oversight

Payroll Taxes: Billions in Delinquent Taxes and Penalties Due But Unlikely to Be Collected

Published by the Government Accountability Office on 1999-08-02.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                          United States General Accounting Office

GAO                       Testimony
                          Before the Subcommittee on Government Management,
                          Information and Technology, Committee on Government
                          Reform, House of Representatives


For Release on Delivery
Expected at
10 a.m.
                          PAYROLL TAXES
Monday,
August 2, 1999

                          Billions in Delinquent
                          Taxes and Penalties Due
                          But Unlikely to Be
                          Collected
                          Statement of Gregory D. Kutz
                          Associate Director, Governmentwide Accounting and
                          Financial Management Issues
                          Accounting and Information Management Division

                          Statement of Cornelia M. Ashby
                          Associate Director, Tax Policy and Administration Issues
                          General Government Division




GAO/T-AIMD/GGD-99-256
        Mr. Chairman and Members of the Subcommittee:

        We are pleased to be here today to discuss the results of our work on
        payroll taxes owed to the federal government and the associated trust fund
        recovery penalties assessed against individuals responsible for the
        nonpayment of these taxes. This work was performed in response to your
        request for information on unpaid payroll taxes and associated tax
        penalties. We are issuing our report on the results of this work today.1

        In your request, you asked that we determine

        • the extent to which payroll taxes are not remitted to the federal
          government,
        • the magnitude of the trust fund recovery penalties (TFRP) assessed
          against individuals who withheld federal payroll taxes from employees’
          salaries but did not forward them,
        • the extent to which individuals who have not remitted payroll taxes are
          responsible for not paying these taxes at multiple businesses,
        • the extent to which businesses and individuals who failed to pay payroll
          taxes are also receiving federal benefits or other federal payments, and
        • the factors that affect the Internal Revenue Service’s (IRS) ability to
          enforce compliance or pursue collections in this area.

        The report we are issuing today responds to each of these questions. This
        statement summarizes the major issues contained in our report.

        In summary, at September 30, 1998, $49 billion in cumulative unpaid payroll
        taxes were owed by nearly 2 million businesses, and $15 billion in TFRPs
        had been assessed against, and remained owed by, 185,000 individuals
        responsible for the nonpayment of payroll taxes. The majority of these
        unpaid payroll taxes and associated TFRPs will unlikely be collected.
        Nearly 25,000 individuals with outstanding TFRPs were responsible for
        withholding but not forwarding payroll taxes to the government at more
        than one business. A significant number of both businesses with unpaid
        payroll taxes and individuals with outstanding TFRPs are also receiving
        billions of dollars in federal benefits and payments. Several factors,
        including financial management system deficiencies and internal control
        weaknesses, ineffective taxpayer education and early warning programs,


        1
          See Unpaid Payroll Taxes: Billions in Delinquent Taxes and Penalty Assessments Owed
        (GAO/AIMD/GGD-99-211, August 2, 1999).




Leter   Page 1                                                                  GAO/T-AIMD/GGD-99-256
                         and federal and state laws, affect IRS’ ability to enforce compliance and
                         pursue collection of unpaid payroll taxes.



Payroll Taxes and the    Employers are required to withhold from their employees’ salaries amounts
                         for individual federal income taxes and Federal Insurance Contribution Act
Process for              (FICA) taxes, which include taxes for Social Security and hospital
Distributing Monies to   insurance (Medicare). Employers are required to forward these withheld
                         taxes, as well as the employers’ matching FICA tax amounts, to the federal
the Trust Funds          government. The Department of the Treasury, through IRS, is responsible
                         for collecting these taxes.

                         The information IRS receives at the time it collects several types of tax
                         payments, including those for Social Security and hospital insurance, is not
                         sufficient to allow it to attribute these payments to specific trust funds. For
                         this reason, initial distributions to the Social Security and hospital
                         insurance trust funds are based on estimates prepared by the Social
                         Security Administration’s (SSA) Office of the Chief Actuary and Treasury’s
                         Office of Tax Analysis (OTA), with adjustments subsequently made as a
                         result of certifications made by the Commissioner of SSA. This process is
                         illustrated in detail in appendix I.

                         It is important to emphasize that the amounts distributed to the Social
                         Security and hospital insurance trust funds are based on the wages an
                         individual earns as required by law, not the amount the employer actually
                         forwards to the government. This ensures that individuals who work and
                         have taxes withheld to pay into the Social Security program—or their
                         spouses and qualified dependents—receive the appropriate level of
                         program benefits when they retire, become disabled, or die.

