Understanding and Preparing for the Corporate Transparency Act
02/07/2024: Here’s a practical update on how small businesses can comply with the CTA.
The Corporate Transparency Act
The Corporate Transparency Act is a new law that creates a reporting obligation for small businesses, and will affect all of us working with small businesses beginning in 2024. It’s a simple obligation in principle, but the way it has been structured and implemented means that compliance will be a chore.
At this point it’s a good idea for business owners and advisors to start determining who has to comply, and to start gathering reporting information.
I Kvetch Upfront
Analyzing the CTA is so annoying that I want to unload here a bit before we get on with the practical guidance. First of all, take note that no reporting process is in place, so that no matter how much you know about the CTA you will not be able to comply at this time. Next, the legislative purpose of the law is to crack down on “anonymous shell companies,” and “to prevent wrongdoers from exploiting United States corporations for criminal gain, to assist law enforcement in detecting, preventing, and punishing terrorism, money laundering, and other misconduct.” The reasoning persists at the agency level:
“For too long, it has been far too easy for criminals, Russian oligarchs, and other bad actors to fund their illicit activity by hiding and moving money through anonymous shell companies and other corporate structures right here in the United States,” said Acting FinCEN Director Himamauli Das. “This final rule is a significant step forward in our efforts to support national security, intelligence, and law enforcement agencies in their work to curb illicit activities. The final rule will also play an important role in protecting American taxpayers and businesses who play by the rules, but are repeatedly hurt by criminals that use companies for illegal reasons.”
— from a FinCEN press release, “FinCEN Issues Final Rule for Beneficial Ownership Reporting to Support Law Enforcement Efforts, Counter Illicit Finance, and Increase Transparency,” Sept. 29, 2022.
Yes, you may question whether the burden of implementation advances the legislative purpose at all. Finally, the regs are written and structured in an absurdist way. Is this some undergraduate intern’s final project on Franz Kafka? When Americans have to deal with rules like this, it feels like the oligarchs have won.
We can move on from here, but I’m telling you you’re going to be feeling the same way soon.
Overview
Three Classes. Three classes of persons are required to report basic information to an agency called the Financial Crimes Enforcement Network (FinCEN), which is under the Treasury Department. The first class covers small businesses defined as “reporting companies” that have to report basic corporate information; the second class includes individuals defined as “beneficial owners” of reporting companies, who have to report personal information; the third class includes the individuals who file or are responsible for filing the state articles that created any reporting company, who also have to report personal information.
Timing. The filing obligations begin on January 1, 2024 for companies that are formed on or after January 1, 2024; filing must be within 30 calendar days of formation. Companies formed before January 1, 2024 must report by January 1, 2025 — note that companies formed earlier have the later compliance date.
FinCEN. The CTA was part of the Anti-Money Laundering Act of 2020, which was enacted at the beginning of 2021, and FinCEN promulgated final reporting requirements at the end of September 2022. FinCEN has published proposed regulations regarding the use of the information it collects. FinCEN anticipates establishing a web portal for reporting compliance before January 1, 2024. Keep checking the FinCEN website for updates.
Penalties. For willful reporting violations (false info or willful failure to report) civil penalties of $500/day up to $10,000 and criminal penalties of up to 2 years in prison. There seem to be no penalties for non-willful (i.e., negligent) failure to report. Unauthorized disclosure or use of CTA information can be punished by additional criminal penalties up to $250,000 and 5 years in prison, bumped up to $500,000 and 10 years in prison for disclosure/use violations carried out “as part of a pattern of any illegal activity involving more than $100,000 in a 12-month period.” Public Law No.: 116-283, §6403 amending 31 USC 5336(h)
Compliance Part I: Do You Have a Reporting Company?
OK, here’s how you figure out the compliance obligations. The CTA creates an extremely broad definition of reporting companies, then creates exemptions with detailed definitions, so many companies will have to review all of the exemptions to determine their obligation to comply.
Step 1, Registration. The general definition of a Company is any entity that is formed by filing with a state Secretary of State or Indian tribe, including foreign companies required to file. Therefore, from the get go, common law entities such as general partnerships and sole proprietors will be exempt from filing. But if the company files articles with a state or tribe, then it may have to comply with the CTA unless it falls under one of the exemptions.
Step 2, Reporting Company Exemptions. If you are a registered company, you are a reporting company unless you qualify for an exemption. Here are the main exemptions from filing:
“Large operating corporations” that employ more than 20 FTEs in the United States and have more than $5 million of domestic “gross receipts or sales” reported in the previous year.
A new company that expects to be a large operating corporation apparently still has to file in year one, because no receipts would have been reported for the previous year.
Companies issuing registered securities
Certain registered financial organizations such as banks, credit unions, registered securities advisors, accounting firms, securities exchanges, and public utilities.
Accountants, you are only exempt from the CTA if you are a “public accounting firm registered in accordance with section 102 of the Sarbanes-Oxley Act.”
Tax-exempt organizations.
Other. There are some other categories of exemptions (such as “inactive companies”) so if you do not fall clearly within one of the categories listed above you should still review the complete list of exempt companies to dig into the definitions specifically. Here’s the list.
