The Real Nightmare Before Christmas – Corporate “Transparency”

Nossaman eAlert

As we prepare for another spooky night, many of you may have seen stories of an impending horror – the intrusive filing requirements of the Corporate Transparency Act (the CTA). Congress passed the CTA in December 2020 to increase transparency about the ultimate ownership of privately-held businesses, and thereby reduce the role of shell companies in money laundering and other nefarious activities. Companies in the U.S. have never before been subjected to such an invasive look into their management and ownership structure. These reporting requirements begin January 1, 2024 (for companies formed after 2023) and January 1, 2025 (for companies formed before 2024). But we are here to show you that the CTA may not be the big bad “Oogie-Boogie” that everyone dreads.

The Treasury Department’s Financial Crimes Enforcement Network (FinCEN) is responsible for implementing, operating and enforcing the new reporting regime. You can read the final FinCen rules (31 CFR 1010.380) here. FinCen also maintains and updates an FAQ section on its web site, and has published a comprehensive small business guide.

As a threshold matter, only corporations, limited liability companies, or entities that are created by a filing with a Secretary of State or equivalent state agency are required to report to FinCEN. This definition will include corporations, limited liability companies, limited partnerships, limited liability partnerships and the like. Thus, entities not created by such a filing are not required to report under this regime, including:

  1. government agencies and instrumentalities (such as transportation administration systems),
  2. qualified retirement plans (whether public or private), and
  3. general partnerships or joint ventures (though entities that are partners in such arrangements may have their own reporting obligations).

An entity that cannot get past the first cut above–and unless it can find an applicable exemption below– must provide FinCen with personal information about its “Beneficial Owners”, who are individuals (i) with “Substantial Control” over the entity, or (ii) directly or indirectly controlling 25% or more of the “Ownership Interests” of the entity. Those with Substantial Control are any of the senior officers (think the C-Suite), directors, managers (of a limited liability company) or other persons that direct the actions of the reporting entity (e.g., both the Mayor and Pumpkin King of Halloweentown). Ownership Interests can include stocks, profits interests, options, convertible options and everything in-between (Congress’ intent here being to cast a wide net). The entity also must provide information about any “Company Applicant” which means an individual (iii) who directly files the document that creates, or first registers, the reporting company; or (iv) is primarily responsible for directing or controlling the filing of the relevant document.

Each of these individuals – Beneficial Owners and Company Applicants – must provide several layers of personal information, including residential address and confirmed against government-issued identification such as a passport. (The process is not dissimilar to the invasive process of applying for a Real ID and uploading personal documents and information to the California DMV web site.) There is a procedure whereby an individual can obtain a unique identifier number, thereby avoiding the need to constantly upload personal information on account of a variety of reporting companies. (Again, a real-life analogy is obtaining a unique traveler ID number for TSA PreCheck or Global Entry.)

Before you become too spooked about the invasion of privacy, FinCen has provided another layer of exemptions which may give your entity an exit. In general, these exemptions reflect entities that are already subject to heavy reporting and disclosure requirements with the federal government. Such entities would include companies whose securities are already registered or required to report to the Securities and Exchange Commission; entities established under the laws of the United States, a State or a political subdivision thereof and exercising governmental authority on behalf of the same; banks and related entities; brokers/dealers; certain investment companies and insurance companies; public accounting firms; political organizations formed under Internal Revenue Code (Code) section 527; and entities formed under Code section 501(c) which file publicly-available Form 990 returns with the IRS (e.g., 501(c)(3) charities and educational institutions; 501(c)(4) social welfare organizations; 501(c)(5) labor, agricultural, and horticultural organizations; 501(c)(6) business leagues and trade organizations; and 501(c)(7) social clubs).

But be warned – subsidiaries of exempt entities do not automatically qualify for their parent’s exemption. For example, in the case of a government instrumentality, the subsidiary is only entitled to the exemption if it also performs an essential government function. So, if the subsidiary houses the headquarters “nerve center” of the government instrumentality, it would likely also be exempt; however, if the subsidiary holds an investment property, then it might not. There are workarounds available (such as forming the subsidiary as a 501(c)(25) title holding company which would then qualify for the exemption for 501(c) entities); however, one must evaluate the circumstances individually for each potential subsidiary.

Perhaps the exemption of widest use will be the one for a “large operating company”. This is a company

  1. with an operating presence at a physical office in the U.S.;
  2. that has at least 20 full time employees in the U.S., and
  3. with more than $5 million in gross receipts or sales.

For purposes of tracking the number of employees for ii, the FinCen rules cross-reference to the IRS employee counting regulations (Treasury regulations sections 54.4980H-1 and 54.4980H-3) under the Code section 4980H “shared responsibility” employer requirements for health insurance coverage. As for iii, you will know if you meet the $5 million test based on your last filed tax return (e.g., Form 1120, 1120S or 1065). Therefore, new potential reporting entities probably will have to report to FinCen at least in their first year, regardless of whether they anticipate utilizing this exemption in the future, because they will not yet have filed a tax return. Further, FinCEN applies the $5 million gross receipts test on a “stand-alone” basis except in the case of corporations filing a consolidated return.

The “tragedy at hand” is that the burden of complying with the CTA filings will fall largely on those entities that are less prepared (and have less cash at hand ) to deal with it; namely, small corporations, limited liability companies and limited partnerships, and the entrepreneurs that stand behind them.

It’s unclear whether you will still need to file paperwork to claim or acknowledge the exemption, because as of October 19, 2023, FinCEN has not yet published the forms or made them available to the public. In fact, the “secure” network to interface the reports and store the data (having the somewhat ironic name of Beneficial Ownership Secure System, or BOSS) also is not up and running. FinCEN’s apparent lack of readiness, and short time horizon to work out the bugs, has caused some consternation in the industry regarding the federal government’s information technology and security capacities following the impending onslaught of filings. The penalties for failure to comply with the CTA filings are $500 per violation, up to $10,000, and a potential for two years in jail, and one hopes that the feds will take into account any lack of readiness at their end in doling out punishment.

We anticipate that much of the issues will be made clear in the coming months, as the fed is forced to roll out the network, website, forms and other practical details regarding the upcoming CTA filings. We will keep you updated as these changes roll out. After all, “Life’s no fun without a good scare!”

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