                         However, this also creates a situation in which the general revenue fund
                         subsidizes the Social Security and hospital insurance trust funds to the
                         extent that Social Security and hospital insurance taxes owed are not
                         actually collected. While the vast majority of businesses pay the taxes
                         withheld from employees’ salaries as well as the employers’ matching
                         amounts, a significant number of businesses do not. Over time, the
                         cumulative amounts of unpaid payroll taxes, and thus the amount of this
                         subsidy, is significant. As of September 30, 1998, the estimated amount of
                         unpaid taxes and interest in IRS’ $222 billion unpaid assessments balance




             Leter       Page 2                                                   GAO/T-AIMD/GGD-99-256
                      was approximately $38 billion for Social Security and hospital insurance
                      taxes.2


Trust Fund Recovery   To the extent a business withholds money from an employee’s salary for
Penalties             federal income taxes and the employee’s FICA obligation but does not
                      forward these monies to the federal government, that business is liable for
                      these unpaid taxes, as well as its own matching FICA contribution. Under
                      statute, if determined to be “willful and responsible,” individuals can also
                      be held personally liable and subject to a TFRP for federal income and
                      FICA taxes withheld from employees but not forwarded to the federal
                      government. It should be noted that IRS does not have to determine that
                      there was a deliberate intent or desire to defraud the federal government as
                      a prerequisite to assessing a TFRP.

                      More than one individual can be found willful and responsible for a
                      business’ failure to pay the federal government withheld payroll taxes and
                      thus be assessed a TFRP. Additionally, the business itself is still liable for
                      the entire amount of the unpaid payroll taxes. However, IRS policies
                      require that it collect the unpaid tax only once.



Cumulative Unpaid     According to IRS records, as of September 30, 1998, businesses owed the
                      federal government about $49 billion in payroll taxes.3 This represents
Payroll Taxes Are     about 22 percent of the $222 billion in IRS’ inventory of unpaid tax
Significant           assessments as of September 30, 1998. The $49 billion includes about
                      $19 billion in unpaid tax assessments and another $30 billion in penalties
                      and interest.

                      While consisting of less than a quarter of IRS’ outstanding balance of
                      unpaid assessments at September 30, 1998, unpaid payroll taxes make up


                      2
                       This estimate includes both FICA and Self-Employment Contribution Act (SECA) taxes, but does not
                      include federal income tax withholdings, which are a component of payroll taxes. SECA taxes are
                      Social Security and hospital insurance taxes required to be paid by self-employed individuals. Accrued
                      interest is also included in the estimate because assessments distributed to the trust funds earn interest
                      at Treasury-based interest rates, similar to IRS’ interest accruals.
                      3
                       Differences between this amount and the estimated cumulative subsidy amount of $38 billion
                      discussed previously are due to the following: (1) the $49 billion in unpaid payroll taxes includes
                      federal income tax withholdings, which are not included in the estimate, and (2) the $38 billion
                      estimated subsidy includes unpaid SECA taxes, which are not included in the $49 billion in unpaid
                      payroll taxes.




                      Page 3                                                                      GAO/T-AIMD/GGD-99-256
                           over 50 percent of IRS revenue officers’ caseloads in many regions of the
                           country. Consequently, they represent one of IRS’ most significant
                           enforcement challenges.


The Number and Age of      IRS records show that over 1.8 million businesses owe the $49 billion in
Delinquent Payroll Taxes   unpaid payroll taxes for more than 4.9 million separate tax periods or
                           quarters (see table 1). Nearly 50 percent of the businesses with
Are Significant
                           outstanding payroll taxes are delinquent for more than one quarter. Some
                           of these businesses have in excess of 40 quarters of delinquent payroll
                           taxes.



                           Table 1: Businesses With Multiple Quarters of Unpaid Payroll Taxes

                                                                               Unpaid payroll taxes
                                                                                                Outstanding balancea
                           Number of businesses                         Number of quarters       (dollars in billions)
                           1,702,177                                                 1 to 6                     $26.4
                           158,106                                                  7 to 20                      21.0
                           5,281                                                   21 to 40                        1.5
                           86                                                      Over 40                         0.1
                           Total    1,865,650                                           —                       $49.0
                           a
                           Consists of taxes, penalties and interest.
                           Source: IRS Business master file.


                           As table 1 illustrates, a significant number of businesses have multiple tax
                           periods of unpaid payroll taxes. Over 52 percent of the 4.9 million in
                           delinquent quarters of payroll taxes predate 1994, as shown in table 2.
                           Moreover, these multiple periods of unpaid payroll taxes can go back as
                           much as 20 years or more. The outstanding balance of these delinquent
                           quarters of payroll taxes totals over $34 billion, representing over 70
                           percent of the total balance of unpaid payroll taxes in IRS’ inventory of
                           unpaid assessments at September 30, 1998.




                           Page 4                                                             GAO/T-AIMD/GGD-99-256
                              Table 2: Delinquent Quarters of Unpaid Payroll Taxes and Their Outstanding
                              Balances by Age

                                                                                    Unpaid payroll taxes
                                                                                                         Outstanding balancea
                              Tax years                                    Number of quarters             (dollars in billions)
                              1994-1998                                              2,348,838                           $14.4
                              1988-1993                                              2,198,493                            25.4
                              1980-1987                                                 407,619                             9.0
                              Before 1980                                                 3,491                             0.2
                              Total                                                  4,958,441                           $49.0
                              a
                              Consists of taxes, penalties and interest.
                              Source: IRS Business master file.