A reporting company that becomes exempt still has to file a notice of exemption with 30 days.
Information reporting companies have to report to FinCEN: legal name of the company; any tradename or DBA; principal place of business, and primary location in the USA; jurisdiction of corporate formation; IRS TIN.
Compliance Part II: Are You A Beneficial Owner?
Once you identify a reporting company, you have to identify its beneficial owners, who also have a duty to report. Unfortunately, although the idea of a beneficial owner is simple in the vernacular, the definition in the CTA is expansive and includes individuals with varying degrees of governance and management influence in the company, not just owners.
Step 1: Are you a 25% Owner?
Total ownership interests of the company are considered in calculating ownership, including common and preferred interests, profits interests, options and other contingent or discretionary rights (the CTA treats all such rights as exercised).
If the total ownership can’t be determined, any individual who holds 25% or more of any class of ownership interest is considered a BO.
Owners who who have to report as beneficial owners include trustees and certain beneficiaries of trusts holding ownership interests, and legal guardians of minor children who hold ownership interests.
Step 2: Do you have substantial direct or indirect control over the reporting company?
Even if you are not a 25% owner you are a beneficial owner if you are one of the following:
Senior officer;
Someone with authority over the appointment or removal of any senior officer or a majority of the board of directors;
Someone who has makes or has substantial influence over “important decisions” made the RC;
Someone who makes such decisions through board representation, has control over a majority of the voting power of the organization, has rights associated with any financing arrangement or interest, controls an entity that controls the company, has any other arrangement, formal or informal, for controlling the company.
Exclusions from BOs. Even if you are a 25% owner or have substantial control, you do not have to report if you are one of the following:
A minor child (as defined by state or tribal law), as long as your guardian reports under CTA
An individual who is an agent or intermediary for another individual.
An employee of the reporting company, who is not a senior officer and is “acting solely as an employee,” and whose substantial control is “derived solely from the employment status of the employee.”
An individual whose only interest is a future inheritance interest.
A individual who is a creditor whose rights of the RC are solely through loan covenants securing the payment of a predetermined sum of money.
It’s important to note that operating agreements, bylaws, loan documents, and other contractual rights will be crucial to determining whether people such as board members, minority shareholders, management employees, and creditors are “beneficial owners” or not.
Information individuals who are beneficial owners have to report to FinCEN: full legal name; date of birth; residential address; ID number from passport, drivers license or state ID; foreign passport; picture of the ID card or document.
Compliance Part III: Are You a Company Applicant?
A company applicant is the individual who files a reporting company’s articles with the state or tribe; and any individual who may be primarily responsible for filing the document if more than one individual is responsible for filing the document.
What does that even mean? I don’t know, and here’s an example. An accountant advises a client’s adult child to form an LLC to hold rental property. The accountant calls the client’s lawyer to form an LLC for the child, and the lawyer has her paralegal file the new company articles with the secretary of state. In this case, the secretary is the actual filer, but who else is probably “primarily responsible” for the filing? Is it the accountant’s client, the accountant (even though the accounting firm may be a non-reporting company, the individual accountant may be a company applicant in this case), or the lawyer, or all of them?
Information individuals who are company applicants have to report to FinCEN: full legal name; date of birth; residential address; ID number from passport, drivers license or state ID; foreign passport; picture of the ID card or document.
Who Sees CTA Information?
FinCEN’s has proposed regulations addressing cybersecurity and disclosure guidelines for their CTA site. The cybersecurity part sounds like it’s supposed to be reassuring, and I suppose we can expect the level of cybersecurity we get from, say, the IRS, which is another Treasury agency. The authorized disclosure recipients, however, include the following:
Federal agencies, including national security, intelligence, law enforcement (criminal and civil)
State governments and courts
Financial institutions
Regulatory agencies (federal and “other”)
Dept. Treasury employees (including, by definition, IRS employees)
We can at least expect CTA information to be available in lawsuits and to the IRS.
What are Your Post Reporting Obligations?
You have to file again with 30 days if a reporting company become exempt, and if there are any changes or corrections to reported information.
A Puzzle
Um, this is not really a puzzle — it’s just meant to be a practical, not-farfetched illustration that highlights some of the difficulties and ambiguities that we can anticipate when we have to comply with the CTA.
Let’s assume we have a reporting company with four owners: an individual founder who is the CEO; an investment company owned by a general partnership of unrelated investors, including Russian oligarchs; a key employee who has a profits interest; and a company set up by the founder and owned by 10 different trusts set up for other family members. The company has taken a large loan from a private investor. It also has a COO who is not an owner, and a management company that manages the company’s investment real estate assets.
Resolving a puzzle like this would require us to decode the obligations of unregistered companies, the various financial and management roles an individual may have, individual trustees and beneficiaries, creditors, and holders other contractual or employment rights — just to figure who has to send their name & address to FinCEN.
For now, the key is still to keep an eye out for FinCEN’s reporting portal and compliance guidance, expected some time before January 1, 2024.