By John M. Goralka
Sacramento, CA
On Jan. 1, 2024, the Corporate Transparency Act (CTA) becomes effective. Every new corporation, limited liability company (LLC), limited partnership and any entity whose existence is created by a filing with a Secretary of State in any state must file with the Financial Crimes Enforcement Network (FinCEN). More than 32 million entities are estimated to be affected.
This filing will require the business name, current address, state of formation and tax identification number for the entity. The filing will also require the name, birth date, address and a copy of a government-issued photo ID such as a driver’s license or passport of every direct and indirect owner. Each of the 32 million or more entities will almost certainly involve a filing by more than one person. The inclusion of this information for indirect owners creates both complexity and a very broad range of who qualifies as an indirect owner requiring filing of individual otherwise personal information. Penalties for failure to comply are high — $500 a day up to $10,000 and up to two years in jail (per occurrence).
The CTA was enacted on a bipartisan basis on Jan. 1, 2021. The broad definition of an owner and wide range of inclusion of owners’ personal information appears to be intentional. The stated purpose for the CTA is to combat money laundering and the concealment of illicit funds through “shell” corporations or other entities in the United States.
Not all shell corporations are used for nefarious purposes, though, and not every person who wants privacy is up to no good. Indeed, we have had many clients seeking privacy in a world where public information grows exponentially each day. These people who want privacy include professionals seeking liability protection, public figures and athletes. The largest group that we work with are law enforcement officers who are concerned about criminals knowing where they live. That said, the CTA seeks to prevent a wide variety of financial crimes and terrorist activities.
Business attorneys are presently accustomed to exemptions for smaller companies from the more rigorous securities filing requirements for large public companies. The CTA is the opposite and may be considered applicable to any company “no matter how small.”
Exceptions to CTA reporting
Exemptions from the reporting requirements under the CTA are for large corporations. These large entities include:
- Regulated companies such as banks and credit unions.
- Large companies defined as having more than 20 employees and $5 million in annual revenue.
- Companies that are inactive or dormant — but inactive is defined as not holding any kind or type of assets and has not sent or received any funds greater than $1,000 directly or indirectly, was in existence on Jan. 1, 2020, and is not owned by a foreign person. This is a much more limited exception that the title “inactive” would imply.
Information included in the reports
Information to be included in the CTA reports includes company information and information on any individual who is a direct beneficial owner. The inclusion of “beneficial owners” will affect people listed as trustee or even successor trustees in the direct owner’s state plan.
My clients will name successor trustees in their estate plans without even asking the person named. This could now result in the successor trustee filing private information with the federal government under the CTA. This may inspire difficult conversations with potential successor trustees.
Company information reported includes:
- Legal name and all trade names or DBA (doing business as) names for the company.
- Actual street address for the company’s principal place of business (not a P.O. Box or lawyer’s or adviser’s address).
- State of formation.
- Identification number. A pass-through entity, like a single-member LLC, that may not be required to have a tax ID number may now have to obtain a unique identification number.
- An identity document from an issuing jurisdiction such as filed Articles of Incorporation or Organization, including an image of that document.
Beneficial owner reporting. Reporting companies will be required to file reports for all “beneficial owners.” A company can and often will have more than one beneficial owner. Information required for each beneficial owner is:
- Full legal name (not just initials)
- Date of birth
- Home address (not P.O. Box or adviser/lawyer’s address)
- Photocopy (PDF) of the individual’s U.S. passport or driver’s license
The information required is more personal and invasive than ever required in the United States before. This type of reporting is already required in Europe.
Who is a beneficial owner? A reporting company can have more than one beneficial owner. A beneficial owner owns or controls at least 25% of the interests of a reporting company. A reporting company could have one beneficial owner who both exercises substantial control and owns or controls at least 25% of the ownership interest of the reporting company. There is no maximum number of beneficial owners.
Virtually all small family businesses will need to report. The CTA will catch and require reporting from almost every small family business, including LLCs and other entities designed to hold only real estate. Even the single-member LLCs, which are “disregarded” for income tax purposes, must file reports with FinCEN under the CTA.
