Summary

GAO first designated DOD financial management as high risk in 1995. GAO's biennial reports on high-risk areas are meant to bring focus to specific areas needing added attention. Areas are identified, in some cases, as high risk due to their greater vulnerabilities to fraud, waste, abuse, and mismanagement. Since 1995, weaknesses in DOD's financial management have adversely affected not only the reliability of reported financial data, but also the efficiency and effectiveness of its business operations. The department has annually acknowledged that pervasive, long-standing weaknesses in business systems, processes, and controls have prevented auditors from determining the reliability of reported financial statement information. Weaknesses in Army military pay systems, processes, and controls have contributed to this problem. The Department of the Army paid about $4.7 billion in federal payroll taxes for approximately 638,900 active duty military servicemembers for calendar year 2007, from the active duty Army military personnel appropriation. The Secretary of the Army relies on the Defense Finance and Accounting Service-Indianapolis (DFAS-IN) for processing and accounting support in paying the taxes for active duty servicemembers. This support includes calculating and reporting federal payroll taxes for active duty Army servicemembers to the Internal Revenue Service (IRS) and paying those taxes to the Department of the Treasury. Federal payroll taxes are amounts withheld from employees' wages for federal income taxes, Social Security, and Medicare (Hospital Insurance) taxes, as well as the employer's mandatory matching contributions for Social Security and Medicare taxes. GAO's five standards of internal control provide the overall framework for establishing and maintaining internal control in the federal government. These standards help management identify and address major performance and management challenges and areas at greatest risk of fraud, waste, abuse, and mismanagement. Further, the Office of Management and Budget Circular No. A-123, Management's Responsibility for Internal Control, relies on GAO's standards to provide the specific requirements for federal agencies, such as the Department of Defense (DOD), to assess and report on controls. The scope of this review comprises control activities and monitoring--two of the five standards for internal control. Our prior reviews of the DOD budget requests for military personnel appropriations identified possible inaccuracies in the processing of the active duty Army military personnel federal payroll taxes and potential weaknesses in control activities at DFAS-IN. Following that identification of possible inaccuracies, under the authority of the Comptroller General to conduct evaluations under his own initiative, we conducted this performance audit to determine whether DFAS-IN has effective controls in place for processing of the active duty Army military personnel federal payroll taxes. We also assessed whether DFAS-IN conducted periodic monitoring of its processing of federal payroll taxes. We focused our review on federal payroll taxes for the period January 2004 through June 2008.

DFAS-IN lacked effective controls for processing and accounting for active duty Army military personnel federal payroll taxes because of weaknesses in its procedures for information processing and accurate and timely documentation of transactions. We found that DFAS-IN did not systematically reconcile payroll taxes; it made numerous calculation and data entry errors in its worksheets; and in numerous instances, it incorrectly calculated and reported Social Security and Medicare withholding amounts for servicemembers. We were not able to determine the extent to which individual servicemembers identified errors in their pay statements and requested corrections. However, we determined that the underlying control weaknesses that resulted in errors and untimely calculation and reporting of payroll data have continued for several years. DFAS-IN further lacked effective procedures to ensure the accuracy and timeliness of transaction documentation. In addition, neither DFAS nor DFAS-IN internal review staff performed periodic monitoring of the processing of federal payroll taxes for the 2004-2008 time period to assure that the related internal controls were operating effectively, and neither has developed plans to conduct such reviews. As a result of these control weaknesses, some servicemembers had too much tax withheld, while others had too little withheld. Additionally, DFAS-IN did not follow IRS employer tax guidance. As a result, the Department of the Army may be owed refunds from the IRS due to erroneous overpayments of federal payroll taxes; or the Army may owe additional payments to the IRS due to erroneous underpayments of federal payroll taxes. If there were erroneous overpayments, the Army will have lost the opportunity to use those funds for other pressing needs. In the case of underpayments, the general fund of the Treasury will ultimately be subsidizing the Social Security and Hospital Insurance trust funds to make up for amounts that are owed by employers but not collected. Because of DFAS-IN's lack of effective procedures for documentation of its transactions, and errors in calculating and recording payroll taxes, neither the Army nor the IRS can be certain of the Army's current payroll tax liabilities. Lastly, as a result of the lack of periodic monitoring or plans to perform the monitoring, DFAS-IN is unable to take prompt corrective actions to resolve any weaknesses in its control activities. We are making recommendations to the Under Secretary of Defense (Comptroller) / Chief Financial Officer to strengthen DFAS-IN internal control and monitoring activities over active duty Army military personnel payroll.

Recommendations

Our recommendations from this work are listed below with a Contact for more information. Status will change from "In process" to "Open," "Closed - implemented," or "Closed - not implemented" based on our follow up work.

Recommendations for Executive Action