Tax Compliance: Thousands of Federal Contractors Abuse the	 
Federal Tax System (19-APR-07, GAO-07-742T).			 
                                                                 
Since 1990, GAO has periodically reported on high-risk federal	 
programs that are vulnerable to fraud, waste, and abuse. Two such
high-risk areas are managing federal contracts more effectively  
and assessing the efficiency and effectiveness of federal tax	 
administration. Weaknesses in the tax area continue to expose the
federal government to significant losses of tax revenue and	 
increase the burden on compliant taxpayers to fund government	 
activities. Over the last several years, the Senate Permanent	 
Subcommittee on Investigations requested GAO to investigate	 
Department of Defense (DOD), civilian agency, and General	 
Services Administration (GSA) contractors that abused the federal
tax system. Based on that work GAO made recommendations to	 
executive agencies including to improve the controls over levying
payments to contractors with tax debt--many of which have been	 
implemented--and referred 122 contractors to IRS for further	 
investigation and prosecution. As requested, this testimony will 
highlight the key findings from prior testimonies and related	 
reports. This testimony will (1) describe the magnitude of tax	 
debt owed by federal contractors, (2) provide examples of federal
contractors involved in abusive and potentially criminal activity
related to the federal tax system, and (3) describe current law  
and proposed federal regulations for screening contractors with  
tax debts prior to the award of a contract.			 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-07-742T					        
    ACCNO:   A68468						        
  TITLE:     Tax Compliance: Thousands of Federal Contractors Abuse   
the Federal Tax System						 
     DATE:   04/19/2007 
  SUBJECT:   Competitive advantage				 
	     Contractor violations				 
	     Contractors					 
	     Department of Defense contractors			 
	     Federal law					 
	     Federal procurement				 
	     Federal regulations				 
	     Federal taxes					 
	     Investigations by federal agencies 		 
	     Noncompliance					 
	     Tax return audits					 
	     Tax violations					 
	     Taxpayers						 

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GAO-07-742T

   

     * [1]Summary
     * [2]Federal Contractors Owe Billions of Dollars in Unpaid Federa
     * [3]Examples of Federal Contractors Involved in Abusive and Pote
     * [4]Contractors with Unpaid Taxes Are Not Prohibited from Receiv
     * [5]Restrictions on IRS Tax Disclosure and Failure to Use Availa
     * [6]Contractors with Tax Debts Have Unfair Advantage in Contract
     * [7]Proposed FAR Rule Would Require Prospective Contractors to P
     * [8]Concluding Comments
     * [9]GAO's Mission
     * [10]Obtaining Copies of GAO Reports and Testimony

          * [11]Order by Mail or Phone

     * [12]To Report Fraud, Waste, and Abuse in Federal Programs
     * [13]Congressional Relations
     * [14]Public Affairs

Testimony

Before the Subcommittee on Government Management, Organization, and
Procurement, Committee on Oversight and Government Reform, House of
Representatives

United States Government Accountability Office

GAO

For Release on Delivery
Expected at 1:00 p.m. EST
Thursday, April 19, 2007

TAX COMPLIANCE

Thousands of Federal Contractors Abuse the Federal Tax System

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

GAO-07-742T

Mr. Chairman and Members of the Subcommittee:

Thank you for the opportunity to discuss our past work on government
contractors that have failed to pay their federal taxes. Our remarks today
are based on work that we have performed over the last several years for
the Senate Permanent Subcommittee on Investigations, Committee on Homeland
Security and Governmental Affairs. In hearings held before that
Subcommittee over the last several years,^1 we testified that federal
contractors at the Department of Defense (DOD), selected civilian
agencies, and the General Services Administration (GSA) abused the federal
tax system with little consequence. As requested, this testimony
highlights the key findings from those testimonies and related reports.
Specifically, this testimony will (1) describe the magnitude of tax debts
that were owed by federal contractors at the time of our previous
testimonies and related reports, (2) provide examples of federal
contractors involved in abusive and potentially criminal activity related
to the federal tax system, and (3) discuss current law and proposed
changes to the Federal Acquisition Regulation (FAR) concerning contractor
tax debt.

