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updated 2/11/2004 3:35:37 PM ET 2004-02-11T20:35:37

The Department of Defense paid billions of dollars in 2002 to more than 27,000 contractors that owed $3 billion in unpaid taxes, according to a draft copy of the findings of a General Accounting Office investigation obtained by NBC News.

Despite mechanisms in place since 1997 to help the government reclaim back taxes from federal contractors, the DOD has failed to fully implement those procedures, a move that would have “offset and collected at least $100 million,” the GAO says.

Instead, inconsistent participation by the DOD in the tax levy program, similar to those used to collect delinquent child support payments, has resulted in only $332,000 being collected from tax delinquent military contractors.

Most of the tax-dodging claims stem from contractors simply refusing to give the government the range of payroll taxes —Social Security, Medicare and federal income tax — they deduct from employee paychecks. Some of these contractors have unpaid taxes dating to the 1990s. 

“Rather than fulfill their role as ‘trustees’ … these DOD contractors diverted the money for personal gain or to fund the business,” the GAO says.

A Pentagon spokeswoman, asked for comment, would only say that the DOD’s formal response is contained in the full GAO report, to be issued on Thursday.

According to the Internal Revenue Service, as of September 2002, businesses and individual citizens owed the federal government a total of $249 billion in unpaid taxes and interest. Of that, $49 billion stems from unpaid payroll taxes, the GAO study says.

Some cases stand out
The GAO said it found 47 particularly egregious cases in which potentially criminal activity took place; the companies aren’t identified in the study. In two cases, the business owners borrowed nearly $1 million from their firms while not sending the government the payroll taxes. One owner bought a boat, several cars and a home outside of the United States, the GAO said. The other paid more than $1 million for a home “despite having substantial unpaid payroll taxes,” the study says.

In both those cases, the contractors received “large payments” for work performed under government contract but “recently went out of business,” according to the study.

Free ride
The Senate Permanent Subcommittee on Investigations intends to explore why tax abusing companies are allowed to compete for and receive federal tax dollars on Thursday when the GAO study is formally issued.

The subcommittee will re-examine a House bill introduced four years ago that would have banned the government from giving contracts to tax delinquent businesses.  That bill, dubbed the Debt Payment Incentive Act of 2000, never made it out of committee for a floor vote. 

At the time, the DOD opposed the bill, saying that its provisions “may be more punitive than is necessary.”  To support that stance, an agency official cited the Treasury Department’s tax levying program, in which, as the current GAO study notes, the DOD doesn’t fully participate. 

“At this juncture, the criteria calling for federal agencies to do business only with responsible contractors does not include whether they pay taxes when due,” the GAO says.

Even if federal contractors wanted to conduct background checks on contractors' tax standing they couldn’t, the GAO says, because there is no “coordinated process” for identifying businesses and individuals receiving government contract money “who abuse the federal tax system,” the GAO says. 

The GAO study recommends full participation by the DOD in current tax collection programs that allow the IRS to efficiently levy military contractor payments against back taxes.  It also recommends a system be set up for prohibiting the awarding of contracts to business and individuals “who abuse the federal tax system.”

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