The Financial Crimes Enforcement Network (FinCEN) of the U.S. Treasury Department issued a notice to financial institutions on August 15, 2023, calling attention to what it describes as “a concerning increase in state and federal payroll tax evasion and workers’ compensation insurance fraud in the U.S. residential and commercial real estate construction industries.” It reported that state and federal tax authorities lose hundreds of millions of dollars to these schemes. It further noted that “[t]hese schemes further affect the local and national construction job markets, and put legitimate construction contractors and their employees at a competitive disadvantage.”
“FinCEN is committed to combating fraud by shedding light on how illicit actors within the construction industry are using shell companies and other tactics to commit workers’ compensation fraud and avoid payroll taxes,” says FinCEN Acting Director Himamauli Das. “We are proud of our collaboration with [IRS Criminal Investigation (CI)] in issuing this Notice and exposing tax and insurance fraud that has plagued the construction industry and undermines law-abiding construction firms. Today’s Notice provides information that financial institutions can use to remain vigilant in monitoring, detecting, and reporting suspicious activity that may be indicative of payroll tax evasion and workers’ compensation fraud in the construction industry.” CI Chief Jim Lee adds, “By enlisting the help of financial institutions, we hope to crack down on fraudsters and level the playing field for legitimate business owners.”
SHELL COMPANIES & FRAUD
Among other things, the Notice notes that such payroll tax evasion and workers’ compensation fraud schemes are often generally perpetrated through the use of shell companies and fraudulent documents. “The basic structure of the scheme is as follows: (1) 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. (2) The shell company achieves this by engaging in two kinds of fraud: First, once established, the shell company operator takes 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.”
This Notice is intended to further the efforts of FinCEN and CI to combat the use of shell companies in this and other illicit activity. Last year, FinCEN issued a final rule establishing a beneficial ownership information reporting requirement, pursuant to the bipartisan Corporate Transparency Act. These are substantial new reporting requirements requiring attention presently.
The rule requires most corporations, limited liability companies, and other entities created in or registered to do business in the United States to report information about their beneficial owners to FinCEN.
REQUIRED TO REGISTER
Under the Rule, which becomes effective Jan. 1, 2024, all such entities not otherwise exempted existing as of the effective date will be required to register with FinCEN and provide Beneficial Ownership Information (BOI) within one year of the effective date (i.e., by Jan. 1, 2025). FinCEN estimates that the number of the reporting companies exceeds 30 million entities. All such entities formed after the effective date will be required to provide such BOI within 30 days of formation. The rule also requires that the information be kept current, so any changes in beneficial ownership must be reported timely.
The exemptions under the rule are generally not applicable to construction companies. The exemptions pertain mostly to entities whose ownership information is otherwise publicly available, such as publicly traded companies, banks and other financial institutions, other entities operating under the securities acts, certain “large operating companies”, etc.
The definition of “beneficial owners” who must be identified is very broad: “For purposes of this section, the term ‘beneficial owner’, with respect to a reporting company, means any individual who, directly or indirectly, either exercises substantial control over such reporting company or owns or controls [directly or indirectly] at least 25 percent of the ownership interests of such reporting company.” Direct or indirect ownership may include: (a) joint ownership of an undivided interest; (b) ownership through another individual acting as a nominee or similar intermediary; (c) ownership through a trust (including a trustee or a settlor or beneficiary of a trust if that individual holds the authority to direct certain activities of the trust); and (d) ownership through one or more intermediary entities. Likewise, the definition of control is very expansive, including not only senior officers, but also one who has authority over the appointment or removal of any senior officer or a majority of the board of directors (or similar body), or who directs, determines, or has substantial influence over “important decisions” made by the reporting company. And even the definition of “important decisions” is expansive and covers many decisions most would consider routine.
There are substantial penalties for non-compliance.
FinCEN is developing a new federal BOI data base, called the Beneficial Ownership Secure System, or BOSS, to receive, store and maintain collected BOI information from the reporting companies to FinCEN, including updates. The BOI information will be available to certain government agencies, as well as financial institutions that are required to obtain BOI under other FinCEN regulations.
Companies should be analyzing their reporting requirements and gathering their necessary information presently so they will be prepared for filing when required to do so. While the deadline for existing companies is January 1, 2025, that time will be upon us quickly. In addition, if an existing company creates a new subsidiary, joint venture or other entity after January 1, 2024, it will need that analysis and information for filing well before then, i.e., within 30 days of formation.
Two additional regulations will be issued by FinCEN to address: (a) the protocols for accessing the BOI database by permitted users; and (b) revisions to the current Customer Due Diligence Rule.
Additional information may be found at:
Related IRS notice:
Rule, 31 CFR Part 1010: www.govinfo.gov/content/pkg/FR-2022-09-30/pdf/2022-21020.pdf
Related Rule Notice by FinCEN:
FinCEN FAQ: www.fincen.gov/boi-faqs
About the Author:
Christopher Scott D’Angelo is a partner and chair of both the Business Disputes & Products Liability Practice and International Practice at Montgomery McCracken Walker & Rhoads LLP, based in Philadelphia and New York City. His practice involves business, products liability, construction, class action, and insurance counseling and litigation, including his role as national counsel for several major U.S. clients and his representation of foreign concerns in the United States and U.S. concerns abroad. He is a member of the Construction Law and Litigation Committee of the International Association of Defense Counsel. He can be reached at email@example.com.
Modern Contractor Solutions, September 2023
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