The Basic Ins and Outs of the Corporate Transparency Act

• Jurisdiction: United States,Federal
• Pages: 25
• Citation: Vol. 35 No. 2 Pg. 25
• Year: 2023
• Publication year: 2023

The Basic Ins and Outs of the Corporate Transparency ActNo. Vol. 35 Issue 2 Pg. 25South Carolina Bar JournalSeptember, 2023

By Matthew B. Edwards and D. Parker Baker III

The Corporate Transparency Act of 2021 is the largest increase in corporate reporting obligations in the last decade. With reporting obligations about not only the business but also the attorneys themselves, this increase in obligations directly impacts both business attorneys and many of their clients. The penalties for failing to comply are steep: there are civil fines of $500 per day and criminal penalties for willful failure to comply.

The Corporate Transparency Act (CTA) was passed as part of the William M. Thornberry National Defense Authorization Act, which Congress passed over the President's veto on January 1, 2021. The Act was an attempt by Congress to adopt European-style entity registration requirements. The goal of the legislation is to combat the use of "shell entities" used to help facilitate illegal activity, including money laundering, terrorism finance, tax fraud, and human and drug trafficking.^[1] The intended targets of the bill are drug dealers, money launderers and non-United States individuals hiding funds in American companies.^[2]

Since the bill passed, Treasury has made slow work of its required directive to promulgate regulations and put together the required computer systems to store confidential company and owner information. The original bill directed the Treasury to enact regulations relating to the CTA within a year, but the Treasury failed to do so.^[3]

This first delay pushed the effective date of the law back to January 1, 2024. As of July 2023, the Treasury has not taken any steps to further delay the implementation of the CTA. Therefore, attorneys and their clients should be ready to comply with the requirements of the Act before the end of this year. This article defines the key terms of the CTA and provides an overview of the law's requirements; identifies which companies are required to report the specified information and about whom those companies need to report such information; and finally, provides some recommendations for attorneys to help their clients comply with the requirements of the law. Please note that this article was finalized as of early July 2023, and there are still two sets of Final Regulations due from Treasury before the effective date of the Regulations in January 2024.

The General Framework of the Corporate Transparency Act and Important Definitions

The CTA requires "Reporting Companies" to provide certain specific information to the Financial Crimes Enforcement Network ("FinCEN"), a department of the Treasury, about the company itself, the "Beneficial Owners" and the "Company Applicants." This framework effectively requires each nonexempt company to report information about individuals who own the company, individuals who serve in important positions within the company, and individuals who formed the company. The specific due date of this information depends on the formation date of the company. When the Act becomes effective on January 1, 2024, all new entities formed on or after that date must report the required information within thirty (30) days of the entity's creation.^[4] However, if the entity was formed before January 1, 2024, then the first report is due no later than January 1, 2025.^[5]

Reporting Companies

First, the Act requires certain entities, known as "Reporting Companies," to disclose certain information. A "Reporting Company" is any corporation, limited liability company (LLC), limited partnership (LP), or "other similar entity" created by the filing of a document with the Secretary of State or similar office under the law of a state or Indian tribe.^[6] The focus is whether the filing of some document creates the entity; businesses formed without the filing of a document with a state or Indian tribe, such as general partnerships and sole proprietorships, are exempt from the definition.^[7] Also, according to the definition of a Reporting Company, there are 23 exceptions, which fall into three general categories.^[8] First, entities with significant disclosure obligations, such as banks, insurance companies, and registered investment advisors, comprise most of the exceptions.^[9] Second, the Act outlines exceptions for tax-exempt entities, such as charities, charitable trusts and political organizations.^[10] Finally, there is an exception for "Large Operating Companies."^[11]

The most important exception is the "Large Operating Company" exception, which has three requirements. First, the entity must have an operating presence at a physical office within the United States.^[12]Second, the entity must have at least twenty (20) full-time employees in the United States.^[13] Third, the entity must have filed an income tax or information return demonstrating at least five million dollars in gross receipts from US sources.^[14]It is important to note that these requirements are determined as of the report's filing date, and FinCEN does not allow any averaging of these figures.^[15] Furthermore, the duty to keep the reporting information current requires the company to update the report within 30 days (discussed further below). Therefore, any time a company falls below the employee or receipts threshold, it becomes a Reporting Company and subsequently triggers reporting obligations. Attorneys advising clients close to either threshold should make these clients aware that while they are not currently required to report any information, a sudden change in the business or economic conditions could subject them to reporting obligations.

Beneficial Owners

Next, the Reporting Company is required to report certain information about the company's "Beneficial Owners." A "Beneficial Owner" is any individual who, either directly or indirectly, owns at least 25% of a Reporting Company or exercises "substantial control" over a Reporting Company.^[16]

The ownership prong can be met through ownership of a wide variety of financial instruments and arrangements. First, ownership includes equity, stock, or similar instruments regardless of their transferability, classification as stock or conferment of voting power, as well as capital or profit interests in an entity.^[17] Second, ownership includes any instrument that can be converted into shares or instruments described in the first two categories, including warrants, rights or futures.^[18] Furthermore, options, privileges or arrangements to buy or sell the aforementioned items are also considered ownership interests, except for those created and held by third parties without the Reporting Company's knowledge or involvement.^[19] Lastly, the definition of ownership interest encompasses any other instrument, contract, arrangement, understanding, relationship or mechanism used to establish ownership.^[20]

Direct or indirect ownership may be used to satisfy the ownership prong. The regulations provide that an individual will be deemed to indirectly own any interest owned through a nominee, intermediary, custodian or agent.^[21]Additionally, individuals holding an interest in a trust can be deemed to indirectly own interests owned by such trust. The Act will regard the individual trustee or any other individual as controlling the ownership interest that the trust owns if that trustee or other individual has the authority to dispose of trust assets.^[22] Additionally, a beneficiary who is the sole permissible recipient of income or principal from the trust or has the ability to withdraw a substantial portion of the trust's assets is also considered as owning an ownership interest.^[23] Finally, a grantor of a revocable trust with the right to revoke the trust or withdraw assets is deemed to hold an ownership interest.^[24]

The second...