As part of a broader effort reflected by the Corporate Transparency Act to combat the use of shell companies for illicit purposes, the Financial Crimes Enforcement Network within Treasury, or FinCEN, issued FinCEN Notice FIN-2023-NTC1 (Aug. 15, 2023) designed to promote reporting by U.S. financial institutions regarding payroll tax evasion and workers’ compensation fraud schemes involving shell companies that are prevalent in construction industries.
Transactions of Interest
According to FinCEN, these schemes cost state and federal tax authorities hundreds of millions of dollars and put legitimate construction businesses at a competitive disadvantage. They start with a shell company that purports to be a legitimate construction contractor. The shell company obtains a workers’ compensation insurance policy for a minimal number of workers, resulting in very low premiums. Having a workers’ compensation policy allows the shell company to obtain a business license. The shell company then “rents” its business license to a construction contractor with a large number of employees. This allows the construction contractor to falsely represent that it is properly licensed and maintains workers’ compensation insurance on its many employees. In contrast, a compliant construction contractor with a similarly large number of employees would have to take out a much larger and more expensive workers’ compensation policy. Of course, the noncompliant construction contractor’s “rent” payments to the shell company are far lower than the premiums that a compliant construction contractor would have to pay. The shell company typically ceases “doing business” just before an annual workers’ compensation audit one year into the policy, a new shell company is formed, and the cycle begins anew. To avoid payroll taxes, a construction contractor writes checks to a shell company, which the shell company either uses to pay the contractor’s workers or returns the funds to the contractor in cash, which the contractor then uses to pay its workers off the books.
The Notice
In consultation with IRS Criminal Investigation (CI) and Homeland Security Investigations, FinCEN identified red flags to assist financial institutions in detecting, preventing, and reporting these flavors of payroll tax evasion and workers’ compensation fraud. Financial institutions are subject to a host of reporting requirements, most notably in this instance, the requirement to file a Suspicious Activity Report if a financial institution knows or suspects a transaction lacks an apparent lawful purpose or is to facilitate criminal activity. FinCEN instructs financial institutions to provide information and maintain records regarding these particular types of suspicious transactions as well as the entities and persons involved. FinCEN further encourages information sharing among financial institutions to increase detection and prevention of payroll tax evasion and workers’ compensation fraud.
The IRS has long treated payroll tax evasion as a priority and is signaling its intention to pursue criminal tax charges against parties to these shell company transactions. Financial institution reporting is an initial step in identifying and investigating targets. Taxpayers and tax professionals who are at risk based on current or prior conduct should evaluate their options, including potential voluntary disclosure, now before a visit from IRS CI. And if there is a knock at the door, individuals should immediately consult experienced tax controversy counsel to protect their rights and navigate a course to the optimal resolution under the circumstances.
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