The Corporate Transparency Act (CTA)
WHAT IS THE CTA?
Starting on January 1, 2024, business entities will need to comply with the reporting rules under the Corporate Transparency Act (CTA). The CTA was passed as part of the National Defense Authorization Act (NDAA) which became effective on January 1, 2021, after former President Trump’s veto of the NDAA was overridden by Congress. The CTA is widely recognized as the most substantial anti-money laundering legislation since the USA Patriot Act of 2001 and will create the first federal database of entity ownership used for law enforcement purposes.
The stated purpose of the CTA is to protect national security by preventing bad actors from hiding behind corporate structures to carry out illegal activities. These entities—often referred to as “shell companies”—attempt to mask the identities of their owners in order to commit crimes such as money laundering, financing terroristic activities, tax evasion, fraud, and cybercrime.
The CTA will require both existing and newly created entities to report certain identifying information about their beneficial owners to the Treasury Department’s Financial Crimes Enforcement Network (FinCEN). FinCEN has estimated that approximately 32.6 million such “Reporting Companies” will be subject to these reporting rules when they go into effect with an additional 5 million entities becoming Reporting Companies each year after that.
For all Reporting Companies currently in existence, a Beneficial Ownership Information (BOI) Report will need to be provided to FinCEN prior to January 1, 2025. For any Reporting Companies that are formed or registered on or after January 1, 2024, a BOI Report is required to be filed within 30 days of the acceptance of the company’s formation/registration filing. Additionally, any change in beneficial ownership or change in exemption status is also required to be reported within 30 days of any such change.
The CTA is poised to have significant implications for existing and future businesses, especially for small businesses, as it imposes new burdens and reporting requirement on entities formed or operating in the United States. Business entities will need to establish processes and protocols to monitor the entity’s operation and ownership status, as well as to gather, store, and report beneficial owners’ information. Bylaws, operating agreements, subscription agreements, and similar documents will likely need to be revised to require that such information is provided, and updated immediately upon any change, by beneficial owners, as well as authorizing the Reporting Company to share such information with FinCEN, to avoid any penalties for failing to comply.
WHAT ENTITIES QUALIFY AS A “REPORTING COMPANY”?
Whether your entity is a Reporting Company or not is determined on an entity-by-entity basis and requires a fact specific analysis for each entity’s unique circumstances.
A “Reporting Company” is a domestic or foreign corporation, limited liability company, or other entity that was either formed or registered to do business in any state or jurisdiction by filing a document with a secretary of state (or other similar office) and which does not qualify for an exemption.
There are 23 types of entities that are exempt from the CTA reporting requirements. These exemptions primarily apply to entities that are already subject to substantial federal reporting requirements, such as banks and other financial institutions, securities brokers and dealers, registered investment companies and advisors, insurance companies, publicly traded companies, and tax-exempt entities (including their wholly owned subsidiaries), among others.
The CTA also provides two other notable exemptions. First, is the “large operating company” exemption which applies to companies with (1) more than 20 full time employees, (2) an operating presence in a physical office within the United States, and (3) a filed Federal income tax or information return in the United States for the previous year demonstrating more than $5 million in gross receipts or sales from US sources. Second, is the “inactive entity” exception. This applies to entities that (a) existed on or before January 1, 2020, (b) are not engaged in an active trade or business, (c) have no direct or indirect ownership by a foreign person, (d) have had no change in ownership in the preceding 12 months, (e) have not sent or received any funds greater than $1,000 in the preceding 12 months, and (f) do not hold any assets, including ownership interests in another entity.
While these rules may appear straight forward, and are in many cases, more complex entity structures will require greater scrutiny in determining how the rules apply, which entities and subsidiaries are considered Reporting Companies, and what information, if any, needs to be reported. Additionally, there may be on-going compliance issues as changes with related or tiered entities may have implications for lower-tier and affiliated entities. For instance, a change in ownership of an upstream holding company or umbrella corporation may cause an exemption to no longer apply for its subsidiaries and would therefore trigger the reporting requirements for all the affected entities.
WHO ARE THE “BENEFICIAL OWNERS”?
For BOI reporting purposes, a beneficial owner is any individual who, directly or indirectly, through any contract, arrangement, understanding, relationship, or otherwise either (1) exercises substantial control over the reporting company or owns, or (2) controls at least 25% of the ownership interests of the reporting company. A Reporting Company will always have at least one owner with substantial control and possibly several owners with such control, even if no individual holds a 25% ownership interest.
What does “Exercising Substantial Control” mean?
Substantial control generally means control over important decisions and actions of the Reporting Company. According to the regulations, an individual exercises substantial control over a Reporting Company if the individual does some or all of the following:
- Serves as a senior officer of the Reporting Company, such as its CEO, CFO, COO, general counsel, or any other officer who performs a similar function (Note: secretary and treasurer are excluded because their functions are viewed as ministerial, with little control over the company).
- Has authority over the appointment or removal of any senior officer or a majority of the board of directors.
- Directs, determines, or has substantial influence over important decisions made by the Reporting Company such as directing the nature, scope, and attributes of the business, or the reorganization, dissolution, or merger of the Reporting Company. issuances of any equity
- Directs, determines, or has substantial influence over important decisions such as the sale, lease, mortgage, or other transfer of principal assets of the company, major expenditures or investments, the incurrence of significant debt, or the approval of the company’s operating budget.
- Performs any other actions or duties demonstrating substantial control over the company.
How is 25% of “Ownership Interests” determined?
For purposes of determining “beneficial ownership” under the CTA, an ownership interest is very broadly defined and includes a variety of different arrangements and ownership interest types. The most straight forward examples of ownership interests are stock and other equity interests, capital interests, and profits interests. However, puts, calls, and straddles, as well as debt instruments with equity-like or conversion features, are also factored into determining whether the 25% threshold is met.