To address our objectives, we reviewed prior findings from GAO audits of
federal contractors that have abused the federal tax system. Our audit
work was performed 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

In each of our audits and related investigations, we found thousands of
federal contractors that had substantial amounts of unpaid federal taxes.
Specifically, we testified that about 27,000 DOD contractors, 33,000
civilian agency contractors, and 3,800 GSA contractors owed about $3
billion, $3.3 billion, and $1.4 billion in federal taxes, respectively.^2
Much of the unpaid taxes were payroll taxes.^3 However, each estimate of
contractors' unpaid federal taxes is understated because IRS data do not
reflect all amounts owed. Specifically, our estimates do not include
amounts owed by contractors who have not filed tax returns or that have
failed to report the full amount of taxes due (referred to as nonfilers
and underreporters) and for which Internal Revenue Service (IRS) has not
determined the amount owed.

^1 GAO, Financial Management: Some DOD Contractors Abuse the Federal Tax
System with Little Consequence, [15]GAO-04-414T (Washington, D.C.: Feb.
12, 2004); Financial Management: Thousands of Civilian Agency Contractors
Abuse the Federal Tax System with Little Consequence, [16]GAO-05-683T
(Washington, D.C.: June 16, 2005); and Financial Management: Thousands of
GSA Contractors Abuse the Federal Tax System, [17]GAO-06-492T (Washington,
D.C.: Mar. 14, 2006).

We conducted more in-depth case study investigations of 122 federal
contractors that appeared to demonstrate abusive or potentially criminal
activity related to the federal tax system. We found that, in fact, each
of the 122 federal contractors was involved in abusive and potentially
criminal activity related to the tax system. Many of these case-study
contractors were small, closely held companies that operated in wage-based
industries; such as security; building maintenance; computer services; and
personnel services for GSA, DOD, and the Departments of Homeland Security,
Justice, and Veterans Affairs. The types of contracts that were awarded to
these federal contractors included products or services related to weapon
components, space and aircraft parts, law enforcement, disaster relief,
and national security. Many were established businesses (such as
corporations) that owed payroll taxes that include amounts withheld from
their employees. However, rather than fulfill their role as "trustees" of
these funds and forward them to IRS as required by law, these federal
contractors diverted the funds for other purposes.^4

At the same time that they were not paying their federal taxes, many
individuals associated with our 122 cases bought or owned significant
personal assets, including a sports team, a high-performance airplane,
commercial properties, multimillion dollar homes, and luxury vehicles. In
one case, the owner of a federal contracting firm purchased a number of
multimillion-dollar properties, an unrelated business, and a number of
luxury vehicles while his business failed to remit to IRS a substantial
amount of payroll taxes. Several owners also gambled hundreds of thousands
of dollars at the same time they were not paying the federal taxes that
their businesses owed. Further, several of the owners or officers of the
businesses with unpaid federal taxes were investigated or indicted for
nontax offenses such as embezzlement, fraud, and money laundering.

^2 Because federal contractors may do business with more than one federal
agency, some federal contractors that owe tax debts may be included in
more than one analysis concerning DOD, GSA, and civilian federal
contractors that abuse the federal tax system. Because our analysis for
each segment covered different time periods, we cannot provide an overall
number of federal contractors with tax debts and the magnitude of such
debts.

^3 Payroll taxes include amounts withheld from employee wages for Social
Security, Medicare, and individual income taxes.

^4 Willful failure to remit payroll taxes is a criminal felony offense
while the failure to properly segregate payroll taxes can be a criminal
misdemeanor offense. 26 U.S.C. SS 7202, 7215 and 7512 (b).

