On August 15, 2023, the Financial Crimes Enforcement Network (FinCEN) announced the agency issued a notice to financial institutions regarding a concerning increase in federal and state payroll tax evasion and workers’ compensation insurance fraud in the U.S. residential and commercial real estate construction industries, which results in the loss of hundreds of millions of dollars by tax authorities due to illicit actions mainly through banks and check cashers (FinCEN Notice, FIN-2023-NTC1, 8/15/2023).
Structure of a payroll tax evasion scheme.
The FinCEN notice, coordinated along with IRS Criminal Investigation (CI), explains that payroll tax evasion and workers’ compensation fraud schemes are perpetrated through the use of shell companies and fraudulent documents. The basic structure of the scheme is as follows:
- Individuals involved in the scheme will set up a shell company whose sole purpose is to allow certain construction contractors to avoid paying workers’ compensation premiums as well as state and federal payroll taxes.
- The shell company achieves this by engaging in two kinds of fraud:
- First, once established, the shell company operators take out a minimal workers’ compensation policy and rents or sells the policy to construction contractors that employ a much larger number of workers than the policy is designed to cover, thereby committing insurance fraud.
- Second, the shell company operators facilitate tax fraud because the contractors use the shell company to pay their workers “off the books,” and without paying the required state and federal government payroll taxes.
Red flags to watch out for.
FinCEN, in coordination with IRS-CI and Homeland Security Investigations (HSI), has identified a range of red flags to assist financial institutions in detecting, preventing, and reporting suspicious transactions associated with shell companies perpetrating payroll tax evasion and workers’ compensation fraud in the construction industry. One of the 11 red flags includes if a company’s bank account has minimal to no tax- or payroll-related payments to the IRS, state and local tax authorities, or a third-party payroll company despite a large volume of deposits from clients.
Another red flag might be if the account holder or company representative makes statements to bank tellers or check cashers that the purpose of the cash withdrawals, negotiation of checks for cash, or check cashing activity is for payroll and the volume, amount, and frequency of transactions are uncharacteristic for a construction company with a small number of employees.
Reporting suspicious activity.
A financial institution is required to file a suspicious activity report (SAR) if it knows, suspects, or has reason to suspect a transaction conducted or attempted by, at, or through the financial institution involves funds derived from illegal activity; is intended or conducted to disguise funds derived from illegal activity; is designed to evade regulations promulgated under the BSA; lacks a business or apparent lawful purpose; or involves the use of the financial institution to facilitate criminal activity.
Recordkeeping.
When a financial institution files a SAR, it is required to maintain a copy of the SAR and the original or business record equivalent of any supporting documentation for a period of five years from the date of filing the SAR. FinCEN’s notice explains that SARs, and compliance with other Bank Security Act (BSA) requirements, are crucial to identifying and stopping payroll tax evasion and workers’ compensation fraud schemes.
Guidance to help expose schemes.
Earlier this year, IRS-CI Chief Jim Lee noted how “BSA data plays an instrumental role in the agency’s criminal investigations.” He added that the data received in response to FinCEN’s notice will help “crack down on fraudsters and level the playing field for legitimate business owners.”
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