Potential Collectibility of   Taxpayer account status codes maintained in IRS’ systems indicate little
Unpaid Payroll Taxes Is Low   potential for collection for many of the 4.9 million delinquent payroll tax
                              accounts, as shown in table 3. In fact, these records would indicate that the
                              majority of the unpaid payroll tax accounts are not likely to be collected.



                              Table 3: Delinquent Payroll Tax Accounts With Little Likelihood of Collection

                                                                                        Number of          Percentage of 4.9M
                              Business status                                            accounts         delinquent accounts
                              No longer in existence                                      1.4 million                       28
                              Insolvent or IRS is unable to locate or contact               487,000                         10
                              Does not have resources to pay amount owed                    444,000                          9
                              In bankruptcy or other litigation proceedings                 189,000                          4
                              Total                                                                                         51

                              Our previous work on IRS’ unpaid assessments4 has shown that older
                              delinquent taxes have little likelihood of collection. Additionally, our
                              review of a statistical sample of 690 unpaid tax assessments selected as
                              part of our audit of IRS’ fiscal year 1998 financial statements reinforces this
                              conclusion. Of the 690 unpaid tax assessment accounts selected for
                              review, 191, with outstanding balances of about $121 million, were unpaid

                              4
                                See Internal Revenue Service: Composition and Collectibility of Unpaid Assessments
                              (GAO/AIMD-99-12, October 29, 1998).




                              Page 5                                                                    GAO/T-AIMD/GGD-99-256
                           payroll taxes or associated TFRPs.5 In our review of these cases, both we
                           and IRS determined that only about 9 percent of the outstanding balances
                           would likely be collected.


Types of Businesses With   There are many types of businesses with delinquent payroll taxes. IRS
Unpaid Payroll Taxes       records indicate that corporations represent about 56 percent of the total
                           number of businesses with unpaid payroll taxes. Sole proprietorships
                           represent the second most significant category, about 29 percent of the
                           total, and partnerships represent the third most significant category, about
                           7 percent.

                           Our review of the 191 unpaid payroll tax cases and discussions with IRS
                           revenue officers throughout the country identified additional
                           characteristics of the businesses that have failed to forward payroll taxes
                           to the federal government. These businesses are typically in wage-based
                           industries, with few assets available as a potential collection source for the
                           IRS. They are usually small, closely held businesses using a corporate
                           structure, but this can vary by region of the country. As can be seen in
                           figure 1, construction businesses make up the greatest percentage of
                           industries with unpaid payroll taxes identified in our review of the
                           191 cases.




                           5
                             While our sample of 690 unpaid assessment accounts is a representative sample, the 191
                           unpaid payroll tax and TFRP cases selected as part of this sample cannot be considered
                           statistically representative of the entire population of such cases. Thus, any analysis of these
                           191 cases cannot be projected to the entire population of unpaid payroll taxes and TFRPs.




                           Page 6                                                               GAO/T-AIMD/GGD-99-256
Figure 1: Most Common Businesses/Industries With Unpaid Payroll Taxes From
Cases Reviewed




Other types of businesses noted in our review of the 191 unpaid payroll tax
cases included (1) professional services, (2) consultants, (3) education and
training, (4) computer software, and (5) child care.




Page 7                                                  GAO/T-AIMD/GGD-99-256
Unpaid Penalties             According to IRS records, as of September 30, 1998, outstanding TFRPs
                             assessed against individuals were about $15 billion. This amount includes
Assessed Against             initial assessments of about $9 billion and accumulated interest of about
Individuals for Not          $6 billion. IRS records indicate a total of about 237,000 separate TFRP
                             assessments made against, and owed by, nearly 185,000 individuals.
Forwarding Payroll
Taxes to the                 As discussed earlier, a TFRP assessment is only for the federal tax
Government Are               withholding and FICA taxes withheld from employees’ salaries; it does not
                             include the business’ or employer’s matching FICA contributions.
Significant                  Additionally, a TFRP can be assessed against anyone found willful and
                             responsible for the withholding and nonpayment of payroll taxes. If
                             several individuals involved in a business are found willful and responsible,
                             they can each be separately assessed a TFRP for the unpaid taxes.
                             However, while TFRPs are assessed against one or more individuals and
                             thus appear as separate unpaid assessments on IRS’ records, the total
                             payroll taxes owed by the business are to be collected only once. This
                             means that if the business responsible for the unpaid payroll taxes pays
                             some or all of its delinquent taxes, or if one of several individuals assessed
                             a TFRP covering the same delinquent tax period pays some or all of the
                             assessment, the tax liability for all related parties should be reduced or
                             eliminated from IRS’ records.