Federal law does not prohibit a contractor with unpaid federal taxes from
receiving contracts from the federal government. Currently, regulations
calling for federal agencies to do business only with responsible
contractors do not require contracting officers to consider a contractor's
tax delinquency unless the contractor was specifically debarred or
suspended by a debarring official for specific actions, such as conviction
for tax evasion. According to the FAR, a responsible prospective
contractor is a contractor that meets certain specific criteria,^5
including having adequate financial resources and a satisfactory record of
integrity and business ethics. However, the FAR does not currently require
contracting officers to take into account a contractor's tax debt when
assessing whether a prospective contractor is responsible. As a result,
the FAR does not currently require contracting officers to determine if
federal contractors have federal unpaid taxes at the time a contract is
awarded. Further, federal law generally prohibits the disclosure of
taxpayer data to contracting officers. Thus, contracting officers do not
have access to tax data directly from IRS unless the contractor provides
consent. In March 2007, the Civilian Agency Acquisition Council and the
Defense Acquisition Regulations Council proposed to amend the FAR to
require prospective contractors to disclose whether they have, within a
3-year period preceding their offer, been notified of any delinquent taxes
that remain unsatisfied or whether they have received notice of any tax
lien filed against them that remains unsatisfied or has not been
released.^6 The proposed rule also includes, among other things,
delinquent taxes and unresolved liens as causes for suspension or
debarment.

Finally, we also reported that for wage-based businesses that provide
goods and services, federal contractors with unpaid federal taxes have an
unfair advantage in price competition when competing against other
businesses for federal contracts. Companies that do not pay their payroll
tax, which is typically over 15 percent of the employees' wages, would
have a significantly lower costs advantage and therefore have a
substantive competitive advantage over their competitors. For example, we
identified instances in which companies that had unpaid payroll taxes were
competitively awarded contracts over companies that had paid their federal
taxes.

^5 FAR 2.101; 9.104-1

^6Representations and Certifications - Tax Delinquency, 72 Fed. Reg. 15093
(proposed Mar. 30, 2007) (to be codified at 48 C.F.R. pts. 9 and 52).

As result of the work we performed for the Senate Permanent Subcommittee
on Investigations, Committee on Homeland Security and Governmental Affairs
we made numerous recommendations to executive agencies to improve the
controls over levying payments to contractors with tax debt, many of which
the agencies have implemented. We also referred 122 contractors to IRS for
further investigation and prosecution.

Federal Contractors Owe Billions of Dollars in Unpaid Federal Taxes

In each of our audits and related investigations, we found thousands of
federal contractors that owed billions of dollars of federal taxes.
Specifically,

           o In February 2004, we testified that DOD and IRS records showed
           that about 27,000 DOD contractors owed nearly $3 billion in
           federal taxes. About 42 percent of this $3 billion represented
           unpaid payroll taxes.
           o In June 2005, we testified that about 33,000 civilian agency
           federal contractors owed over $3.3 billion in federal taxes. Over
           a third of the $3.3 billion represented unpaid payroll taxes.
           o In March 2006, we testified that over 3,800 GSA contractors owed
           about $1.4 billion in federal taxes. About one-fifth of the $1.4
           billion represented unpaid payroll taxes.

Because federal contractors may do business with more than one federal
agency, some federal contractors that owe tax debts may be included in
more than one analysis concerning DOD, GSA, and civilian federal
contractors that abuse the federal tax system.

In each of our audits, we found that government contractors owed a
substantial amount of unpaid payroll taxes. Employers are subject to civil
and criminal penalties if they do not remit payroll taxes to the federal
government. When an employer withholds taxes from an employee's wages, the
employer is deemed to have a fiduciary responsibility to hold these funds
"in trust" for the federal government until the employer makes a federal
tax deposit in that amount. To the extent these withheld amounts are not
forwarded to the federal government, the employer is liable for these
amounts, as well as the employer's matching Federal Insurance Contribution
Act contributions for Social Security and Medicare. Individuals employed
by the contractor (e.g., owners or officers) may be held personally liable
for the withheld amounts not forwarded and assessed a civil monetary
penalty known as a trust fund recovery penalty.^7 Willful failure to remit
payroll taxes can also be a criminal felony offense punishable by
imprisonment of up to 5 years,^8 while the failure to properly segregate
payroll tax funds can be a criminal misdemeanor offense punishable by
imprisonment of up to a year. ^9 The law imposes no penalties upon an
employee for the employer's failure to remit payroll taxes since the
employer is responsible for submitting the amounts withheld. The Social
Security and Medicare trust funds are subsidized or made whole for unpaid
payroll taxes by the federal government's general fund. Thus, personal
income taxes, corporate income taxes, and other government revenues are
used to pay for these shortfalls to the Social Security and Medicare trust
funds.

