Use of Shell Companies in Construction to Evade Taxes, Workers’ Comp On the Rise

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The workers’ compensation industry and state and federal tax authorities are losing hundreds of millions of dollars every year from fraud schemes involving shell companies in the construction industry, federal authorities are warning.

The schemes, in which the shell companies are used to dodge payroll taxes and workers’ compensation premiums, are carried out by illicit actors primarily through banks and check cashers.

The Financial Crimes Enforcement Network (FinCEN) and the Internal Revenue Service-Criminal Investigation (IRS-CI) recently issued a notice to financial institutions calling attention to the increase in the fraud schemes that they say affect the local and national construction job markets and put legitimate construction contractors and their employees at a competitive disadvantage.

IRS-CI Chief Jim Lee said that the agencies hope that by drawing attention to the schemes, they will be able to get financial institutions to assist in preventing fraud and reporting suspicious activity. “By enlisting the help of financial institutions, we hope to crack down on fraudsters and level the playing field for legitimate business owners,” Lee said.

The agencies’ notice provides financial institutions with an overview of the underlying schemes, red flag indicators, and specific suspicious activity reporting instructions. (See sidebar below.)

According to the notice, payroll tax evasion and workers’ compensation fraud schemes may involve networks of individuals and the use of shell companies and fraudulent documents.

Based upon Bank Secrecy Act (BSA) reporting and other available information, FinCEN said it has identified money laundering activity by drug trafficking organizations and transnational criminal organizations that leverage these schemes to launder cash. These schemes are often part of a broader, global money laundering network that inserts cash into the U.S. financial system in small amounts, across a large number of cities, and then collects checks from the involved businesses—including shell construction companies.

How the Schemes Work

According to FinCEN, the workers’ compensation insurance fraud scheme typically begins when individuals, usually part of an existing fraud network, recruit others into that network. The new recruits establish a shell company purporting to be a legitimate subcontracting construction company. This shell enables its construction contractors to underbid law-abiding construction firms and evade paying the requisite payroll taxes and workers’ compensation premiums. The shell company may also engage in other illicit transactions such as money laundering.

11 Select Red Flag Indicators

The Treasury’s FinCEN, in coordination with the 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 in the construction industry:

The customer is a new (i.e., less than two years old) small construction company specializing in one type of construction trade (e.g., framing, drywall, stucco, masonry, painting, etc.) with minimal to no online presence and has indicators of being a shell company for illicit activity.
The person or company opening the account has no known prior involvement with, or in, the construction industry, and the individual opening the account provides a non-U.S. passport as a form of identification.
Beneficial owners of the shell company have no known prior involvement with, or in, the construction company and may have prior convictions involving fraud.
The company’s recently acquired workers’ compensation insurance policy, which may be verifiable through an official state website, was issued within the last year and covers only a small number of employees. However, a high volume of transactions is observed in the company’s bank accounts, which is not commensurate with a construction company of that size.
A customer receives weekly deposits in their account that exceed normal account activity from several construction contractors involved in multiple construction trades (e.g., framing, drywall, stucco, masonry, painting, etc.). The deposits may be conducted from locations in multiple cities or states.
A customer engages in behavior that suggests efforts to evade CTR filing requirements (e.g., the account holder or company representative alters or cancels a transaction when advised a CTR would be filed or engages in structuring with multiple check payments for under $10,000).
A representative of the construction company conducts large or unusual volumes of cash withdrawals or negotiation of checks for cash when accompanied by another involved person(s) or using an armored car service to deliver bulk cash.
Large volumes of checks for under $1,000 are drawn on the company’s bank account and made payable to separate individuals (i.e., the workers), which are subsequently negotiated for cash by the payee.
The 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.
The Internet Protocol (IP) address identified from the account holder’s online banking activity also may be associated with the online banking activity for another customer involved in the same type of purported construction-related activity.
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.

Source: Financial Crimes Enforcement Network (FinCEN)

According to law enforcement, the contractors frequently employ undocumented workers, and the scheme typically involves undocumented individuals setting up and running the shell companies. The shell companies may engage with a crew of undocumented workers to work on a construction project, without including those workers formally on the payroll or workers’ compensation policy. In these cases, the shell company “rents” itself to the undocumented workers for a fee.

