Since at least 2004, the Government Accountability Office (GAO) has issued reports finding that “thousands of federal contractors, tax exempt entities, and Medicare providers” receive funds from the Federal government while owing overdue Federal taxes.  According to the various GAO reports, the primary area of delinquency was in the timely remittance of payroll taxes.  (For example, see this GAO report.)  And according to this GAO report—

Our analysis of data provided by CMS and IRS indicates that over 27,000 health care providers (i.e., about 6 percent of all such providers) paid under Medicare during calendar year 2006 had payroll and other agreed-to federal tax debts totaling over $2 billion. The $2 billion in unpaid tax debts only includes those debts reported on a tax return or assessed by IRS through its enforcement programs. This $2 billion figure is understated because some of these Medicare providers owed taxes under separate tax identification numbers (TIN) from the TINs that received the Medicare payments or they did not file their tax returns.

In another report, GAO asserted that “Eighty-three of the 100 largest publicly traded U.S. corporations in terms of 2007 revenue reported having subsidiaries in jurisdictions listed as tax havens or financial privacy jurisdictions. Sixty-three of the 100 largest publicly traded U.S. federal contractors in terms of fiscal year 2007 federal contract obligations reported having subsidiaries in such jurisdictions.”  GAO estimated that “more than $5 billion in unpaid taxes” are owed the government from its contractors.

Needless to say, Congress was not pleased to learn that Executive Branch agencies were paying contractors good money while, at the same time, those contractors were scheming to illegally avoid, delay, or underpay required taxes.  In response to the series of GAO reports, the FAR was revised in 2008 to address tax delinquency as a matter of contractor responsibility as well as a cause for suspension/debarment.  (See the solicitation provision at 52.209-5 for non-commercial acquisitions and at 52.212-3 for commercial item acquisitions.)  Effective with that FAR revision, a contractor can be suspended or debarred for “delinquent taxes” in amounts as little as $3,000.  (The definition of “delinquent taxes” is found in the regulations.)

In addition to the action above, in 2006 the Tax Increase Prevention and Reconciliation Act (P.L. 109-222) required Federal, State, and local government entities to withhold 3 percent when making payments to contractors, to cover the delinquent income taxes owed by them.  (Note that the delinquent area was payroll taxes, not income taxes, but apparently that was too hard for Congress to deal with.)  See the proposed rule for more details.  As currently amended, the rule is scheduled to go into effect January 1, 2012, negatively impacting prime contractors’ cash flow.  (Note the rule does not affect prime contractors’ payments to their subcontractors.)

Critics of the tax withhold point out that the 3 percent decrement would be applied to the bottom line of the invoice amount, not to profit, which means that—in some circumstances—contractors would not be receiving sufficient payments to cover incurred costs.  For construction contractors, the impact to cash flow may lead to higher bonding costs.

However onerous they may appear to be, the foregoing actions did not satisfy the Obama Administration.  On January 20, 2010 a Presidential Memorandum was issued to the heads of all Executive Branch departments and agencies, directing the Commission of Internal Revenue “to conduct a review of certifications of non-delinquency in taxes” and to report on the accuracy of those certifications.  In addition, the Memorandum directed the Office of Management and Budget (OMB), in conjunction with other Cabinet officials, to “evaluate practices of contracting officers and debarring officials” and to recommend process improvements designed to ensure that contractors owing taxes “are not awarded new contracts.”

Among the improvement ideas is the intention to “make contractor certifications available in a Government-wide database”—though it is not immediately clear how creating such a database will help to ensure that contracting officers don’t award contracts to entities that are delinquent in paying their tax bills.

If we are forced to opine on this issue, we would say that the problem here is a lack of training and/or discipline by the Government contracting officers.  They need to review the certifications executed by contractors, and make sure that the FAR is followed with respect to the information disclosed on the certs.  Moreover, there are already plenty of teeth in the law, which could be applied to any entity that knowingly falsifies a certification.  For example, a violation of the False Statements Act (18 U.S.C. 1001) can lead to a fine and up to 5 years in prison.

So it’s a bit of a mystery why the Obama Administration thinks the Memo is going to do what the FAR rules cannot.  In any case, this is an area that continues to be a sore spot with Congress and, about two years from now, is going to be a sore spot with contractors, when they see their cash flow decremented by 3 percent.