Although each of our estimates for taxes owed by federal contractors was a
significant amount, it understates the full extent of unpaid taxes owed by
these contractors. The IRS tax database reflected only the amount of
unpaid federal taxes either reported on a tax return or assessed by IRS
through its various enforcement programs. The IRS database did not reflect
amounts owed by businesses and individuals that have not filed tax returns
and for which IRS has not assessed tax amounts due. Our analysis did not
attempt to account for businesses or individuals that did not file
required payroll or other tax returns or that purposely underreported
income and were not specifically identified by IRS as owing the additional
federal taxes. According to IRS, underreporting of income accounted for
more than 80 percent of the estimated $345 billion annual gross tax
gap.^10

As result of the work we performed for the Senate Permanent Subcommittee
on Investigations, Committee on Homeland Security and Governmental Affairs
we made numerous recommendations to DOD and civilian agencies to improve
their controls over levying payments to contractors with tax debt. Many of
those recommendations have been implemented and have resulted in
additional collections of unpaid tax debt. We also referred 122
contractors to IRS for further investigation and prosecution.

^7 26 U.S.C. S 6672.

^8 26 U.S.C. S 7202.

^9 26 U.S.C. S 7215 and 26 U.S.C. S 7512 (b).

^10 According to IRS, nonfilers and underpayment of taxes comprised the
rest of the gross tax gap.

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

In our previous testimonies, we discussed the results of our in-depth
audits and related investigations of 122 federal contractors with
outstanding tax debt. For each of these 122 federal contractors, we found
instances of abusive or potentially criminal activity related to the
federal tax system.^11 Many of our case study contractors were small,
closely held companies that operated in wage-based industries, such as
security, weapon components, space and aircraft parts, building
maintenance, computer services, and personnel services. These 122 federal
contractors provided goods and services to a number of federal agencies
including DOD, GSA, the National Aeronautics and Space Administration, and
the Departments of Homeland Security, Justice, and Veterans Affairs. The
types of contracts that were awarded to these contractors also included
products or services related to variety of government functions including
law enforcement, disaster relief, and national security.

Most of the contractors in our case studies owed payroll taxes, with some
federal tax debts dating back nearly 20 years. However, rather than
fulfilling their role as "trustees" and forwarding these funds to IRS,
many of these federal contractors used the funds for personal gain or to
fund their contractor operations.

Our investigations also revealed that some owners or officers of our case
study federal contractors with unpaid taxes were associated with other
businesses that had unpaid federal taxes. For example, we reported that
one of our case study contractors had a 20-year history of opening a
business, failing to remit taxes withheld from employees to IRS, and then
closing the business, only to start the cycle all over again and incur
more tax debts almost immediately through a new business. We also found
that a number of owners or officers of our case study contractors had
significant personal assets, including a sports team, commercial
properties, multimillion dollar houses, and luxury vehicles. Several
owners also gambled hundreds of thousands of dollars at the same time they
were not paying the taxes that their businesses owed. Despite owning
substantial assets and gambling significant amounts of money, the owners
or officers did not ensure the payment of the delinquent taxes of their
businesses, and sometimes did not pay their own individual income taxes.
Table 1 provides summary information on 10 of our 122 case study
contractors that we discussed in our previous testimonies and related
reports.

^11 We considered activity to be abusive when a federal 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.

Table 1: Summary Information on 10 Federal Contractors with Unpaid Federal
Taxes

Source: Previous GAO testimonies on federal contractors with tax debts.(
[18]GAO-04-414T , [19]GAO-05-683T, and [20]GAO-06-492T .)

Notes: Dollar amounts are rounded. The information provided in this table
has not been updated in the information provided from our original
testimonies.

a Federal payments represent payments made by federal agencies to federal
contractors for goods and services. Payments for cases 1, 2, and 3 were
made by four DOD contractor payment systems during fiscal year 2002.
Payments for cases 4, 5, 6, and 7 were made by the Department of Treasury
on behalf of other federal agencies during fiscal year 2004. Payments for
cases 8, 9, and 10 were amounts reported by the Department of the Treasury
and GSA from October 2003 through June 2004.

b Unpaid tax amount for cases 1, 2, and 3 are as of September 30, 2002.
Unpaid tax amount for cases 4, 5, 6, and 7 are as of September 30, 2004.
Unpaid tax amount for cases 8, 9, and 10 are as of June 30, 2005.