System Deficiencies Affect   In our October 1998 report6 on internal control weaknesses at IRS, which
the Completeness and         was based on the results of our audit of IRS’ fiscal year 1997 custodial
                             financial statements,7 we discussed serious financial management systems
Accuracy of TFRP
                             issues that affected IRS’ ability to effectively manage and accurately report
Information                  on its unpaid assessments. One of the most serious issues we discussed
                             related to IRS’s inability to link related taxpayer accounts to ensure that
                             they all receive appropriate credit when a payment is made on one account.
                             This is of particular concern for unpaid payroll taxes and related TFRPs.
                             The unpaid payroll tax of a business and the TFRP assessed against an
                             individual, or individuals, are maintained on IRS’ business and individual
                             master files—the detailed databases of taxpayer information for businesses
                             and individuals, respectively. These are two separate and distinct


                             6
                               See Internal Revenue Service: Immediate and Long-Term Actions Needed to Improve Financial
                             Management (GAO/AIMD-99-16, October 30, 1998).
                             7
                               See Financial Audit: Examination of IRS’ Fiscal Year 1997 Custodial Financial Statements
                             (GAO/AIMD-98-77, February 26, 1998).




                             Page 8                                                                    GAO/T-AIMD/GGD-99-256
databases that are not integrated. Consequently, if a payment is received
from the business, there is no automated entry to record the reduction in
the individual, or individuals’, TFRP account or accounts. This has led to
instances in which IRS has pursued collection against officers of a business
for amounts that had already been paid.

IRS has attempted to correct this problem by manually entering a code on
related taxpayer accounts to alert IRS personnel that related accounts exist
and should be reviewed to ensure that all transactions are appropriately
reflected on each account. However, as reflected in table 4, our audits of
IRS’ fiscal year 1997 and 1998 financial statements have shown that the use
of these codes, referred to as cross-references, has not been effective in
providing the compensating link between related taxpayer accounts. In
fact, in over half of the unpaid payroll tax cases we reviewed during both
years, payments were not properly reflected in each related account.



Table 4: Frequency of Payments Not Properly Recorded to Related Taxpayer
Accounts Identified in Fiscal Years 1997 and 1998

                                                      Cases reviewed in which
                                                  payments were not reflected on
                                                   all related taxpayer accounts
                      Number of unpaid payroll
                    tax cases reviewed in which
Fiscal year               a TFRP was assessed             Number           Percent
1997                                        83                  53                 64
1998                                       104                  54                 52

In our fiscal year 1998 audit, we also determined that this problem was not
caused solely by the lack of an automated link between IRS’ business and
individual master files. In 7 of the 54 cases we reviewed in which payments
were not properly recorded, IRS failed to credit one individual’s TFRP
liability account for payments made by another individual who had also
been assessed a TFRP for the same business’ unpaid payroll taxes.
Additionally, in 52 of the 104 unpaid payroll tax cases we reviewed in fiscal
year 1998 in which a TFRP was assessed (50 percent), a cross-reference
was not present in the master files to alert IRS personnel that the account
was related to one or several other accounts. These problems create
instances of unintentional taxpayer burden, such as that caused by
inappropriate federal tax liens on taxpayers’ property, and affect the
accuracy of reported balances of both the unpaid payroll tax and the
associated TFRPs.



Page 9                                                     GAO/T-AIMD/GGD-99-256
                           Significant delays in recording payments also affect the completeness and
                           accuracy of the reported amounts for both unpaid payroll taxes and TFRPs.
                           In one instance, we found that payments were recorded to the individual’s
                           account over 8 years after they had been received. Additionally, we found
                           that IRS did not always assess TFRPs against responsible individuals in a
                           timely manner. Specifically, we found two cases in which IRS did not
                           assess a TFRP against officers of businesses until 36 and 55 months,
                           respectively, after the businesses filed their payroll tax returns and IRS
                           would have become knowledgeable of the tax delinquencies. During this
                           period, these officers received tax refunds. Had IRS assessed the TFRPs
                           more promptly, it would have been able to retain, or offset, the refunds to
                           recover a portion of the balance of unpaid payroll taxes.


Not All Individuals        In addition to the serious financial management deficiencies and internal
Responsible for            control issues that affect the integrity of IRS’ data on unpaid payroll taxes
                           and TFRPs, IRS does not track or otherwise systemically maintain
Nonpayment of Payroll
                           information on the number and dollar value of potential TFRPs that are not
Taxes Are Assessed TFRPs   assessed—the value of which could be significant. Several factors affect
                           whether IRS assesses an individual a TFRP for unpaid payroll taxes.

                           First, IRS must be able to establish that an individual was, in fact, willful
                           and responsible for the nonpayment of payroll taxes. Some businesses
                           operate in a fashion that allows an individual without direct responsibility
                           to nonetheless indirectly influence the nonpayment of payroll taxes. An
                           example would be a corporate director who, by all established lines of
                           authority, has no direct involvement in the day-to-day operations of the
                           business but who, in practice, is heavily involved in the business’
                           operations. Thus, establishing that an individual was both willful and
                           responsible is not always easy.