The term “ownership” itself is not as straightforward or simple as it may appear. Ownership is not limited to actual record title to the shares or membership interests. Ownership is defined broadly in the CTA to include profit interests, capital interests, options, calls, puts and convertible notes or warrants.
Ownership can arise under the CTA definition through joint arrangements such as trusts, voting trusts and informal partnerships.
Note that holders of interests in a phantom stock plan would not appear to be included until the phantom shares become actual ownership interests.
Who holds substantial control under the CTA? People holding “substantial control” must be included in the report. They would appear to include:
- Managers or officers of the reporting entity
- Directors of the reporting entity
- An individual with authority over the appointment of any senior office or the majority of the board of directors
Note that minors do not report, but a legal guardian or trustee may have to report. What if the parents are divorced? Will a wife have to report her ex-husband’s information?
Professionals handling filings must report. Professional creating entities (“applicants”) and filing with the Secretary of State after Jan. 1, 2024, may be required to report. There are two types of applicants. First, the direct filer who directs or controls the filing. Second, the person who actually files or pushes the buttons to file. For example, the attorney, myself and my paralegal, who may actually push the buttons and enter the information to file.
Inheritances and trusts. An exception is provided for an “inheritor.” However, this exception is much more limited than the name implies. The qualifying person as an inheritor is exempt only while this is a future interest. Once the inheritance and the company interest are received, the reporting under the CTA is required.
Presumably, the successor trustee or executer (if no trust) would be required to report the death before the company interest is distributed to the inheritor.
Most trusts are not formed with a filing to a Secretary of State and, therefore, are not subject to CTA reporting as an entity. Certain business trusts formed with a Secretary of State filing may be reporting entities. A trustee of any trust may have direct or indirect ownership or control through the trust. A gray area is a trust protector, which is most often used in completed gift trusts. A trust protector is used to effect change in an otherwise irrevocable trust. A trust protector is usually utilized for a single specific action. Nevertheless, a trust protector may be able to exert substantial control over a company that is owned at least in part by a trust with trust protector provisions.
Beneficiaries. A beneficiary who is the sole permissible recipient of income and principal must report. A beneficiary with the right to distribute or withdraw assets from the trust would be required to report. But would a larger class of beneficiaries avoid having to report? Not so clear is if a person who has the right to borrow or loan assets would be required to report.
When are reports required?
Every reporting company must file a report for companies that are in existence on Jan. 1, 2024. Initial reports are due by Jan. 1, 2025. For new entities created on or after Jan. 1, 2024, the initial reports are due within 90 days from the formation date.
The reporting company must also report changes within 30 days of any change. Such a short timeframe could be very challenging in today’s busy world.
Business owners and advisers must take the appropriate steps to inform the appropriate people of these requirements.
An alternative approach for privacy: The FinCEN identifier
In order to avoid sharing personal information, a beneficial owner may instead obtain a special identification number to be used instead of disclosing all the personal information that is otherwise required.
To apply for the FinCEN identifier, the individual must provide the name, date of birth, address, unique identity number (such as Social Security number) and acceptable government-issued identification document (such as a driver’s license or passport). Note that this is the same information that a beneficial owner must provide, but at least that is being provided only once. Once obtained, that FinCEN identifier may be used instead of sending that information to multiple companies.
The CTA will be a massive undertaking and carries potential risk for professionals such as myself who have been forming entities for over 25 years. The reporting may be uncomfortable for my business owners seeking privacy.
Finally, the National Small Business Association (NSBA) has challenged the constitutionality of the CTA in a case currently in the United States District Court. The NSBA asserts that the CTA illegally encroaches on each individual state’s power to regulate entity formations:
- Congress has no authority over corporate formation or reporting because a reporting company has not engaged in or conducted any foreign, interstate or Indian commerce.
- CTA violates the Fourth Amendment’s search and seizure laws.
- CTA compels speech and puts unreasonable burdens on free speech and violates the due process laws.
- NSBA also complains of the high cost of compliance. FinCEN itself estimates that the average burden for a beneficial owner is 650 minutes per response for reporting companies with complex beneficial ownership structures.
The CTA requirements should not be ignored, as the penalties are severe both in terms of financial and even jail time for intentional failures to report. Additional information can be found at the FinCEN website.
