K. Steven Burgess, Director of Examination Small Business/Self Employed Division of the IRS recently testified before the Senate Committee on Homeland Security and Governmental Affairs.  The topic of discussion was the use of certain states for incorporation, particularly those that feature privacy of ownership. 

His testimony points out one more problem (of many) that forum shopping can bring you.  What you might now expect is that creating entities in NV and WY will put you in the direct line of IRS fire.  Even if you have legitimate reasons to set up your business in NV or WY, who needs the extra IRS scrutiny that will come along with it?

For those of you that would lead to read his full written testimony, it is currently available here:  http://hsgac.senate.gov/_files/STMTBurgessIRS.pdf.  If you prefer sound bites, here are a few of the more interesting ones.

“As I will discuss today, and as this committee is already well aware, it is not just the secrecy laws in these foreign tax havens that can be exploited by persons to evade taxes or conceal criminal transactions. Within our own borders, the laws of some states regarding the formation of legal entities have significant transparency gaps which may even rival the secrecy afforded in the most attractive tax havens. This domestic transparency gap is an impediment to both U.S. law enforcement and the enforcement of tax laws in other countries.”

“The lack of transparency possible in corporations, trusts, limited liability companies (LLCs), and other entities enables countless numbers of taxpayers to hide their noncompliance behind a legal entity. This noncompliance would include such things as the non-filing of proper returns and the hiding of taxable income.”

“According to the Money Laundering Threat Assessment, issued jointly by several federal law enforcement agencies late last year, a handful of U.S. states offer company registrations with cloaking features --- such as minimal information requirements and limited oversight --- that rival those offered by offshore financial centers. The three states cited as the most accommodating for the organization of these legal entities are Delaware, Nevada, and Wyoming.

“From an IRS perspective, non-compliant taxpayers, including non-filers, fraudulent taxpayers, abusive promoters and under-reporters, have taken advantage of certain state laws, particularly in Nevada. Nevada has laws that may be used to help hide the identity of the non-compliant taxpayers; these laws are perceived by some taxpayers as available to facilitate taxpayer non-cooperation with the IRS; and non-compliant taxpayers may take advantage of an established industry for forming and servicing corporate entities.

Wyoming has similar laws. In fact, Wyoming incorporators advertise that a Wyoming corporation can offer the same benefit of “asset protection” as Nevada but at a lower cost and without the perceived stigma of a Nevada corporation.”

Bearer shares and nominee officers are particularly effective and popular in establishing an anonymously owned entity. Bearer shares are issued by the corporation upon formation and actually deem ownership of the corporation to the holder of the share. To determine ownership, one must actually find who has physical possession of the shares. Nevada and Wyoming are the only states that permit bearer shares.”

Nominee officers also make it easy for non-compliant taxpayers to establish a corporation and remain completely anonymous. While most states require that corporate officers have some meaningful relationship to the corporation, Nevada and Wyoming do not require this.”

“The IRS has authorized several investigations under Section 6700 of the Internal Revenue Code (IRC) into promoters of Nevada corporations and resident agents. These investigations have revealed widespread abuse, as well as problems in curtailing that abuse.”

“While the non-compliance rates found in the client samples of the promoters we have investigated (50 to 90 percent) are probably not the norm across all Nevada corporations, even if non-compliance is a fraction of those numbers the potential loss to the Treasury is still considerable. There are over 650,000 active and inactive entities in Nevada.”

“As part of this, we are contemplating mass audits of non-filers that would produce a list of non-filer and non-compliant participants. This list would be categorized from the most egregious (high income non-filers, corporation sole, fraud, etc.) to the least egregious taxpayers as a means to plan efficient and effective audits. This audit list would be compiled from promoter audits, the Nevada Secretary of State database, and possible John Doe summonses.”

“Second, we are also looking at additional promoter investigations. Even if the promoters themselves are not found to be in violation, accessing their client lists could provide valuable information. Criteria for selection of promoters for such investigations could include the size of the entity, the existence of corporation sole, the number of inactive corporations, the company’s own compliance data, etc. Once authorized, the investigations could concentrate on securing a client list to determine levels of non-compliance and conducting audits to determine whether the promoter made any overt abusive statement in the formation and administration of the corporations.”

“Third, the Service will consider “John Doe summonses” to resident agents. The summonses would be similar to the ones issued to credit card companies related to the use of offshore credit cards. Nevada resident agents and incorporation companies provide a legitimate service to a group of unknown “Does” whom the Service has reason to believe are using these valid services to abuse the tax system. The John Doe summons could request the identity of individuals who are paying for resident agent services or who have paid for the formation of a Nevada corporation. This information should reveal ownership of active and inactive Nevada Corporations which the Service suspects could include a large amount of non-filers and abusive schemes.”

"The IRS has formed an Issue Management Team to address this matter. We will be going after both the promoters and their clients. We want to continue to work with FinCEN, the FBI, the Department of Homeland Security, and other Federal agencies. We also want to work with the states, both in sharing information and in making sure they recognize the risks of allowing the formation of corporations using techniques such as nominee officers and directors and bearer shares.”