                           In determining whether to assess a TFRP, IRS also considers the amounts
                           involved and the cost associated with pursuing collection actions against
                           the individual. If IRS concludes that the amounts involved do not warrant
                           the cost of pursuing collection, it typically will not assess the TFRP.
                           Additionally, IRS does not assess sole proprietors and partnerships TFRPs
                           for unpaid payroll taxes, believing that it can best pursue collection against
                           the individuals through their individual tax return filing. Finally, IRS also
                           considers the potential to collect the assessment in determining whether to
                           assess the TFRP.




                           Page 10                                                 GAO/T-AIMD/GGD-99-256
                              Consequently, the numbers and dollar value of outstanding TFRPs
                              discussed above likely significantly understate the extent to which
                              individuals are responsible for not forwarding payroll taxes to the federal
                              government.


Collectibility Potential on   IRS’ records, our discussions with revenue officers, and our work on a
TFRPs Is Not Considered       sample of unpaid assessments performed as part of our audit of IRS’ fiscal
                              year 1998 financial statements indicate that the potential for significant
Great
                              collections on TFRPs is not great. Status codes in IRS’ individual master
                              files for about 76,000 (32 percent) of the 237,000 TFRPs assessed against
                              individuals reflect conditions suggesting minimal likelihood of collection.
                              These conditions include the following:

                              • the individual cannot be located or contacted,
                              • the individual is in bankruptcy proceedings or some other form of
                                litigation,
                              • the individual does not have the ability to pay the assessment, and
                              • the individual is deceased.

                              Discussions with revenue officers throughout the country have reinforced
                              the conclusion that TFRP assessments are not highly collectible. Many
                              revenue officers we interviewed believe that less than 30 percent of
                              amounts assessed as TFRPs are ultimately collected. Of the 104 unpaid
                              payroll tax cases we reviewed in fiscal year 1998 in which TFRPs were
                              assessed, we determined that only 8 cases had some potential for
                              collectibility.



Significant Numbers of        IRS records indicate that as of September 30, 1998, nearly 25,000
                              individuals, or about 13 percent of the 185,000 individuals with TFRPs,
Individuals Are               have been assessed such penalties for unpaid payroll taxes at more than
Responsible for               one business. As shown in table 5, about three-quarters of these individuals
                              have TFRP assessments for two separate businesses, and about a quarter
Withholding But Not           have TFRP assessments at three or more businesses.
Paying Payroll Taxes at
Multiple Businesses




                              Page 11                                                GAO/T-AIMD/GGD-99-256
Table 5: Number of Individuals With Trust Fund Recovery Penalties for Two or More
Businesses

Number of businesses                                        Number of individuals
2                                                                          18,993
3                                                                           3,925
4                                                                           1,079
5                                                                             409
6                                                                             192
7-12                                                                          235
Over 12                                                                        29
Total                                                                      24,862
Source: IRS UNLCER files and individual master file.


In fact, IRS’ records indicate that 7 individuals have been assessed TFRPs
at 20 or more separate and distinct businesses. However, we must reiterate
that these data may not provide a complete and accurate assessment of the
degree to which such “multiple offenders” exist because of the significant
deficiencies in IRS’ financial management systems and internal controls
and because IRS does not always assess an individual a TFRP. Additionally,
these data cannot account for those individuals who establish new
businesses under other names or otherwise conceal their identities.

Our review of the 191 unpaid payroll tax related cases and our discussions
with revenue officers throughout the country confirm that a significant
number of individuals are found liable for the nonpayment of payroll taxes
at more than one business. Of the 104 unpaid payroll tax cases we
reviewed in which TFRPs were assessed against individuals, we found that
30 (29 percent) involved individuals assessed TFRPs for more than one
business. In one case, we found that an individual had TFRP assessments
outstanding for four separate businesses and had been determined
responsible for the nonpayment of payroll taxes at a fifth business. In all
instances, the individual established and operated construction-related
(electrical) companies, in which he was both owner and president. Each
company accumulated unpaid payroll taxes and then went out of business.
Shortly after each company went out of business, the individual opened a
new company in the same line of business.




Page 12                                                   GAO/T-AIMD/GGD-99-256
Reasons Individuals         Most of the revenue officers we interviewed believe the majority of the
Continue to Have Unpaid     individuals responsible for not paying payroll taxes at multiple businesses
                            do not flagrantly disregard their responsibility to forward such payments to
Payroll Taxes at Multiple
                            the federal government. Most of the revenue officers stated that the
Businesses                  individuals responsible for not paying these taxes lack the skills necessary
                            to properly manage a business. We were told that many start up businesses
                            with little capital and quickly find themselves experiencing cash flow
                            problems. In their struggle to stay in business, these individuals prioritize
                            and direct their payments to those recipients without which the businesses
                            would quickly fail, such as employees’ net salaries, rent, and utilities.
                            Eventually the businesses are unable to sustain even these payments, and
                            they fail. Revenue officers further stated that, unfortunately, these
                            individuals do not learn from some of the mistakes they make, and are soon
                            opening and operating new businesses in much the same manner.

