FinCEN and IRS Issue Joint Notice on Red Flags for Tax Evasion and Insurance Fraud Schemes

The Financial Crimes Enforcement Network (FinCEN) and the Internal Revenue Service (IRS) have issued a joint notice highlighting red flags for financial institutions to detect tax evasion and insurance fraud schemes. These schemes typically involve tax evasion through payroll practices and fraudulent workers’ compensation insurance claims.

The notice outlines various ways individuals perpetrate these schemes and provides red flags for financial institutions to be vigilant about. However, it acknowledges that some of the red flags may require information that is not readily available to financial institutions and may pose operational challenges.

Key points highlighted in the notice include:

1. Insurance Fraud Scheme: This scheme involves the establishment of a shell company, which may not be immediately evident to financial institutions. The notice suggests that the initial red flag for this scheme would be the creation of a shell company.
2. Tax Evasion (Payroll): Tax evasion through payroll practices is the main focus of the notice. It highlights red flags related to shell companies, checks, cash, and cashed checks. Some of these red flags can be operationalized by financial institutions, while others may require external data sources.
3. Operational Challenges: Some of the red flags mentioned in the notice, such as the lack of prior involvement in the construction industry or prior convictions for fraud by beneficial owners of shell companies, may be challenging for financial institutions to detect without access to external data.
4. No Single Red Flag: The notice emphasizes that no single red flag is determinative of suspicious activity, and financial institutions should consider the surrounding facts and circumstances.

The author of this analysis suggests several takeaways for financial institutions:

1. Add Construction Companies to Higher-Risk NAICS List: Consider adding construction companies to the higher-risk industry list but ensure that additional transactional components are part of the flagging process, such as cashed checks, non-US passport beneficial owners, etc.
2. Evaluate Online Presence: When researching companies online, assess their web presence. Lack of a website or online presence for a company with significant revenue could be an indicator of a shell company.
3. Analyze Payments Flow: Investigate the owners and agents of companies to which payments flow from the target company, especially if they are related entities.
4. Review Tax Payments: During analysis of construction companies’ revenue and expenses, look for indications of IRS or state tax payments. The absence of ACH descriptions for tax payments, despite justifiable revenue, may raise suspicions.
5. Communication with Branch Staff: Provide guidance to branch staff to report any customer statements indicating that checks being cashed or cash withdrawals are for payroll. Establish internal procedures for suspicious activity referrals.
6. Operationalize Red Flags: Consider running analytics based on IP address matching, with differing Employer Identification Numbers (EINs) and related NAICS codes to operationalize red flag #10.

In summary, financial institutions should carefully review the red flags outlined in the notice and consider how to operationalize them within their compliance and risk management processes. Detecting and reporting suspicious activity related to tax evasion and insurance fraud is crucial for combating financial crime.