Congress enacted the Corporate Transparency Act (CTA) as part of the National Defense Authorization Act for Fiscal Year 2021. Under the CTA, and the final regulations released Sept. 29, 2022, a “Reporting Company” must provide certain identifying information about its “Beneficial Owners” and certain individuals who helped form or register the Reporting Company (a “Company Applicant”). Failure to report can result in both civil and criminal penalties.1 The CTA is intended to “help prevent and combat money laundering, terrorist financing, corruption, tax fraud, and other illicit activity…”2
Collection and Use
Reporting Companies created before Jan. 1, 2024 will have until Jan. 1, 2025 to file their initial report with the Financial Crimes Enforcement Network (FinCEN), a bureau of the U.S. Department of the Treasury. Reporting Companies formed on or after Jan. 1, 2024 will need to file an initial report within 30 calendar days.3 FinCen will collect the reported information. This information will be stored in a searchable registry that’s available to Treasury and to other federal agencies involved in national security, intelligence or law enforcement. It will also be available to state or local law enforcement agencies with court approval, to financial institutions as part of their know your customer/anti-money laundering (KYC/AML) functions (with the consent of the Reporting Company) and to U.S. regulators or certain foreign governments subject to certain approvals.4 The registry won’t be available to the public.
What’s a Reporting Company?
The obligation to report to FinCEN is imposed on Reporting Companies. Under the CTA, a Reporting Company is any entity formed by a filing with a secretary of state5 or any foreign entity that’s registered to do business in the United States by a filing with a secretary of state.6 As a result, Reporting Companies include corporations, limited liability companies, limited partnerships and limited liability partnerships, but typically don’t include general partnerships, sole proprietorships or trusts because those entities don’t require a filing to be brought into existence.
This general definition of “Reporting Company” is very broad, but the CTA and the final regulations exempt 23 categories of businesses from the definition of Reporting Company.7 These exempt companies don’t have to collect or report any information to FinCEN. For the most part, these are businesses that are already highly regulated and, therefore, unlikely to be used for criminal purposes. Exempt companies include banks, broker-dealers, insurance companies and public accounting firms registered under Section 102 of the Sarbanes-Oxley Act.
Two types of exempt companies are of particular interest to private client lawyers: tax-exempt entities and large operating companies. A tax-exempt entity for purposes of the CTA includes: (1) an organization that’s described in Internal Revenue Code Section 501(c) and exempt from tax under IRC Section 501(a); (2) an IRC Section 527(e)(1) political organization; and (3) trusts described in IRC Section 4947(a)(1) or (2).8 The Large Operating Company exception9 excludes entities that have more than 20 full-time employees in the United States, a physical office in the United States and more than $5 million in U.S. gross receipts.
While these exemptions will remove many entities from the definition of Reporting Company, the vast majority of privately owned businesses will be Reporting Companies, including most law firms.
What Must be Reported?
A Reporting Company must disclose information about itself and two distinct categories of individuals: Company Applicants and Beneficial Owners.
The Reporting Company must disclose its full legal name, any names under which it does business, a principal business address, the jurisdiction of formation and a taxpayer identification number.10 A foreign reporting company must also disclose the U.S. jurisdiction where the company first registers.
A Company Applicant is the individual who filed the formation or registration document for the Reporting Company and the individual “primarily responsible for directing or controlling such filing” if any.11 Under the final regulations, there can be no more than two Company Applicants. This could be, for example, a paralegal who submits the formation document to the secretary of state and the attorney who asked the paralegal to make that submission.
The Company Applicant for entities existing on Jan. 1, 2024 doesn’t need to be disclosed. Thereafter, for each Company Applicant, a newly formed entity will need to disclose the name, date of birth, street address, unique identifying number from a passport, driver’s license or other identifying document and a copy of that document.12
Beneficial Owners
There are two types of Beneficial Owners: (1) those who exercise substantial control over the Reporting Company, and (2) those who are 25% owners of the Reporting Company.13 In both cases, the Reporting Company must report the same information as it does for a Company Applicant, but a residential (not business) address must be provided.
An individual exercises substantial control over a Reporting Company if that individual: (1) serves as a senior officer of the Reporting Company, (2) has authority over the appointment or removal
of a senior officer or a majority of the board of directors (or similar body), (3) directs, determines or has substantial influence over important decisions of the Reporting Company, or (4) has any other form of substantial control over the reporting company.14 Substantial control can be direct or indirect.15
“Senior officer” is defined as “any individual holding the position or exercising the authority of a president, chief financial officer, general counsel, chief executive officer, chief operating officer, or any other officer, regardless of official title, who performs a similar function.”16 The proposed regulations had included “secretary” and “treasurer” in the definition, but they were removed in the final regulations because those positions are often ministerial with little control over the actual operation of an entity.