                            However, the revenue officers acknowledged that some individuals
                            intentionally disregard their responsibility to forward payroll taxes to the
                            federal government. One revenue officer noted a case in which an
                            individual was ultimately determined to be responsible for not paying the
                            payroll taxes at three businesses. This individual used family members to
                            conceal his involvement in two of the businesses. He was the president of
                            the first business and had the business assets listed in his name. After this
                            corporation had accrued but not paid substantial payroll tax liabilities, the
                            corporation went out of business and he established a new corporation,
                            listing his wife as president and placing the assets in her name. He
                            subsequently established a third corporation, this time listing his daughter
                            as the president and placing the assets in her name. Both of these
                            subsequent corporations also accrued significant unpaid payroll tax
                            liabilities.

                            Regardless of an individual’s intent, the failure to pay withheld payroll
                            taxes has the same effect on the federal government. In either case, the
                            federal government incurs costs to pursue collection of the delinquent tax
                            debt and loses revenue to the extent that such taxes are not ultimately
                            collected. Additionally, as discussed previously, to the extent payroll taxes
                            are not paid, the general revenue fund subsidizes the Social Security and
                            hospital insurance trust funds. As a result, fewer funds are available to
                            finance other federal programs.




                            Page 13                                                 GAO/T-AIMD/GGD-99-256
Businesses and         We found that businesses and individuals responsible for withholding but
                       not paying payroll taxes receive substantial payments from the federal
Individuals            government, either for federal benefits or for other payment purposes, such
Responsible for Not    as federal contracts or loans.
Paying Payroll Taxes   Specifically, based on a matching of IRS records of individuals with
Receive Significant    outstanding TFRPs with certain Financial Management Service (FMS)
Federal Benefits and   payment records, we estimate that about 18,800 (10 percent) of these
                       individuals were receiving about $212 million in annual federal benefit
Other Federal          payments while owing almost $2 billion in delinquent payroll taxes, as
Payments               shown in table 6.



                       Table 6: Delinquent Taxpayers Receiving Federal Benefits at September 30, 1998,
                       and Their Tax Liability Balances (Dollars in millions)

                                                                         Estimated annual            Tax liabilities at
                       Payment type                      Taxpayers              payments         September 30, 1998
                       SSA                                   18,199                   $200.4                  $ 1,902.0
                       Civilian Retirement                      271                       3.9                         21.5
                       Civilian Salary                          215                       6.3                         14.1
                       Railroad Retirement                        81                      1.0                          7.7
                       Total                                 18,766                   $211.6                      $1,945.3
                       Source: GAO analysis of FMS payments and IRS’ records for trust fund recovery penalties.


                       Additionally, based on a matching of FMS records of payments made to
                       civilian vendors over a 3-month period to IRS’ records of businesses with
                       unpaid payroll taxes and individuals with outstanding TFRPs, we found
                       that about 16,700 taxpayers with payroll tax liabilities of about $507 million
                       at September 30, 1998, received about $7 billion in federal payments over
                       this 3-month period.

                       Finally, based on our matching of IRS records of businesses with unpaid
                       payroll taxes with the Small Business Administration’s (SBA) records of
                       outstanding loans as of September 30, 1998, we estimate that about
                       12,700 taxpayers with unpaid payroll taxes estimated at more than
                       $295 million had received loan disbursements totaling about $3.5 billion.
                       Further analysis disclosed that 38 of these taxpayers, with outstanding
                       TFRPs of about $1.6 million, received SBA loans estimated at $10.6 million
                       after IRS had assessed the TFRPs. In addition, 1,719 taxpayers (businesses
                       and individuals) with unpaid payroll taxes of about $31.6 million received



                       Page 14                                                               GAO/T-AIMD/GGD-99-256
                             SBA loans estimated at $448.7 million after accumulating these tax
                             delinquencies.

                             However, any conclusions drawn from this analysis must consider the
                             potential problems with the reliability and completeness of IRS data due to
                             the serious financial management system deficiencies and internal control
                             weaknesses discussed previously.



Factors Affecting IRS’       Several factors affect IRS’ ability to enforce compliance with respect to the
                             payment of payroll taxes and to pursue collections of unpaid payroll taxes
Ability to Enforce           from businesses or responsible individuals. These factors are discussed
Compliance or Pursue         briefly below.
Collection of Unpaid
Payroll Taxes

Financial Management         As discussed previously, the lack of an automated link or interface between
System Deficiencies and      IRS’ separate taxpayer databases for businesses and individuals leaves IRS
                             no assurance that its records for an individual taxpayer or business are
Internal Control
                             complete and accurate. IRS efforts to date to address this lack of linkage
Weaknesses Affect Accuracy   have not been fully effective in ensuring the accuracy of taxpayer accounts.
of Taxpayer Account Status   In addition, delays in assessing individuals TFRPs result in missed
                             opportunities to collect amounts through such means as retaining or
                             offsetting refunds against unpaid payroll taxes.


