The Corporate Transparency Act: Anti-Crime Legislation Impacts Small Businesses
Anyone who operates a small business knows there are numerous annual reporting requirements that cause them to expend time, energy, and dollars making sure they remain in compliance. Some of the more common reporting requirements include the annual statement of information, annual business license renewals, quarterly employment tax returns, and annual income tax returns. In 2020, Congress added yet another reporting requirement when it passed the Anti-Money Laundering Act of 2020.
The Corporate Transparency Act (CTA) became law as of January 1, 2021, as part of the Anti-Money Laundering Act of 2020. It is codified entirely at 31 USC §5336 which is part of the federal law pertaining to monetary transactions. Ostensibly, Congress added the CTA to enhance the ability of the Financial Crimes Enforcement Network (“FinCEN”) to better protect national security to prevent drug traffickers, oligarchs, and fraudsters from laundering money and terrorism financing.
The CTA aims to do this by creating a uniform national registry of the ownership of certain business entities. This registry will be populated by imposing federal reporting requirements to domestic and foreign reporting entities. There are significant civil and criminal penalties for false reporting and/or failure to report, including a civil penalty of not more than $500 per day that the violation continues, and a fine of not more than $10,000, imprisonment for up to 2 years, or both.1
What is a “Reporting Company?”
The CTA will become effective January 1, 2024. Reporting companies formed prior to that date will have one year (until January 1, 2025) to file their initial reports. Any reporting company formed after the effective date of the rule will have 30 days after they receive their notice of formation from the Secretary of State to file their initial reports. Additionally, if there is a change of ownership, or to any information otherwise provided in the original filing, the reporting company has 30 days to update the information or to correct any information it later discovers.2
The CTA defines the term “reporting company”3 as a corporation, limited liability company, or other similar entity that is—
(i) created by the filing of a document with the secretary of state or a similar office under the law of a State or Indian Tribe; or
(ii) formed under the law of a foreign country and registered to do business in the United States by the filing of a document with a secretary of state or a similar office under the laws of a State or Indian Tribe.
The CTA definition is broad, and, perhaps unsurprisingly, the CTA also includes a long list of highly technical exemptions from the above definition. Those exemptions generally include the following, among others:
- Public companies;
- Government-controlled entities;
- Regulated financial institutions, including banks, credit unions, bank holding companies, money transmitters, brokers, dealers, securities exchanges, investment companies, and investment advisers;
- Regulated insurance companies;
- Public accounting firms;
- Nonprofit entities that are tax-exempt under IRC §501, and certain entities that control such nonprofits;
- Certain shell companies that are not foreign-owned;
- Entities that have (i) more than 20 full-time employees, (ii) more than $5 million in gross sales or receipts, based on their previous year filed federal tax returns, and (iii) an operating physical office in the United States; and
- Other entities that the Secretary of the Treasury has exempted by regulation.
Absent from the list of exemptions are small businesses, and most professional firms such as law firms. Accordingly, since a very large percentage of companies have fewer than 20 full-time employees and less than $5 million in gross sales, the exemption will not apply to them. This same exemption will also not apply to any newly formed company even if it has more than 20 employees but has not yet filed its first tax return.
In addition, nonprofit entities are not exempt until they receive a letter of determination from the IRS. Considering the time it takes to obtain such a letter, every newly-formed nonprofit corporation will likely be a reporting company.
If a company is a reporting company, there are two categories of individuals who must file information. These are applicants and beneficial owners.4
The CTA limits the term “applicants” to include only the individual who directly files the document that creates the reporting company and/or the individual who is primarily responsible for directing or controlling the filing of the relevant document by another. In other words, if you directly file or direct someone else to file articles of incorporation or other such formation documents, you would be an applicant and the reporting company would need to file a report with FinCEN identifying you as such.
The rule does not require applicants to be identified by reporting companies if the reporting company was in existence prior to January 1, 2024. For example, if your reporting company was formed in 1998, it does not have to identify its applicants in its initial report. Reporting companies formed after January 1, 2024 will not have to update their information as it may pertain to the applicant(s).