The following provides additional detailed information from our previous
testimonies on case numbers 1, 4, and 8 summarized in table 1:

Case # 1: In February 2004, we testified on a business that had nearly $10
million in unpaid federal taxes, and was contracted by DOD to provide
services such as trash removal, building cleaning, and security at U.S.
military bases. The contractor reported that it paid the owner a six
figure income and that the owner had borrowed nearly $1 million from the
business. The owner bought a boat, several cars, and a home outside the
country. This contractor went out of business in 2003 after state tax
authorities seized its bank account for failure to pay state taxes. The
contractor subsequently transferred its employees to a relative's
business, which also had unpaid federal taxes, and continued submitting
invoices and receiving payments from DOD on the previous contract.

Case # 4: In June 2005, we testified on a case that involved many related
companies that provided health care services to the Department of Veterans
Affairs (VA). During fiscal year 2004, these related companies received
over $300,000 in federal contract payments. The related companies had
different names, operated in a number of different locations, and used
several different Taxpayer Identification Numbers (TIN).^12 However, they
shared a common owner and contact address. At the time they were paid by
VA, the businesses collectively owed more than $18 million in unpaid
federal taxes--of which nearly $17 million was unpaid federal payroll
taxes dating back to the mid-1990s. 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 # 8: In March 2006, we testified on a GSA contractor that provided
security services for a civilian agency. Our investigative work indicated
that an owner of the company made multiple cash withdrawals, totaling
close to $1 million, while owing payroll taxes. In addition, the company's
owner also diverted the cash withdrawals to fund an unrelated business and
purchased a men's gold bracelet worth over $25,000. The company's owner
has been investigated for embezzlement and fraud.

^12A 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.

Contractors with Unpaid Taxes Are Not Prohibited from Receiving Contracts from
the Federal Government

Federal law and regulations, as reflected in the FAR, do not prohibit
contractors with unpaid federal taxes from receiving contracts from the
federal government. Although the FAR provides that federal agencies are
restricted to doing business with responsible contractors, it does not
require federal agencies to deny the award of contracts to contractors
that abuse the federal tax system, unless the contractor was specifically
debarred or suspended by a debarring official for specific actions, such
as conviction for tax evasion.

The FAR specifies that unless compelling reasons exist, agencies are
prohibited from soliciting offers from, or awarding contracts to,
contractors who are debarred, suspended, or proposed for debarment for
various reasons, including tax evasion.^13 Conviction for tax evasion is
cited as one of the causes for debarment and indictment for tax evasion is
cited as a cause for suspension. The deliberate failure to remit taxes, in
particular payroll taxes, is a felony offense, and could result in a
company being debarred or suspended if the debarring official determines
it affects the present responsibility of the government contractor. Most
of the contractors in our case studies owed payroll taxes, for which
willful failure to remit payroll taxes, a criminal felony offense,^14 or
failure to properly segregate payroll taxes, a criminal misdemeanor
offense, may apply.^15 At the time of our review, none of the 122 federal
contractors described in our previous case study work were debarred from
government contracts, despite conducting abusive and potentially criminal
activities related to the tax system.

As part of the contractor responsibility determination for prospective
contractors, the FAR also requires contracting officers to determine
whether a prospective contractor meets several specified standards,
including determination as to whether a contractor has 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.

^13 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.

^14 26 U.S.C. S 7202.

^15 26 U.S.C. S 7215 and 26 U.S.C. S7512 (b).

Restrictions on IRS Tax Disclosure and Failure to Use Available Tools Hamper
Consideration of Tax Debts in Contractor Qualification Determinations

Because of statutory restrictions on the disclosure of taxpayer
information, even if contracting officers were required to consider tax
debts in contractor qualification determinations, contracting officers do
not currently have access to tax debt information unless reported by
prospective contractors themselves or disclosed in public records.
Consequently, unless a prospective contractor consents, contracting
officers do not have ready access to information on unpaid tax debts to
assist in making contractor qualification determinations with respect to
financial capability, ethics, and integrity.