The total ownership interests that an individual owns or controls, directly or indirectly (such as through an intermediary entity), is calculated as a percentage of the total outstanding ownership interests of the Reporting Company. For these calculations, the percentage is based on either the total voting power of all ownership interests entitled to vote, or the total outstanding value of all classes of ownership interests, whichever is greater. These calculations also assume that any potential or available options are exercised.
The CTA provides five exceptions for when an individual who otherwise would be a beneficial owner of a Reporting Company is exempt: (1) a minor child if the Reporting Company provides information about a parent or legal guardian; (2) an individual acting as a nominee, intermediary, custodian, or agent on behalf of another individual; (3) an employee, acting solely as an employee, whose substantial control over or economic benefits from such entity are derived solely from the employment status of the employee and who is not a senior officer; (4) an individual whose only interest is a future interest through a right of inheritance; and (5) a creditor.
What information must to be reported?
The Reporting Company will be required to provide identification information about itself, its beneficial owners, and Company Applicants. Information required about the Reporting Company itself includes:
- The full legal name and any trade name or “doing business as” (DBA) name of the Reporting Company
- A complete current address
- The State, Tribal, or foreign jurisdiction of formation or registration of the Reporting Company
- The IRS Taxpayer Identification Number (TIN) (including an Employer Identification Number) of the Reporting Company
Additionally, for each beneficial owner and Company Applicant of the Reporting Company, the BOI Report submitted to FinCEN must include the individual’s full legal name, date of birth, complete current address (in the case of a Company Applicant, a business address may be used, in all other cases a residential address must be used), and a unique identifying number from an acceptable identification document (such as a valid driver’s license or passport), as well as copies of such documents.
What is a “Company Applicant”?
A “Company Applicant” is the individual who directly files the formation document to the secretary of state that creates the Reporting Company or who registers the company to do business in the United States. This may also include the individual who is primarily responsible for directing or controlling such filing. Typically, this is the entity’s founder, officer, or attorney. There can be more than one Company Applicant.
DO I HAVE TO DISCLOSE MY PERSONAL INFORMATION? WHAT IS A “FINCEN IDENTIFIER”?
The short answer is yes. However, in lieu of giving your personal information to the Reporting Company to report, an individual or company may provide a unique identifier assigned by FinCEN (“FinCEN Identifier”). A FinCEN Identifier is a unique number issued by FinCEN to an individual or entity upon request that can be used instead of BOI for reporting purposes. Under proposed rules, an individual would submit an application for a FinCEN Identifier that contains all of the BOI that would otherwise be required in the initial report. The use of a FinCEN Identifier consequently puts the burden of updating the applicable BOI on the applicable individual or entity as each FinCEN Identifier is specific to that individual or entity. Any individual or entity that used a FinCEN Identifier must file an updated application to FinCEN reflecting the change within 30 calendar days after the date on which either the change occurred or when the individual or entity becomes aware or has reason to know of the inaccuracy in the application. A Reporting Company may also obtain a FinCEN Identifier by submitting an application to FinCEN at or after the time that the entity submits its initial report. This may be helpful if the Reporting Company is a Beneficial Owner of other Reporting Companies.
WHO HAS ACCESS TO THE BENEFICIAL OWNERSHIP INFORMATION?
FinCEN will store BOI for no fewer than five years after the date on which the Reporting Company terminates. BOI will be provided upon request by a federal agency engaged in national security, intelligence, or law enforcement activity, and to a State, local, or Tribal law enforcement agency if a court of competent jurisdiction has authorized the law enforcement agency to seek the information in a criminal or civil investigation. With the consent of the Reporting Company, a financial institution can obtain BOI to facilitate compliance with applicable customer due diligence requirements of a financial institution.
Congress has directed the U.S. Treasury Department to maintain BOI in a “secure nonpublic database, using information security methods and techniques that are appropriate to protect non-classified information security systems at the highest security level.” FinCEN has been developing the Beneficial Ownership Secure System (BOSS) to receive, store, and maintain BOI to comply with this requirement. BOSS is expected to open on 1 January 2024, and Reporting Companies will be required to provide their BOI Reports to FinCEN through BOSS.
ARE THERE PENALTIES FOR VIOLATIONS OR NONCOMPLIANCE?
Yes. Failure to meet the reporting requirements or unauthorized disclosure of BOI can result in civil or criminal actions. Willful failure to file a complete initial or updated report with FinCEN is subject to a $500-per-day fine (up to $10,000) and imprisonment for up to two years. An individual who knowingly discloses BOI, without authorization, is subject to a $500-per-day penalty (up to $250,000) and imprisonment for up to five years.
The implementation of the CTA continues to evolve. On July 18, 2023, the House Financial Services Committee held a hearing entitled “Potential Consequences of FinCEN’s Beneficial Ownership Rulemaking,” which focused on deviations from Congressional intent underlying the CTA in the FinCEN rulemaking process. Committee Chairman Patrick McHenry has introduced H.R. 4035, Protecting Small Business Information Act of 2023, which would delay the effective date for BOI reporting requirements from January 1, 2024, until FinCEN finalizes both the BOI reports and the rules concerning who may request BOI, who may access and receive BOI, how recipients may use the information, how they must secure and safeguards the information, and the penalties for such information users to fail to follow applicable requirements. Other legislation has been introduced that would further modify the CTA and FinCEN’s application. To date, however, none of the proposed delays or modifications have passed, and all official statements form the Treasury Department indicate they are proceeding with the rules and timelines currently set forth.
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