With regard to ownership, it’s broadly defined to include equity, capital or profits interests, convertible instruments and options.17 Ownership can be direct but also includes various types of indirect ownership.18 In determining whether an individual is a 25% owner of a Reporting Company, all options are treated as exercised.19 For corporations, owning 25% of the voting power of all classes of stock or the value of all classes of stock is sufficient to be a 25% owner.20 For partnerships that issue both capital and profits interests, the language of the regulations is less clear. In such a case, the regulations direct us to determine the “percentage of the total outstanding capital and profits interests of the entity” owned or controlled by the individual.21 The regulations provide no guidance on how to aggregate capital and profits interests, which may reflect very different economic arrangements. Hopefully, there will be additional guidance over the next year.
With regard to partnerships and corporations, if it’s not possible to determine ownership “with reasonable certainty,” the regulations direct that any individual “who owns or controls 25 percent or more of any class or type of ownership interest of a” Reporting Company should be reported as a 25% owner.22 Given the purpose of the CTA, it’s understandable why FinCEN believes if there’s a complex equity structure, it’s appropriate to disclose all individuals who own 25% or more of any equity class.
The regulations specify that a trustee who can dispose of trust assets is deemed to own an interest in a Reporting Company held in the trust. For a corporate trustee, it’s logical to assume it’s the entity, and not a trust officer acting solely as an employee, that would be disclosed, but the general structure of the CTA is designed to identify controlling individuals. Additional guidance is required.
A beneficiary of a trust is deemed to own an interest in a Reporting Company held in the trust only if the beneficiary: (1) is the sole income and principal beneficiary, or (2) has the right to withdraw substantially all of the trust assets. A grantor will be considered to own the assets of a trust if the trust is revocable or if the grantor can otherwise withdraw the trust assets.23
As a result, trust-owned assets will almost always be deemed owned by the trustee for purposes of determining 25% owners of a Reporting Company, while grantors and beneficiaries may be attributed ownership in more limited circumstances. Note that these “rules” with regard to trusts are examples of indirect ownership. An individual with indirect substantial control or indirect ownership must also be reported, so there may be other situations in which discretionary beneficiaries or other types of fiduciaries need to be disclosed as 25% owners of a Reporting Company.
Exceptions
Identifying information about certain individuals who would otherwise be Beneficial Owners needn’t be disclosed. A minor child is excluded from the definition of Beneficial Owner provided information about a parent or legal guardian for that child is disclosed. An individual acting as nominee, intermediary, custodian or agent isn’t a Beneficial Owner, which makes sense because that person doesn’t ultimately control or economically benefit from the entity. For similar reasons, an employee of a Reporting Company acting solely as an employee isn’t a Beneficial Owner. Note this exception only applies if that individual’s status as a Beneficial Owner is derived “solely” from their status as an employee. If they’re also a senior officer or own a 25% interest, this exception doesn’t apply. A future interest through a right of inheritance isn’t enough to make someone a Beneficial Owner. Finally, a creditor of a Reporting Company isn’t a Beneficial Owner, although that exception may not be available in the case of debt convertible into equity.24
Updating Reports
If any report is inaccurate when filed, the Reporting Company must file a correction within 30 days after the company becomes aware “or has reason to know of the inaccuracy.”25 To avoid civil or criminal penalties, however, an inaccurate report must be corrected within 90 days of when it was filed regardless of when the person who filed the original report became aware of the inaccuracy.26
A Reporting Company has only 30 days to report any change to information previously reported to FinCEN concerning a Reporting Company or a Beneficial Owner.27 This would include changes to the legal name or residential address of a Beneficial Owner. Note the 30-day window is from when the change occurs, not when the Reporting Company learns of the change.
If a Beneficial Owner dies, updated information need only be reported “when the estate of the deceased beneficial owner is settled…”28
With regard to an identifying document, the mere renewal of that document isn’t enough to require an update with FinCEN. Only if the name, date of birth, address or unique identifying number on such document changes will the Reporting Company be required to update its report.29
FinCEN Identifier
To help protect the confidential information of Company Applicants and Beneficial Owners, an individual may obtain a FinCEN identifier. This is a unique number issued to an individual by FinCEN once that individual provides the information that would otherwise be reported by a Reporting Company. The individual may then provide that FinCEN identifier to a Reporting Company, which may in turn report that number to FinCEN.30
For example, suppose New LLC is owned equally by Allie and Ben. New LLC owns a single piece of rental real estate and has no employees. New LLC would be a Reporting Company because it doesn’t fall into any exception. Allie and Ben would each be a Beneficial Owner. New LLC would be required to report their name, date of birth, residential address, etc., along with an image of a driver’s license/passport etc. If Allie and Ben each had a FinCEN identifier, they could simply provide that identifier number to New LLC, and that’s what New LLC would report to FinCEN. If Ben moves to a new home, he would be required to notify FinCEN within 30 days because he has a FinCEN identifier.
