Defense contractors owe billions in unpaid federal taxes

U.S. defense contractors failed to pay the federal government billions in taxes and, in some cases, may be guilty of criminal offenses, auditors with the General Accounting Office said Thursday.

But unpaid taxes on defense contracts might only be the tip of the iceberg, as many defense companies also do business with other agencies across the federal government, Gregory Kutz, a director of GAO's financial management and assurance office, told the Senate Permanent Subcommittee on Investigations.

More than 27,000 defense contractors owe the federal government about $3 billion in unpaid taxes as of September 2002, the watchdog agency concluded in a new report, "DoD Contractors Abuse the Federal Tax System with Little Consequences (GAO-04-95)."

The names of the delinquent contractors were not disclosed because of privacy laws.

GAO found that defense contractors primarily failed to pay payroll taxes and corporate income taxes. Kutz said GAO specifically examined 47 delinquent contractors and discovered suspected criminal abuses that could lead to felony charges. Some of the contractors work on military bases or major weapons programs.

"We don't want government contractors coming in and conducting criminal activities on military installations or buildings," said John Ryan, assistant director of the Office of Special Investigations. "I think it is absolutely necessary that we do something to [check] the contractors that we're bringing into our installations and our buildings."

Ryan said some contractors stay in existence just for a short time to get a government contract, and then dissolve and change names to get another contract. He said one contractor used magnetic signs on trucks so it could quickly change names.

In some cases, the tax evasion was flagrant. The owner of one contractor with $10 million in unpaid taxes used corporate funds to buy a home in the Caribbean and a luxury boat. Another owner took $1 million from his company to buy a large home and a luxury car.

"The typical diversion scheme funneled money to the owners and officers of the company through substantial salaries or loans that were never repaid," Kutz said. Other contractors were in financial trouble and used their money to pay utilities or rent rather than the government.

But GAO also concluded that the Defense Department and Internal Revenue Service bear responsibility for the unpaid taxes. Defense has not fully implemented a provision of the 1997 Taxpayer Relief Act that allows the government to levy up to 15 percent of contract payments to offset outstanding debt, while the IRS has not aggressively pursued delinquent contractors due to resource and workload constraints, according to the report.

"Allowing contractors to do business with the government while not paying their taxes creates an unfair competitive advantage for them at the expense of the vast majority of Defense contractors that fulfill their tax obligations," said Steve Sebastian, another director of the GAO office. "DoD's failure to fully comply with debt collection mandates, and IRS' continuing challenges in collecting unpaid taxes have contributed to this unacceptable situation."

Defense is by far the largest federal contracting department, awarding about $165 billion in contracts during fiscal year 2002. The department was responsible for 66 percent of all federal contracts in fiscal year 2002.

Kutz said federal law does not prohibit companies that are tax delinquent from getting new contracts, and GAO found no evidence that defense procurement officials investigated whether companies were delinquent before awarding them contracts.

"This is probably a governmentwide problem, and we're probably losing billions and billions of dollars in waste," said Sen. Peter Fitzgerald, R-Ill.

GAO made several recommendations that should be taken by Defense, the IRS and the Office of Management and Budget. Officials with Defense and the IRS said in written responses that their agencies largely agree with GAO's conclusions and are taking remedial actions.

The IRS' criminal investigation division is reviewing the specific 47 cases identified by GAO to determine whether there is evidence of criminal tax evasion or failure to pay taxes that would warrant an investigation.