Client Alert: A Primer on the Corporate Transparency Act: Highlights of Additional Requirements to Conduct Business
Date: June 26, 2023
On January 1, 2021, heightened entity and beneficial ownership reporting arrived in the United States with the enactment of the Corporate Transparency Act (the “CTA”), part of the National Defense Authorization Act for Fiscal Year 2021. The policy behind the CTA is to strengthen reporting and transparency as to who the beneficial economic owners are of business enterprises doing business in the United States. Prior to the passage of the CTA, the United States was viewed by some in the international marketplace as a tax haven for those looking to create shell companies to hide their assets through the formation of business entities in jurisdictions like Delaware or Florida, for instance.
The CTA is intended to reduce instances of money laundering, tax fraud, drug trafficking, and terrorism financing in the U.S. by creating a federal database that tracks the beneficial ownership of U.S. corporations, limited liability companies, partnerships, and certain foreign entities. The CTA brings the U.S. in alignment with global trends towards heightened transparency and lifting the veil of secrecy from certain otherwise private transactions. CTA is expected to deter bad actors from engaging in money laundering, tax schemes, and concealing assets, as well as provide greater global transparency. Prior to the CTA, the U.S. in many respects has been at the forefront of combatting bad actors, through many of the U.S. reporting and disclosure requirements under U.S. federal tax law and federal anti-money laundering statutes under the Bank Secrecy Act, among other remedies.
The questions we highlight below are:
- What is the new requirement for CTA Reporting Companies in the coming year?
- Which entities are required to report under the CTA?
- What information is required to be reported?
- How should Reporting Companies prepare to comply with CTA requirements?
What is the Final Rule?
The Treasury’s Financial Crimes Enforcement Network (FinCEN) published in September 2022 an extensive set of regulations (“Final Rule”) implementing the CTA and its reporting requirements. These regulations are effective on January 1, 2024. Businesses required to report beneficial owners that fail to file accurate reports after January 1, 2024, will be subject to civil or criminal penalties. This needs to be included on any business’s compliance checklist.
Not every business is required to file a report; but, FinCEN estimates that over 32 million business entities will be required to disclose information about beneficial owners in the first reporting year. FinCEN further estimates that an additional five million business entities will be required to disclose information about beneficial owners for each of the following 10 years. By FinCEN’s estimates, over 80 million business entities will be required to disclose beneficial owner information by the year 2035. It would be prudent for a business entity to check whether it is required to file a report every year.
What Does the Final Rule Require?
Under the Final Rule, Reporting Companies must file reports (called Beneficial Owner Information or BOI reports) with FinCEN. The BOIs will disclose information about Reporting Companies’ beneficial owners, and, in certain cases, the individual(s) responsible for filing the document that creates the entity or for registering it to do business in the United States.
A Reporting Company includes corporations, limited liability companies, limited partnerships, limited liability partnerships, etc. The term also includes any similar entity that is created by filing a document with a state’s secretary of state (or similar office) or formed under the law of a foreign country and registered to do business in the United States by the filing of a document with the secretary of state (or similar office).
Reporting Companies, therefore, may include entities that are not strictly businesses as well, including community associations and some general partnerships. Notably, the definition for Reporting Company is dynamic; so, a business may not be considered a Reporting Company in one year, but then could be required to file a report as a reporting company in the next.
For example, if a business has 21 employees one tax year and more than $5 million in gross receipts or sales, it would not be considered a Reporting Company, under the so-called large operating company exemption. However, if an employee is fired or quits in the next taxable year and the business’ gross receipts or sales do not change, the business would then have to file a BOI because it would be considered a Reporting Company with 20 employees and more than $5 million in gross receipts or sales. Business entities that do not fall within the scope of the Final Rule’s reporting requirements include sole proprietorships, some general partnerships, foreign entities not registered to do business in the U.S., unincorporated associations, and wealth planning trusts.
FinCEN’s regulations provide 23 exemption categories for entities under the Final Rule’s reporting requirements. Many of the exemptions apply to entities that are already subject to substantial federal and/or state regulation or entities that are already required to provide their beneficial ownership information to a governmental authority. This includes, among others, companies that file reports with the U.S. Securities and Exchange Commission, governmental authorities, banks, credit unions, money service businesses, investment advisors, securities brokers and dealers, tax exempt entities under Section 501(c), insurance companies, state-licensed insurance producers, pooled investment vehicles, public utilities, inactive entities, subsidiaries of certain exempt entities, accounting firms, and large operating companies.
The Final Rule notably also excludes sole proprietorships, trusts, some general partnerships, and other entities that would not otherwise obscure an individual’s identity. However, these entities should be aware that they may be included in future legislation or regulations.
What Must be Reported?
The Final Rule requires Reporting Companies to disclose the personal information for any beneficial owner who: (1) owns a 25% equity stake or (2) exercises substantial control over the entity. In this context, persons who exercise substantial control can include senior officers, persons with the power of appointment and removal of senior officers or a dominant majority of the Board of Directors, and persons who have a substantial influence over important matters of the company, such as major expenditures or investments and the selection or termination of business lines or ventures.
