Tax Compliance
Thousands of Federal Contractors Abuse the Federal Tax System Gao ID: GAO-07-742T April 19, 2007Since 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 $1.3 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. 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.
GAO-07-742T, Tax Compliance: Thousands of Federal Contractors Abuse the Federal Tax System
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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:
GAO Highlights:
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
Why GAO Did This Study:
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.
What GAO Found:
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.
Table: Examples of Abusive and Potentially Criminal Activity:
Type of business: Custodial services for DOD;
Unpaid tax debt: Over $1 million;
Payments to contractor: Over $1 million;
Contractor activity: Owner bought a boat, several cars, and a home
outside the country.
Type of business: Temporary help for civilian agency;
Unpaid tax debt: Nearly $900,000;
Payments to contractor: Over $1 million;
Contractor activity: Owner followed pattern of over 20 years of closing
businesses with tax debts, opening new ones, and incurring more tax
debts.
Type of business: Security under GSA contract;
Unpaid tax debt: Over $9 million;
Payments to contractor: Over $1 million;
Contractor activity: Owner made cash withdrawals to fund an unrelated
business and purchase a men's gold bracelet worth over $25,000.
Source: Previous GAO testimonies.
[End of table]
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.
[Hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-07-742T].
To view the full product, including the scope and methodology, click on
the link above. For more information, contact Gregory Kutz at (202) 512-
7455 or kutzg@gao.gov.
[End of section]
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,[Footnote 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.[Footnote 2] Much of the unpaid taxes were payroll
taxes.[Footnote 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.
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.[Footnote 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.
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,[Footnote 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.[Footnote 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.
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,
* 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.
* 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.
* 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.[Footnote 7] Willful failure to remit
payroll taxes can also be a criminal felony offense punishable by
imprisonment of up to 5 years,[Footnote 8] while the failure to
properly segregate payroll tax funds can be a criminal misdemeanor
offense punishable by imprisonment of up to a year. [Footnote 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.[Footnote 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.
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.[Footnote 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.
Table 1: Summary Information on 10 Federal Contractors with Unpaid
Federal Taxes:
Case: Case 1;
Nature of work: Base support and custodial services for DOD;
Federal payments[A]: Over $1 million;
Unpaid federal tax[B]: Nearly $10 million;
Comments:
* State tax authorities levied the business bank account;
* The owner borrowed nearly $1 million from the business;
* The owner bought a boat, several cars, and a home outside the United
States;
* The business was dissolved in 2003 and transferred its employees to a
relative's business, where it submitted invoices and received payments
from DOD on a previous contract through August 2003.
Case: Case 2;
Nature of work: Research services for DOD;
Federal payments[A]: Up to $100,000;
Unpaid federal tax[B]: Over $700,000;
Comments:
* DOD awarded the business a contract in 2002 for nearly $800,000;
* Owner had over $1 million in loans related to cars, real estate, and
recreational activities;
* Owner owned a high-performance airplane.
Case: Case 3;
Nature of work: Vehicle repair services for DOD;
Federal payments[A]: Over $100,000;
Unpaid federal tax[B]: Over $100,000;
Comments:
* The business was investigated for paying employee wages in cash;
* Owner purchased million dollar home and luxury sports car while owing
a substantial tax liability;
* Owner owed child support.
Case: Case 4;
Nature of work: Health-care-related services for Departments of
Veterans Affairs and Health and Human Services;
Federal payments[A]: Over $100,000;
Unpaid federal tax[B]: Over $18 million;
Comments:
* Business was affiliated with many other health care-related
facilities, including nursing and convalescent homes;
* Business and related entities owed taxes covering over 80 tax
periods;
* Owner purchased multimillion-dollar properties, an unrelated
business, and a number of luxury vehicles at the same time the business
was not fully paying its payroll taxes;
* Owner owned other real estate holdings including residential and
commercial properties valued in the tens of millions of dollars.
Case: Case 5;
Nature of work: Security guard services to Departments of Homeland
Security and Veterans Affairs;
Federal payments[A]: Over $100,000;
Unpaid federal tax[B]: Over $400,000;
Comments:
* Business had not filed all required tax returns for several years;
* Business owed taxes covering over 25 tax periods. Tax debt amount
also included owner's individual income taxes totaling tens of
thousands of dollars;
* Owner had repeatedly failed to file personal income tax returns;
* Owner diverted unpaid payroll taxes to a foreign bank account to
build a house overseas.
Case: Case 6;
Nature of work: Armed security guard services to several federal
agencies including the Department of Justice and the Environmental
Protection Agency;
Federal payments[A]: Over $100,000;
Unpaid federal tax[B]: Nearly $400,000;
Comments:
* Business owed over $200,000 in payroll taxes for almost 10 tax
periods;
* Business did not file income tax returns in the early 2000s;
* Officer of the business was convicted for stealing hundreds of
thousands of dollars from the business;
* The owner was indicted for embezzlement and money laundering.