Further, contracting officers do not routinely obtain and use publicly
available information on contractor federal tax debt in making contractor
qualification determinations. Federal law generally does not permit IRS to
disclose taxpayer information, including tax debts.^16 Thus, unless the
taxpayer provides consent,^17 certain tax debt information generally can
only be discovered from public records when IRS files a federal tax lien
against the property of a tax debtor.^18 However, contracting officers are
not required to obtain credit reports. In the instances where they are
obtained, contracting officers generally focus on the contractor's credit
score rather than any liens or other public information showing federal
tax debts. However, while the information is available, IRS does not file
tax liens on all tax debtors nor does IRS have a central repository of tax
liens to which contracting officers have access. Further, the available
information on tax liens may be of questionable reliability 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.^19

16 26 U.S.C. S 6103.

^17 For example, contractors must provide IRS the consent to validate TINs
provided by the contractors in the Central Contractor Registration system.
GSA officials stated that a contractor is not registered into the system
until the TIN is validated with IRS records.

^18 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.

Contractors with Tax Debts Have Unfair Advantage in Contract Competition

Federal contractors who owe tax debts have an unfair competitive advantage
over contractors who pay their fair share. This is particularly true for
federal contractors in wage-based industries, such as security and moving
services. By not paying the employee taxes, these contractors keep their
payroll tax, which is typically over 15 percent of each employee's wages,
thereby reducing the contractor's costs. In this way, contractors who do
not pay their taxes do not bear the same costs that tax compliant
contractors have when competing on contracts. As a result, tax delinquent
contractors can set prices for their goods and services lower than their
tax compliant competitors.

In March 2006, we testified that we found some GSA contractors who did not
fully pay their payroll taxes who were awarded contracts based on price
over competing contractors that did not have any unpaid federal taxes.
Federal contractors' tax debts were not considered in contract award
decisions. For example, a GSA Schedule contractor was awarded two
contracts for services related to moving office and equipment furniture.
On both contracts, the contractor's offer for services was significantly
less than three competing bids on the first contract and two competing
bids on the second contract. The contractor owed about $700,000 in taxes
(mostly payroll taxes) while its competitors did not owe any federal
taxes.

^19 GAO, IRS Lien Management Report: Opportunities to Improve Timeliness
of IRS Lien Releases, [21]GAO-05-26R (Washington, D.C.: Jan. 10, 2005) and
GAO, Financial Audit: IRS's Fiscal Years 2006 and 2005 Financial
Statements, [22]GAO-07-136 (Washington, D.C.: Nov. 9, 2006).

Proposed FAR Rule Would Require Prospective Contractors to Provide Tax-Related
Certifications

The Civilian Agency Acquisition Council and the Defense Acquisition
Regulations Council (councils) have proposed to amend the FAR to require
prospective contractors to certify whether or not they have, within a
3-year period preceding the offer, been convicted of or had a civil
judgment rendered against them for violating any tax law or failing to pay
any tax, or been notified of any delinquent taxes for which they still owe
the tax. In addition, the prospective contractor will be required to
certify whether or not they have received a notice of a tax lien filed
against them for which the liability remains unsatisfied or the lien has
not been released. The proposed rule also adds the following as additional
causes for suspension or debarment: delinquent taxes, unresolved tax
liens, and a conviction of or civil judgment for violating tax laws or
failing to pay taxes.

By issuing the proposed rule on tax delinquency, the councils have
acknowledged the importance of delinquent tax debts in the consideration
of contract awards. The proposed rule requires offerors to certify whether
they have or have not, within a 3-year period preceding the offer, been
notified of any unresolved or unsatisfied tax debt or liens. Contracting
officers generally cannot verify whether prospective contractors
certifying that they have not received notice of unresolved or unsatisfied
tax debts actually owe delinquent federal taxes, unless that information
is disclosed in public records or unless the offeror provides consent for
IRS to disclose its tax records. In March 2006, we testified that in one
contractor file we reviewed, a GSA official did ask the prospective
contractor about a federal tax lien. 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.