Taxpayer Education and       IRS has two programs to prevent payroll tax delinquencies: the (1) Small
Early Warning Programs Are   Business Tax Education Program and (2) Federal Tax Deposit (FTD) Alert
                             Program.
Not Considered Effective
                             The Small Business Tax Education Program attempts to prevent payroll tax
                             and income tax delinquencies by offering education programs and tax
                             workshops to individuals wishing to start up businesses. Despite its
                             purpose, many of the revenue officers we interviewed nationwide noted
                             that this program has not been very effective in reducing or preventing
                             delinquent payroll taxes. Others noted that the individuals in most need of
                             attending these workshops did not appear to be present.




                             Page 15                                                GAO/T-AIMD/GGD-99-256
                              The FTD Alert Program is intended to identify and prevent potential payroll
                              tax payment delinquencies through early identification of required deposits
                              under the FTD system that have not been made. The Alert Program targets
                              larger employers who deposit semiweekly (those who reported more than
                              $50,000 in payroll taxes on their quarterly Tax Form 941 filings during the
                              previous 12-month period). Information regarding taxpayers who failed to
                              make their deposits is transferred to tapes, which are sent to the service
                              centers for printing of alert notices and mailing to the respective district
                              offices.

                              Some revenue officers noted that the alerts are not received in the field
                              early enough to prevent employers from accumulating substantial
                              delinquencies or to provide early warning of potential problems. Some of
                              the revenue officers also noted that the alerts received were often invalid
                              or unproductive. Often the taxpayer’s case has already been designated as
                              delinquent, or the taxpayer has actually gone out of business before the
                              revenue officer makes contact. In other instances, the employer has
                              already paid the delinquent payroll taxes between the time the FTD alert is
                              issued and received in the field and the contact is made with the taxpayer.
                              Some revenue officers also stated that the FTD alerts yield few collections
                              compared to the effort expended in processing the alerts.


Certain IRS Procedures        According to several IRS field office representatives, another factor that
Limit Collection and          inhibits IRS’ ability to collect delinquent payroll taxes and to prevent
                              taxpayers from accumulating multiple payroll tax delinquencies is that IRS’
Prevention Efforts
                              Criminal Investigation Division (CID) and District Counsel do not
                              prosecute taxpayers for failing to pay payroll taxes unless fraud is clearly
                              evident. Field office personnel noted that even in instances in which the
                              taxpayers are multiple offenders, CID and District Counsel appear
                              reluctant to pursue prosecution. A few field personnel noted that IRS
                              could seek injunctions through the U.S. Attorney’s Office to prevent
                              taxpayers from accumulating multiple payroll tax delinquencies and that
                              the District Counsel prefer not to seek such injunctions due to the time and
                              expense required to prosecute such cases.


Federal and State Laws Also   Federal and state laws also affect IRS’ ability to enforce compliance with
Inhibit Compliance and        respect to payment of payroll taxes or to pursue collections on delinquent
                              payroll taxes. Under section 6103 of the Internal Revenue Code, IRS is
Collection Efforts
                              precluded from sharing tax information with state licensing authorities that
                              have the power to grant or deny business licenses for new and existing



                              Page 16                                                GAO/T-AIMD/GGD-99-256
                              businesses. Therefore, IRS is inhibited in its ability to prevent individuals
                              responsible for the nonpayment of payroll taxes from starting up new
                              businesses and repeating the practice. Some Collection Division field
                              representatives noted that due to the same disclosure prohibitions, IRS is
                              unable to publish the names of delinquent taxpayers to increase
                              compliance and generate collections, a process that has been used with
                              some success by a number of states and local taxing authorities.

                              One IRS field representative we spoke with also mentioned that in
                              California, the posting of bonds by a new business for state payroll taxes is
                              required as a prerequisite to the granting of a new business license. In this
                              manner, the state is protected to some degree in the event of nonpayment
                              of state payroll taxes. This avenue is currently not available to the federal
                              government for federal payroll taxes.

                              According to some IRS field representatives, the agency’s ability to pursue
                              collections of delinquent payroll taxes and associated TFRPs is also
                              inhibited by the property laws of some states, as well as varying
                              interpretations of bankruptcy laws. According to some representatives, in
                              a number of states, IRS is unable to enforce collection of delinquent taxes
                              and penalties because state laws preclude attaching liens to, and seizing,
                              personal property. States in which Tenancy by the Entirety8 or Marital Joint
                              Property laws exist limit the assets available for IRS to attach or seize.
                              Also, according to an IRS official, a business under Chapter 119 Bankruptcy
                              Reorganization can continue to operate at the bankruptcy judge’s
                              discretion. This can result in the business incurring additional tax
                              delinquencies.