It is important to note that exercising substantial control does not require ownership in an entity, but instead relates to authority and decision making. FinCEN will require Reporting Companies to report all persons who exercise substantial control over the entity, which requires due diligence to document all of the reportable information for every beneficial owner.
While FinCEN’s regulations go into effect on January 1, 2024, existing Reporting Companies have until January 1, 2025 to file their BOIs. Starting on January 1, 2024, newly created or registered entities will be required to file BOIs within 14-days of their creation or registration. This additional registration requirement will increase the costs of creating an entity if it is a Reporting Company, but the failure to accurately report beneficial owners will prove even more costly. Further, any corrected BOI must be filed within 14-days after a Reporting Company becomes aware or has reason to know that reported information is inaccurate. Updated BOIs must be filed within 30 days of any change in information that requires an update.
Information required about the Reporting Company on a BOI shall consist of the following: (1) its full legal name; (2) any trade or “doing business as” names; (3) a complete current address consisting of: (i) in the case of a reporting company with a principal place of business in the United States, the street address of the principal place of business, and (ii) in all other cases, the street address of the primary location in the United States where the reporting company conducts business; (4) the state, tribal or foreign jurisdiction of formation; (5) for a foreign reporting company, the state or tribal jurisdiction where the company first registers; and (6) the IRS Taxpayer Identification Number (TIN) (including an Employer Identification Number) or where a foreign reporting company has not been issued a TIN, a tax identification number issued by a foreign jurisdiction and the name of that jurisdiction.
The following information must be included in a BOI submitted by a Reporting Company for each beneficial owner or person exercising substantial control over the entity: (1) taxpayer identification number; (2) full legal name; (3) birthdate; (4) address; and (5) a unique identifying number from, and image of, an acceptable identification document, such as a passport.
Businesses who violate these new reporting rules, including failing to report complete or updated beneficial ownership information or reporting false or fraudulent information, could be subject to civil penalties of up to $500 a day and criminal penalties, including up to $10,000 in fines and/or imprisonment for up to two years. Although it is the Reporting Company that has the filing obligation under the CTA, it is critical that individuals exercising substantial control over the entity follow and comply with the CTA’s reporting requirements to avoid civil or criminal penalties.
How Far-Reaching Will this Final Rule Be?
The Final Rule is a natural progression of the Foreign Account Tax Compliance Act (otherwise known as FATCA), which generally requires that foreign financial institutions and certain other non-financial foreign entities report on the foreign assets held by their U.S. account holders or be subject to withholding on withholdable payments. The Final Rule is also similar to initiatives in other countries around the world that are seeking to increase transparency regarding the beneficial ownership of business entities.
Efforts towards increasing corporate transparency in the European Union (EU) were dealt a major blow on November 22, 2022, when the European Union Court of Justice held that the provision of the fifth EU anti-money laundering directive relating to public assess of EU company BOI is invalid because it conflicts with the Charter of Fundamental Rights of the EU. Following the decision, a number of BOI registers have been taken offline. However, Luxembourg’s beneficial ownership register was restored in December 2022 for a number of professionals, including members of the press with a legitimate interest and certain professionals combatting money laundering and terrorist financing. It is currently unclear how the United Kingdom or the British Overseas Territories will react to this decision.
When FinCEN’s database begins functioning in January 2024, foreign parties will be able to request information from the database. Foreign law enforcement agencies, judges, prosecutors, central authorities and competent authorities that wish to request information contained in BOIs will be required to submit their requests to a federal intermediary agency, which will retrieve the information from FinCEN’s database and transmit it to the foreign requestor. Foreign requestors will not be granted direct access to FinCEN’s database.
How and What Should Reporting Entities Prepare?
FinCEN is expected to release a second and third set of regulations implementing the Final Rule. The second set of regulations was sent to the Office of Management and Budget’s Office of Information and Regulatory Affairs (OIRA) for review on October 28, 2022. FinCEN also released proposed regulations governing disclosure, access, and safeguarding of BOIs on December 15, 2022.
In short, the implementation of the Final Rule will effectively create a far-reaching national business registry for many persons doing business in the U.S., including their advisors and facilitators. While the Final Rule’s reporting requirements are complex, our firm is happy to help clients navigate the changes and understand their responsibilities under the Final Rule. Ultimately, business owners should expect to provide their personal information for the privilege of doing business in the U.S. FinCEN estimates that it will cost simple management and ownership structures approximately $85.00 apiece to prepare and submit an initial BOI. However, compliance costs should be expected to be incrementally much higher than initial FinCEN estimates when one considers legal and other advisor fees, and the need to potentially upgrade record keeping and reporting tools and processes.
The information contained here is not intended to provide legal advice or opinion and should not be acted upon without consulting an attorney. Counsel should not be selected based on advertising materials, and we recommend that you conduct further investigation when seeking legal representation.