Concluding Comments

Over the past several years, we have testified that thousands of federal
contractors failed in their responsibility to pay billions of dollars of
federal taxes yet continued to get federal contracts. This practice is
inconsistent with the fundamental concept that those doing business with
the federal government should be required to pay their federal taxes. With
the serious fiscal challenges facing our nation, the status quo is no
longer an option. Enhanced contractor requirements to pay their taxes
would likely increase contractor tax compliance and federal revenues.
Federal law seeking to achieve these objectives should provide flexibility
to agencies, such as exceptions for contractors critical to national
security. Due process and other safeguards should be built into the system
to ensure that contractors that pay their federal taxes are not
inadvertently denied federal contracts. We look forward to working with
the Subcommittee on this important matter.

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

(192246)

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Highlights of GAO-07-742T , a testimony before the Subcommittee on
Government Management, Organization, and Procurement, Committee on
Oversight and Government Reform, House of Representatives

April 19, 2007

TAX COMPLIANCE

Thousands of Federal Contractors Abuse the Federal Tax System

Since 1990, GAO has periodically reported on high-risk federal programs
that are vulnerable to fraud, waste, and abuse. Two such high-risk areas
are managing federal contracts more effectively and assessing the
efficiency and effectiveness of federal tax administration. Weaknesses in
the tax area continue to expose the federal government to significant
losses of tax revenue and increase the burden on compliant taxpayers to
fund government activities. Over the last several years, the Senate
Permanent Subcommittee on Investigations requested GAO to investigate
Department of Defense (DOD), civilian agency, and General Services
Administration (GSA) contractors that abused the federal tax system. Based
on that work GAO made recommendations to executive agencies including to
improve the controls over levying payments to contractors with tax
debt--many of which have been implemented--and referred 122 contractors to
IRS for further investigation and prosecution.

As requested, this testimony will highlight the key findings from prior
testimonies and related reports. This testimony will

(1) describe the magnitude of tax debt owed by federal contractors, (2)
provide examples of federal contractors involved in abusive and
potentially criminal activity related to the federal tax system, and (3)
describe current law and proposed federal regulations for screening
contractors with tax debts prior to the award of a contract.

In our previous audits and related investigations, we reported that
thousands of federal contractors had substantial amounts of unpaid federal
taxes. Specifically, about 27,000 DOD contractors, 33,000 civilian agency
contractors, and 3,800 GSA contractors owed about $3 billion, $3.3
billion, and $1.4 billion in unpaid taxes, respectively. These estimates
were understated because they excluded federal contractors that
understated their income or did not file their tax returns; however, some
contractors may be counted in more than one of these groups.

As part of this work, we conducted more in-depth investigations of 122
federal contractors and in all cases found abusive and potentially
criminal activity related to the federal tax system. Many of these 122
contractors were small, closely held companies that provided a variety of
goods and services, including landscaping, consulting, catering, and parts
or support for weapons and other sensitive programs for many federal
agencies including the departments of Defense, Justice, and Homeland
Security. These contractors 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. A
number of owners or officers of the 122 federal contractors owned
significant personal assets, including a sports team, multimillion dollar
houses, a high-performance airplane, and luxury vehicles. Several owners
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: Previous GAO testimonies.

Federal law, as implemented by the Federal Acquisition Regulation (FAR),
does not now require contractors to disclose tax debts or contracting
officers consider tax debts in making contracting decisions. Federal
contractors that do not pay tax debts could have an unfair competitive
advantage in costs because they have lower costs than tax compliant
contractors on government contracts. GAO's investigation identified
instances in which contractors with tax debts won awards based on price
differential over tax compliant contractors.

References

Visible links
  15. http://www.gao.gov/cgi-bin/getrpt?GAO-04-414T
  16. http://www.gao.gov/cgi-bin/getrpt?GAO-05-683T
  17. http://www.gao.gov/cgi-bin/getrpt?GAO-06-492T
  18. http://www.gao.gov/cgi-bin/getrpt?GAO-04-414T
  19. http://www.gao.gov/cgi-bin/getrpt?GAO-05-683T
  20. http://www.gao.gov/cgi-bin/getrpt?GAO-06-492T
  21. http://www.gao.gov/cgi-bin/getrpt?GAO-05-26R
  22. http://www.gao.gov/cgi-bin/getrpt?GAO-07-136
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