Other Factors IRS             In addition to the factors discussed above, Collection Division field
Employees Cite as Affecting   representatives cited other factors that, they believe, affect their ability to
                              enforce compliance and pursue collections on delinquent payroll taxes and
Enforcement and Collection
                              TFRP assessments. Several field representatives stated that the current
of Unpaid Payroll Taxes       level of collection staff is not sufficient to effectively prevent, collect, and
                              monitor delinquent payroll taxes and TFRPs, and that revenue officers are
                              increasingly being required to spend time supporting IRS’ Customer


                              8
                               Tenancy by the Entirety is one form of jointly held property in which the property is co-owned with a
                              spouse. Each spouse owns 100 percent of the property at all times.
                              9
                              In general, Chapter 11 is a reorganization proceeding for an individual or a business or other entity in
                              which creditors are paid under a plan.




                              Page 17                                                                     GAO/T-AIMD/GGD-99-256
                             Service and other functional areas instead of working on collection issues.
                             Field representatives also said that certain provisions of the Restructuring
                             and Reform Act of 1998, which was enacted to provide fairness to
                             taxpayers, could lengthen the time it takes revenue officers to work cases
                             and result in fewer cases being resolved, and expressed uncertainty about
                             how to operate under certain provisions that contain penalties for IRS
                             personnel if the rules are not followed.


Ability to Offset Federal    Federal law does not prevent businesses or individuals from receiving
Benefits and Other Federal   federal payments or loans when they are delinquent in paying payroll taxes.
                             While IRS can retain, or offset, refunds otherwise due businesses or
Payments Has Yet to Be
                             individuals to recover some or all of the delinquent taxes owed, up to this
Achieved                     point it has not been able to systematically pursue other federal payments
                             made to these taxpayers to recover delinquent taxes.

                             The Debt Collection Improvement Act of 1996, enacted under the
                             leadership of this Subcommittee, called for the centralization and
                             aggressive pursuit of delinquent nontax federal receivables, including
                             delinquent loans and other forms of payments owed the federal
                             government. Treasury also intends to include the collection of federal tax
                             debts as part of the mechanism it is developing to pursue collection of
                             nontax federal receivables as mandated under the act. In doing so,
                             Treasury is using as its legal authority a subsequently passed provision in
                             the Taxpayer Relief Act of 1997. This provision grants IRS the authority to
                             place a continuous levy on a delinquent taxpayer’s federal benefits to assist
                             in recovering overdue taxes. Implementation of the continuous levy
                             provision is expected to begin in July 2000.

                             Treasury’s plan has been revised on several occasions, as it and other
                             affected agencies try to address complex implementation issues to avoid
                             undue harm to individuals. This will be of particular concern with respect
                             to Treasury’s plan to include unpaid tax assessments as part of its federal
                             debt collection efforts. There will be a critical need to address IRS’
                             significant financial management systems deficiencies and internal control
                             weaknesses to ensure that taxpayers are not unduly harmed through the
                             levying of federal benefits and other payments to repay amounts that have
                             already been collected.

                             Mr. Chairman, this concludes my prepared statement. I would be pleased
                             to answer any questions you or other members of the Subcommittee may
                             have.



                             Page 18                                                GAO/T-AIMD/GGD-99-256
Contact and      For future contacts regarding this testimony, please contact Gregory D.
                 Kutz at (202) 512-3406 or Cornelia Ashby at (202) 512-9110. Individuals
Acknowledgment   making key contributions to this testimony included Steven J. Sebastian,
                 Ralph Block, Paul Caban, and Patrick McCray.




                 Page 19                                              GAO/T-AIMD/GGD-99-256
Appendix I

Overview of the Process for Distribution of
FICA and SECA Tax Revenue to Trust Funds                                                                                                         AppenIx
                                                                                                                                                       di




               a
       Taxpayer                               IRS                        SSA            OTA            FMS                    BPD

        Payment/                         Collection/                  Estimation      Estimation    Distribution/          Recording/
         Filing                          Accounting                                                 Adjustment             Accounting

           $                                                          Chief actuary    Calculate   Prepare journal
     Tax payments                                                      develops         monthly       entry to
                                                          FMS          estimate        estimates       record
                                                                           of              of        estimates
                                                                      FICA/SECA       FICA/SECA
                                                                     semiannually         tax                          Record entries into
                           Record                                                                                      - Federal Hospital
                                                 Deposit tax                                                             Insurance
                        FICA/SECA
                                                payments in
                          taxes in                                                                                     - Federal Old Age and
                                                general fund
                         master file                                                                                     Survivors Insurance
                                                                                                                       - Federal Disability
         941                                                                                                             Insurance Trust
      Employer's                                                                                                         funds
       Quarterly
      Federal Tax                   Process tax returns
        Return                       and send payroll                 Certification                Prepare journal
                                        tax data to
                                                                                                   entry to adjust
                                       SSA monthly                     Calculate                   OTA estimates
                                                                      the certified                  to certified       Investment in Treasury
                                                                        amounts                       amounts            securities/payment of
     W2, W3
                                                                       quarterly                      quarterly                benefits
 Annual Wage and
    Earnings
    Statement




 a   Employers and self-employed individuals




(901796)                     Letr                          Page 20                                                   GAO/T-AIMD/GGD-99-256
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