The shell company operators obtain a minimal workers’ compensation policy for a small number of purported employees, typically through a local insurance agent. The insurance policy enables the shell company to apply for official business registration status, which can be verified through the appropriate state authority’s website.

The shell company then “rents” or sells access to its minimal workers’ compensation policy, along with its business license and any tax documents, to construction contractors, most of which employ a larger number of workers than what the insurance policy is designed to cover.

The result is that a workers’ compensation policy that was meant to cover just a handful of workers is used fraudulently to cover potentially hundreds of workers. This enables the construction contractors that have rented or purchased access to the workers’ compensation policy to avoid paying most of their workers’ compensation insurance premiums.

Check Writing

The shell company typically goes out of business just before the first annual workers’ compensation audit. The operator then creates and new shell to assume the operations and repeats the process.

The other component of the scheme involves the construction contractors writing checks payable to the shell company to facilitate “off the books” payroll and evade state and federal payroll taxes. This creates the façade that the shell company is performing construction projects.

The shell company operators will take the checks to a check casher or deposit them into the shell company’s bank accounts and make bulk cash withdrawals from bank accounts. The shell company operator will then return the cash to the construction contractor, after deducting a fee from the contractor.

The shell company operator may also choose to issue individual checks made out directly to each worker working for the construction contractor. The construction contractors will then pay the workers without withholding appropriate payroll-related taxes or paying any workers’ compensation premiums.

Cases Prosecuted

In one case pursued by FinCEN, a Portland, Oregon, area construction company operator was sentenced to 30 months in federal prison and ordered to pay $29.9 million in restitution to the IRS. According to court documents, in total, the group cashed approximately $192 million in payroll checks, causing a combined employment and individual income tax loss of $68 million.

In another case, a Jacksonville man was sentenced to more than four years and ordered to pay to pay more than $5.4 million for facilitating an “off the books’ pay scheme. As a result of contractors using the shell companies’ proof of insurance but never paying any insurance premiums, insurers were defrauded out more than $10 million.

A Massachusetts man was sentenced to 18 months and ordered to pay $1,110,257 to the IRS and $41,352 to an insurer. The man had obtained a workers’ compensation policy in the name of the shell company to cover a minimal payroll for a few purported employees and “rented” the insurance to work crews who had obtained subcontracts with contractors on projects in various Florida counties. The conspirators cashed payroll checks totaling approximately $4,388,371. According to the IRS, the amount of payroll taxes due was approximately $1,110,257. The workers’ compensation policy “rented” out was for an estimated payroll of $91,000, for a premium of $15,206. Had a policy been purchased for a payroll totaling $4,388,371, the policy premium would have totaled about $728,030.

The Manhattan District Attorney announced an indictment alleging workers’ compensation fraud totaling $3 million in premiums. The suspect defrauded the state’s insurance fund by “significantly underreporting his payroll” during annual insurance premium audits. He cashed more than $26 million in checks at locations across Manhattan and Queens, using the cash to fund his companies’ unreported payrolls. He allegedly issued cashier’s checks to shell companies in the names of family members.

After a multi-year investigation, federal prosecutors in South Carolina succeeded in getting 12 people to plead guilty to a check-cashing scheme used to avoid payroll taxes and workers’ compensation premiums. The defendants admitted to cashing at least $15 million in checks. Prosecutors said their investigation found that similar schemes operating along the South Carolina coast have resulted in tens of millions of tax losses.

FinCEN Acting Director Himamauli Das said that data collected under the Bank Secrecy Act plays an “instrumental role” in the agency’s criminal investigations. Last year, FinCEN began to crack down on shell companies and illicit finance by establishing a beneficial ownership information reporting requirement as called for under the bipartisan Corporate Transparency Act. The rule will require most corporations, limited liability companies, and other entities to report information about their beneficial owners—the persons who ultimately own or control the company, to FinCEN.

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