Another Layer – Beneficial Owners
Beneficial owners must also be identified by a reporting company. The term is defined is defined in 31 USC §5336(a)(3)(A) as an individual who, with respect to an entity, directly or indirectly either (1) owns or controls at least 25 percent of the reporting company, or (2) exercises substantial control over the reporting company. The term “substantial control” is not defined in the statute but is defined in the rules which set forth a range of activities that could constitute substantial control of a reporting company such as being a senior officer of the reporting company or being on the board of the reporting company or having authority to remove or replace a senior officer.
The ownership test can also be satisfied by direct or indirect ownership. Holding ownership in trust or through subsidiaries or holding companies would all therefore require the identification of the ultimate beneficial owner or beneficiary of such trust. The term “beneficial owner” does not, however, include5
- A minor child if the minor’s parent's or guardian's information is reported;
- An individual acting as a nominee, intermediary, custodian, or agent on behalf of another individual;
- An employee of a corporation, LLC, or other similar entity whose control over or economic benefit from that entity derives solely from that person's employment status;
- An individual whose only interest is through an inheritance right; or
- A creditor (unless the creditor meets the definition of "beneficial owner").
If a company is a reporting company, then it must identify in its report the beneficial owners and applicants as defined above. Specifically, it would include in its report
- Full legal name;
- Date of birth;
- Current residential or business street address; and
- A unique identifying number from a driver's license, U.S. passport, or other acceptable identification document (or an identifying number obtained from FinCEN).
As explained above, that report would be due either by January 1, 2025 for reporting companies in existence before January 1, 2024 or within 30 days of receiving its notice of formation from the secretary of state if the reporting company is formed after January 1, 2024. Any change to that information would need to be updated within 30 days of the change.
To help with compliance, the CTA requires states, within 2 years after the effective date of the pending regulations, to notify persons filing initial entity formation or registration documents (or periodic renewals of those documents) of the federal reporting requirements and to provide those persons with a copy of the federal reporting form to be developed by the Secretary of the Treasury. States must also update their websites to notify users of the federal reporting requirements.
What Steps to Take?
Given the serious penalties for violation of the CTA, all companies and their counsel should be aware of this new federal law and should monitor guidance and regulations from the Secretary of the Treasury as and when issued. Businesses should evaluate whether they fall within the definition of a “reporting company,” identify all “beneficial owners,” and be prepared to comply with applicable reporting obligations.
Attorneys are in an unusual position and should consider whether and how the CTA applies to them individually and to their law firms, especially if their firm handles any entity formations. If they have reporting obligations with respect to their clients under the CTA, those obligations will likely conflict with their duties of confidentiality to clients, and advance disclosure to clients will be advisable. The reporting obligations of attorneys who have filed formation documents (and thus are “applicants” under the CTA) for former clients is not clear. The rules promulgated currently exempt reporting companies from identifying them as applicants.
For non-attorneys and all reporting or potentially reporting companies (i.e., any company that has fewer than 20 full-time employees and $5 million of gross revenues as reported on their most recent income tax return) stock subscription agreements, shareholder agreements, LLC operating agreements, and limited partnership agreements should be reviewed and modified as necessary to require members to furnish the information required by the CTA as well as providing for what happens to a member who refuses to do so or is otherwise negligent in providing changes to the information contained in the reports previously filed.
Finally, all companies that may be reporting companies should adopt a corporate compliance program. The program should be designed to obtain the information that will be necessary to include in any report to be made as well as add the report to the list of other periodic or annual compliance reports that it is already filing.
Questions?
If you think the CTA may apply to your company or you have any concerns, please contact Adkisson Pitet, LLP. We are here to help determine if your company will be subject to the CTA as well as review your company structure and compliance programs.
1 See, 31 USC §5336(h).
2 31 USC §5336(b)(1). It should be noted that the statute provides up to one year to report a change of beneficial ownership, but the regulations appear to have reduced the time to make such a correction to 30 days.
3 31 USC §5336(a)(11)(A)
4 31 USC §5336(b)(2)(A)
5 31 USC §5336(a)(3)(B)
Joseph Petrucelli
Author