Financial Management:

State and Federal Governments Are Not Taking Action to Collect Unpaid Debt through Reciprocal Agreements

GAO-05-697R: Published: Jul 26, 2005. Publicly Released: Aug 25, 2005.

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The Debt Collection Improvement Act of 1996 (DCIA) allows the federal government to collect state debts from federal payments to contractors. However, before a state can participate in this program, DCIA requires that the state enter into a reciprocal agreement with the Department of the Treasury that would require the state to collect unpaid federal debt from state payments if Treasury collects unpaid state debt from federal payments. In February 2004, we reported that Department of Defense (DOD) and Internal Revenue Service (IRS) records showed that over 27,000 DOD contractors had nearly $3 billion in unpaid federal taxes as of September 30, 2002. In a hearing before the Senate Permanent Subcommittee on Investigations on February 12, 2004, we noted that many of those contractors also had unpaid state taxes. Based on the issues raised in that hearing, Congress requested that we determine (1) the extent to which Financial Management Service (FMS) and the states have entered into reciprocal agreements to collect unpaid state and federal debt from their payments to contractors and (2) whether additional opportunities may exist for the Department of the Treasury's FMS to collect unpaid state taxes from federal contractors. This report responds to that request by providing information on (1) the extent of states' participation in FMS's debt collection levy and offset programs, (2) the potential benefits to states of participation in those programs, and (3) the level of state participation in, and the benefits states derive from, the collection of state tax debt from federal income tax refunds.

Neither the federal government nor the states have as yet pursued potentially beneficial reciprocal agreements authorizing the collection of debt from nontax payments, including payments to contractors. According to FMS officials, no state has expressed interest in such agreements, and FMS has not actively pursued avenues to encourage state participation. None of the officials in the 17 states we contacted said they were aware of the reciprocal agreement provision in DCIA, and all expressed interest in pursuing this debt collection opportunity. Our comparison of FMS disbursements with the database of state income tax debt that FMS maintains found that thousands of federal contractors paid through FMS have unpaid state tax debt. In fiscal year 2004, FMS disbursed a total of about $1.8 billion to over 4,600 federal contractors that had approximately $17 million in state tax debt owed primarily by individuals. According to our analysis, if states had participated in FMS's program that collects debt from nontax payments to contractors, they could have collected over half of the outstanding state tax debt from these federal contractors in fiscal year 2004. On the other hand, the experiences of the federal government and the states in working together to collect unpaid tax debt from state and federal tax refunds demonstrate that reciprocal agreements to collect tax debt from nontax payments, including contractor payments, have had a significant impact. The federal government and most of the states with income taxes collect tax debt on behalf of one another through the offset of income tax refunds, which has resulted in millions of dollars in collections. In fiscal year 2004, although most states submit only personal income tax debt and not business income tax debt to FMS for collection, FMS still collected over $217 million on behalf of various states through offsets of federal income tax refunds to pay state income tax debt. Conversely, IRS received over $77 million from states' levy of state income tax refunds to pay delinquent federal taxes.

Recommendations for Executive Action

  1. Status: Closed - Implemented

    Comments: FMS sent an E-mail out September 12, 2005, from FTA asking states if they would be interested in the program. Four states responded and FMS began working with them to perform matches with their data August-October 2005.

    Recommendation: The Commissioner of the Financial Management Service should notify states of the opportunity to enter into reciprocal agreements with the federal government to collect delinquent debts through offsets of federal and state payments.

    Agency Affected: Department of the Treasury: Financial Management Service

  2. Status: Closed - Implemented

    Comments: To address our recommendation, FMS took action to assess the cost and benefit of developing reciprocal agreements and has implemented a reciprocal agreement with two states as a result. FMS implemented the program in July 2007 with Maryland and New Jersey. The program allows the states to refer debts to the Treasury Offset Program (TOP) for offset against federal vendor payments and to match state payments against federal debt - including the tax debt referred to the Federal Payment Levy Program (FPLP). Since the inception of the pilot program, FMS had collected $25.7 million for the states and $2.9 million for federal agencies as of March 2008.

    Recommendation: The Commissioner of the Financial Management Service should assess the cost and potential benefits of developing reciprocal agreements with the states to collect delinquent debts through offsets of federal and state payments.

    Agency Affected: Department of the Treasury: Financial Management Service

  3. Status: Closed - Implemented

    Comments: In conducting work in response to a congressional request concerning contractors with unpaid federal taxes, we noted that States were not taking full advantage of the Treasury Offset Program (TOP) to collect State tax debts from federal tax refunds. The Financial Management Service (FMS) is authorized to collect unpaid state income tax debt through offsets of federal income tax refunds. Most states--37 of the 44 states with some form of individual income tax--participated in the federal tax refund offset program. As of February 2005, the 37 participating states had referred about $4.9 billion in state income tax debt to TOP for collection. However, our analysis of the TOP database showed that as of February 2005, only two states had referred business income tax debt to TOP. Of the approximately $4.9 billion of state income tax debt recorded in TOP as of February 2005, less than 1 percent--$3.4 million--was business income tax debt. According to FMS officials, FMS began accepting state business income tax debt in April 2004 after a state official inquired whether such debt could be referred to TOP. Even though most states were not referring business tax debt to the program, in fiscal years 2003 and 2004 FMS collected over $169 million and over $217 million, respectively, on behalf of various states through offsets of federal tax refunds to pay state income tax debt. Collections on the behalf of states could be even higher if states were to send business income tax debt to TOP. Based on our findings, we recommended that FMS encourage states to expand their reporting of business tax debts for collection under the federal tax refund offset program. In response to our recommendation, FMS began notifying states of the potential to submit business taxes to the TOP program through monthly meetings with the states. FMS included discussion of business tax debts in October and November of 2005 and February 2006. FMS's action in response to our recommendation should lead to enhanced tax collections on behalf of the states.

    Recommendation: The Commissioner of the Financial Management Service should encourage states to increase their participation in the federal tax refund offset program by submitting more of their business income tax debt to the Treasury Offset Program.

    Agency Affected: Department of the Treasury: Financial Management Service

 

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