A shell company, or shell corporation, is an entity that typically lacks active business operations or employees. Shell companies can have many possible uses, from serving as vehicles to raise funds to facilitating corporate mergers, but they may also be used by individuals and companies to evade taxes, launder money and hide the identities of their owners.

Here’s how shell companies work, the legalities around them and a few examples of shell companies.

How do shell companies work?

In general, a shell company is formed when paperwork is filed establishing the company. Shell companies can be established in the U.S. or abroad, the latter of which is popular with those trying to evade taxes.

The “shell” part of the name is a metaphor for the company being hollow or empty, with no active business or operations. Some shell companies serve primarily as a way to hide identities, concealing the true ownership of real estate, luxury goods and art, among other items. Other shell companies serve as a place to park funds offshore for tax evasion or other reasons.

But there are legitimate uses for shell corporations as well, even if sometimes the purpose is to reduce or avoid taxation. Some U.S. companies set up shell corporations when they have offshore workers. And in some cases shell companies are the remnant of a previously active business that may have money or valuable tax losses that can be used by another company in the event of a merger or acquisition.

Are shell corporations legal?

While shell companies have been used for illegal purposes, shell companies themselves aren’t necessarily illegal. In many cases, they are perfectly legal entities that a person or business establishes for limited liability or other purposes.

In fact, Jason Sharman, a professor of politics and international relations at the University of Cambridge, was quoted in a New York Times article about shell companies as saying: “A large majority are used for pretty legal, pretty boring purposes.”

For example, a very early startup may file paperwork to create a limited liability company (LLC). It may not have employees, assets or property yet, technically making it a shell company. Shell companies can also be used for corporate mergers or for special purpose acquisition companies (SPACs), the latter of which hold a pile of cash and look for a merger partner.

In the past few years, however, the U.S. Treasury has attempted to tighten up the loopholes that allow fraudsters to hide their identities behind shell corporations. The Corporate Transparency Act, enacted in 2021, was described by Secretary of the Treasury Janet Yellen as a means to help strengthen national security as well as “help level the playing field for honest businesses that play by the rules but are at a disadvantage when competing against bad actors who use shell companies to evade taxes, hide their illicit wealth, and defraud customers and employees.”

A huge change is on the horizon with the implementation of the Beneficial Ownership Information database. By 2024, active LLCs will have to file identifying information, including names, addresses and government-issued photo IDs, with the Financial Crimes Enforcement Network (FinCEN). There are some exemptions, including regulated companies, and companies with more than 20 employees and more than $5 million in annual revenue.

Examples of shell companies

In recent years, federal prosecutors have found a number of shell companies used by fraudsters to launder money and hide the owner’s identity, in a sweep by the Justice Department to round up pandemic-related health care scams. One notable scheme included $144 million in false claims related to Covid-19, and $214 million total in false Medicare billings.

Two notable investigations that revealed numerous shell companies in the past decade were 2016’s Panama Papers and 2018’s Paradise Papers. The data exposed the offshore interests, tax havens and more of politicians, world leaders, multinational corporations and other entities.

Bottom line

Some shell companies are legitimate and not involved in questionable activities. In certain circumstances, it might make sense for a company or individual to set-up a shell corporation. That said, it’s more likely that you’ll hear about the nefarious uses of shell companies because it’s more newsworthy than the day-to-day utility of them.