A Reporting Company can also obtain a FinCEN identifier. The proposed regulations made clear if an individual owned their interest in a Reporting Company through an intermediary entity that had a FinCEN identifier, the Reporting Company could disclose that identifier instead of the information about the individual Beneficial Owner.31 For example, suppose Allie was investing in NewCo through HoldCo and that HoldCo was in turn owned equally by Allie and Charles. If HoldCo had a FinCEN identifier, that number could be provided to NewCo. Without a FinCEN identifier, NewCo would need to understand who owned HoldCo and would have to disclose Charles as a 25% owner of NewCo. Some commentators were concerned allowing entities to have FinCEN identifiers would result in incomplete or misleading information, so this area is reserved in the final regulations. Hopefully additional guidance is provided before the end of next year because having FinCEN identifiers for entities will dramatically decrease the reporting burden associated with the CTA.
Observations and Closing Thoughts
As professionals, we’ll need to adapt to the new world of corporate transparency, and we need to be ready to advise our clients on their new obligations. For example, while the CTA requires Reporting Companies to make certain disclosures, it doesn’t require Beneficial Owners to provide the required information. Operating agreements and shareholder agreements should be updated to require all Beneficial Owners cooperate by providing the required information.
I expect the wide scale adoption of FinCEN identifier numbers will be driven by two different, but complimentary, forces. First, many individuals won’t want to provide the required information to a Reporting Company out of fear it will increase the risk of identity theft or otherwise negatively impact their privacy. Second, Reporting Companies won’t want to risk fines for failing to update previously provided information within the 30-day limit, especially when they may not learn of the change until after that 30-day window has closed. Many Reporting Companies may require their Beneficial Owners to obtain a FinCEN identifier.
Finally, when entities are formed, it will be important to clarify who’s responsible for preparing the initial CTA report. Some attorneys may wish to specifically exclude this responsibility through their engagement letters, while others will view it as an additional service they can charge for. This obligation should also be specifically mentioned in any “care and maintenance” memo provided to a client who forms a new entity.
While the final regulations have been published, it’s hardly the last guidance we’ll receive with regard to the CTA. In the coming months, we’ll see the portal for providing the required information, new guidance on how financial institutions will fulfill their KYC and AML responsibilities, as well as additional FAQs and other guidance from FinCEN. Jan. 1, 2024 will arrive quickly, and the burden is on us to be ready.
Endnotes
1. 31 U.S.C. Section 5336(h)(3)(A).
2. 87 Fed. Reg. 59498.
3. 31 C.F.R. Section 1010.380(a)(1).
4. See 31 U.S.C. Sections 5336(c)(2)(B) and (c)(5).
5. The Corporate Transparency Act (CTA) refers to “a secretary of state or a similar office under the laws of a State or Indian Tribe.” Because it’s the most common, and for ease of discussion, this article simply refers to a secretary of state.
6. 31 U.S.C. Section 5336(a)(11)(A) and 31 C.F.R. Section 1010.380(c)(1). While this article speaks in terms of domestic entities, identical rules apply to foreign entities that register to do business in the United States.
7. 31 U.S.C. Section 5336(a)(11)(B) and 31 C.F.R. Section 1010.380(c)(2).
8. The specific exclusion of charitable and split-interest trusts is a bit confusing. Because trusts aren’t formed through a registration with the secretary of state, they’re already outside the definition of a Reporting Company.
9. 31 U.S.C. Section 5336(a)(11)(B)(xxi) and 31 C.F.R. Section 1010.380(c)(2)(xxi).
10. 31 C.F.R. Section 1010.380(b).
11. 31 C.F.R. Section 1010.380(e).
12. 31 C.F.R. Section 1010.380(b)(1)(ii). See also 31 C.F.R. Section 1010.380(b)(2)(iv). The regulations allow individuals and Reporting Companies to apply for unique Financial Crimes Enforcement Network identifiers that can be supplied instead of the specifically enumerated personal information.
13. 31 C.F.R. Section 1010.380(d).
14. 31 C.F.R. Section 1010.380(d)(1)(i).
15. 31 C.F.R. Section 1010.380(d)(1)(ii).
16. 31 C.F.R. Section 1010.380(f)(8).
17. 31 C.F.R. Section 1010.380(d)(2)(i).
18. 31 C.F.R. Section 1010.380(d)(2)(ii).
19. 31 C.F.R. Section 1010.380(d)(2)(iii)(A).
20. 31 C.F.R. Section 1010.380(d)(2)(iii)(C).
21. 31 C.F.R. Section 1010.380(d)(2)(iii)(B).
22. 31 C.F.R. Section 1010.380(d)(2)(iii)(D).
23. See supra note 20.
24. 31 C.F.R. Section 1010.380(d)(3).
25. 31 C.F.R. Section 1010.380(a)(3).
26. 31 U.S.C. Section 5336(h)(3)(C)(i)(I)(bb).
27. 31 C.F.R. Section 1010.380(a)(2).
28. 31 C.F.R. Section 1010.380(a)(2)(iii).
29. 31 C.F.R. Section 1010.380(a)(2)(iv).
30. 31 C.F.R. Section 1010.380(b)(4).
31. Proposed Regulations Section 1010.380(b)(5)(ii)(C).