA
exercised the option without consideration of the bankruptcy. GSA
subsequently could not recover over $100,000 in audit disallowances
pursuant to the bankruptcy ruling.

22 Prior to awarding a contract, contracting officers are required to
consult a governmentwide list, called the Excluded Parties List System
(EPLS), of contractors that have been debarred, suspended, or declared
ineligible for government contracts, and review the prospective
contractor's self-certification of debarment and suspension.

Restrictions on Tax Data Hamper Making Contractor Responsibility Determinations

23 GAO-04-95 , GAO-05-637 .

24 26 U.S.C. S: 6103.

25 For example, contractors must provide IRS consent to validate taxpayer
identification numbers (TINS) provided by the contractors in the Central
Contractor Registration system. GSA officials stated that the contractor
is not registered into the system until the TIN is validated with IRS
records.

26 Under section 6321 of the Internal Revenue Code, IRS has the authority
to file a lien upon all property and rights to property, whether real or
personal, of a delinquent taxpayer.

GSA Contractors Not Required to Undergo Further Determination of Responsibility
or Background Investigation

27 GAO, IRS Lien Management Report: Opportunities to Improve Timeliness of
IRS Lien Releases, GAO-05-26R (Washington, D.C.: Jan. 10, 2005).

 Contractors with Tax Debts Have Unfair Cost Advantage in Contract Competition

                              Concluding Comments

Appendix I: Objectives, Scope, and Methodology

1 Although the GSA Kansas City finance center does make contractor
payments on behalf of other agencies, they were able to identify those
payments made for GSA contracts.

2 Under federal accounting standards, unpaid assessments require taxpayer
or court agreement to be considered federal taxes receivables. Compliance
assessments and memo accounts are not considered federal taxes receivable
because they are not agreed to by taxpayers or the courts.

3 Amount of payments reported by FMS and amounts reported by GSA could
differ because contractors that have been pre-approved by GSA to do
business with the government also receive payments from disbursing
entities other than FMS, for example, Department of Defense or the U.S.
Army Corps of Engineers.

4 We define related entities as entities that share common owner(s) or
officer(s), a common TIN, or a common address.

Data Reliability Assessment

Appendix II: Background

1 GSA is in the process of merging FSS and FTS into a new service
component called Federal Acquisition Service.

2 Over 30 other executive branch agencies, including DOD and the
departments of State, Veterans Affairs, and Transportation, have some
level of authority to purchase, own, or lease office space or buildings.

Appendix III: Contractors with Unpaid Taxes

Table 2: GSA Contractors with Unpaid Federal Taxes

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

(192172)

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www.gao.gov/cgi-bin/getrpt? GAO-06-492T .

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Highlights of GAO-06-492T , a testimony before the Permanent Subcommittee
on Investigations, Committee on Homeland Security and Governmental
Affairs, U.S. Senate

March 14, 2006

FINANCIAL MANAGEMENT

Thousands of GSA Contractors Abuse the Federal Tax System

In February 2004 and again in June 2005, GAO testified that some
Department of Defense (DOD) and civilian agency federal contractors abused
the federal tax system with little consequence. Previous problems we
identified with contractors with unpaid taxes have led to concerns over
whether any interagency contractors, such as those on the General Services
Administration's (GSA) federal supply schedule, failed to pay their taxes.
GSA, through its federal supply schedule and other interagency contracts,
arranges for federal agencies to purchase billions of dollars of goods and
services directly from private vendors. GAO was asked to determine if GSA
contractors, including both contractors that were paid by GSA and GSA
interagency contractors, have unpaid federal taxes, and if so, to (1)
determine the magnitude of tax debts owed by GSA contractors; (2) identify
examples of GSA contractors that have tax debts and are also engaged in
potentially abusive, fraudulent, or criminal activities; and (3) determine
whether GSA screens contractors for tax debts and criminal activities
prior to awarding contracts and at the exercise of any government contract
options.

Over 3,800 GSA contractors had tax debts totaling about $1.4 billion as of
June 30, 2005. This represented approximately 10 percent of the number of
GSA contractors during fiscal year 2004 and the first 9 months of fiscal
year 2005.

GAO investigated 25 GSA contractors with abusive and potentially criminal
activity. These businesses had not forwarded payroll taxes withheld from
their employees and other taxes to IRS. Willful failure to remit payroll
taxes is a felony under U.S. law. Furthermore, some company owners
diverted payroll taxes for personal gain or to fund their businesses.
These contractors worked for a number of federal agencies including the
departments of Defense, Justice, and Homeland Security.

A number of owners or officers of the 25 GSA contractors have significant
personal assets, including commercial properties, houses worth over

$1 million, and luxury vehicles. In addition, several of the owners of
these GSA contractors gambled hundreds of thousands of dollars at the same
time they were not paying the taxes that their businesses owed.

Examples of Abusive and Potentially Criminal Activity

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

Neither federal law, as implemented by the Federal Acquisition Regulation
(FAR), nor GSA policies require contracting officers to specifically
consider tax debts in making contracting decisions either at initial award
or when considering options to extend. In addition, federal law generally
prohibits the disclosure of taxpayer data, and consequently contracting
officers have no access to tax data directly from the IRS. GSA contractors
that do not pay tax debts could have an unfair competitive advantage in
costs because they may have lower costs than tax compliant contractors on
government contracts. This is especially true in wage-based businesses
that provide homogenous types of goods and services. GAO's investigation
identified instances in which contractors with tax debts won awards based
on price differential over tax compliant competing contractors.
*** End of document. ***