Case: Case 7;
Nature of work: Payroll and temporary employment services to the
Department of Housing and Urban Development;
Federal payments[A]: Over $1 million;
Unpaid federal tax[B]: Nearly $900,000;
Comments:
* The owner's history of delinquency stretched nearly 20 years and
covered multiple businesses;
* The owner typically incurred payroll taxes on one business, was
assessed a trust fund penalty on that business but made no or little
payments, closed the business, started another company, and repeated
the same pattern. In at least one case, the owner closed the business
and immediately established a new business with a similar name at the
same address that provided the same services;
* The owner rented office space in an expensive area of a major
metropolitan city and purchased a luxury automobile at the same time
the business was not remitting all of the payroll taxes.
Case: Case 8;
Nature of work: Security services under a GSA contract;
Federal payments[A]: Over $1 million;
Unpaid federal tax[B]: Over $9 million;
Comments:
* Business filed for bankruptcy in 2000s;
* At the time business was not remitting all of its payroll taxes to
IRS, the owner withdrew large amounts of funds from the company for
personal use;
* Owner used over $100,000 on gambling;
* Business submitted false reports on a government contract;
* Owner was investigated for fraud.
Case: Case 9;
Nature of work: Emergency supplies under a GSA contract;
Federal payments[A]: Up to $100,000;
Unpaid federal tax[B]: Over $700,000;
Comments:
* Business made large loans to a company officer at same time the
business was not paying its taxes;
* Business filed for bankruptcy protection owing substantial state and
federal taxes;
* The owner owned multiple real properties, including a million dollar
home and a luxury vehicle, while business owed taxes;
* Business had a federal tax lien at time GSA awarded a federal supply
schedule contract.
Case: Case 10;
Nature of work: Human resource services under a GSA contract;
Federal payments[A]: Over $100,000;
Unpaid federal tax[B]: Over $400,000;
Comments:
* Owner owned multiple real properties and several luxury vehicles at
the time the business owed taxes;
* At the time owner did not remit all taxes owed to IRS, the owner made
multiple, large cash withdrawals at gambling casinos;
* Business obtained contract for hurricane relief efforts.
Source: Previous GAO testimonies on federal contractors with tax
debts.(GAO-04-414T, GAO-05-683T, and 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.
[End of table]
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).[Footnote 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.
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.[Footnote 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,[Footnote 14] or failure to properly segregate
payroll taxes, a criminal misdemeanor offense, may apply.[Footnote 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.
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.[Footnote 16] Thus, unless the taxpayer provides
consent,[Footnote 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.[Footnote 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.[Footnote 19]
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.
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.
FOOTNOTES
[1] GAO, Financial Management: Some DOD Contractors Abuse the Federal
Tax System with Little Consequence, GAO-04-414T (Washington, D.C.: Feb.
12, 2004); Financial Management: Thousands of Civilian Agency
Contractors Abuse the Federal Tax System with Little Consequence, GAO-
05-683T (Washington, D.C.: June 16, 2005); and Financial Management:
Thousands of GSA Contractors Abuse the Federal Tax System, GAO-06-492T
(Washington, D.C.: Mar. 14, 2006).
[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. §§ 7202, 7215 and 7512 (b).
[5] FAR 2.101; 9.104-1
[6] Representations and Certifications - Tax Delinquency, 72 Fed. Reg.
15093 (proposed Mar. 30, 2007) (to be codified at 48 C.F.R. pts. 9 and
52).
[7] 26 U.S.C. § 6672.
[8] 26 U.S.C. § 7202.
[9] 26 U.S.C. § 7215 and 26 U.S.C. § 7512 (b).
[10] According to IRS, nonfilers and underpayment of taxes comprised
the rest of the gross tax gap.
[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.
[12] A TIN is a unique nine-digit identifier assigned to each business
and individual that files a tax return. For businesses, the employer
identification number assigned by IRS serves as the TIN. For
individuals, the Social Security number, assigned by the Social
Security Administration, serves as the TIN.
[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. § 7202.
[15] 26 U.S.C. § 7215 and 26 U.S.C. §7512 (b).
[16] 26 U.S.C. § 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.
[19] GAO, IRS Lien Management Report: Opportunities to Improve
Timeliness of IRS Lien Releases, GAO-05-26R (Washington, D.C.: Jan. 10,
2005) and GAO, Financial Audit: IRS's Fiscal Years 2006 and 2005
Financial Statements, GAO-07-136 (Washington, D.C.: Nov. 9, 2006).
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