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What you need to know about the Corporate Transparency Act

On Behalf of | Apr 6, 2023 | Business Law

The federal government is changing the way we launch new businesses.

Acting under the belief that too many criminals are using anonymous shell companies as a mask, Congress adopted the Corporate Transparency Act. The CTA requires most businesses to make an initial filing with the Department of Treasury’s Financial Crimes Enforcement Network, plus additional filings when ownership changes occur. The FinCEN filing will confidentially inform various federal agencies and (under limited circumstances) state agencies as to who owns and controls the entity.

The regulations, promulgated September 30, 2022, will take effect on January 1, 2024.

For a small business owner, this new obligation is likely to require between one and three hours of a professional’s time. The burden will be substantially greater for a real estate portfolio, which potentially controls hundreds of LLCs. Congress determined that this burden is worthwhile, in order to combat money laundering, organized crime, and foreign governments that cloak their financial transactions through a web of shell companies. Perhaps the greatest risk is to an owner/manager who is not paying attention to CTA and its regulations. That person will face severe penalties ($10,000 fine and up to 2 years in prison) for noncompliance.

Now that the regulations are final, here is what you need to know about the CTA:

  • Key Concepts
    • What is a “reporting company” – This determines what entities must take action.
    • What is a “beneficial owner” – This determines whose personal information will be submitted to FinCEN.
  • What is a “reporting company”
    • In general – Any entity that is formed by a filing with a Secretary of State, and certain foreign entities
    • Exceptions – There are a lot of exceptions, and one should take the time to read them at 31 USC 5336(a)(11)(b). Here are the most noteworthy exceptions:
      • Entities that are not created by a filing with a Secretary of State – General partnerships and trusts fall into this exception.
      • Publicly traded companies
      • Bona fide operating companies – This applies if you can establish these three facts: (1) you have more than 20 employees, (2) you had more than $5MM in gross receipts in the previous taxable year, and (3) you have a physical office in the United States.
      • Dormant entities – This applies if the entity is not engaged in active business, is not owned by any foreign person, holds no assets, and has not in the past 12 months either had a change in ownership or a transfer of funds exceeding $1,000.
      • 501(c)(3) nonprofits
  • Who is a “beneficial owner”?
    • Someone who either owns 25% of the entity or exercises “substantial control” of the entity
      • Ownership –
        • Defined as broadly as possible, including convertible debt, profits interests, options, and joint venture interests.
        • Where the regulations don’t give an answer with reasonable certainty, then any person who holds 25% or more of any class or type of interest is a beneficial owner.
      • Substantial control – The regulations contain many different pathways:
        • Senior officers, and anyone who has authority to appoint a senior officer or a majority of the board
        • Someone who directs major decisions
        • A holder of majority of voting rights
        • Any other contract, arrangement, understanding, relationship, or otherwise
    • Excludes minor children, nominees, employees acting solely as an employee, and creditors
  • What’s in the report?
    • Information about the entity
      • Company name, plus any DBAs
      • Company address
      • Tax identification number. (This may incentivize disregarded entities to obtain EINs.)
    • Information about each beneficial owner
      • Name, date of birth and address
      • An image of either the beneficial owner’s passport, driver’s license, or state-issued ID card
      • If a beneficial owner itself is exempt, then only the beneficial owner’s name is required
  • When is the report due?
    • If formed before 1/1/24 – Report due by 1/1/25.
    • If formed after 1/1/24 – Report due within 30 days after filing of new company is effective. (Each Secretary of State will be asked to remind filers of the CTA responsibilities.)
    • If entity loses its exemption after 1/1/24 – Report due within 30 days of loss of exemption.
    • If information within report changes – Updated report due within 30 days of the change.
    • If entity learns of an inaccurate report – Correct report due within 30 calendar days after person becomes aware or has reason to know of the inaccuracy.
  • Who can see the report?
    • Federal agencies engaged in national security, intelligence, or law enforcement activity, for furtherance of such activity
    • The IRS
    • State agencies, so long as the request is coupled with a court order
    • This author believes that parties to business transactions (i.e., a lender for a commercial loan) will request voluntary production of these reports to confirm authority and ownership
  • What are the penalties?
    • Penalties for failure to file, or filing a false report
      • $500 per day civil penalty
      • Fines up to $10,000
      • Up to two years in prison
    • Safe harbor – If you correct an innocent mistake on a filed report, within 90 days of the original filing, you are exempt from civil and criminal penalties.
  • What can I do now?
    • Make a list of all entities that you control or own. This will not necessarily match your tax return.
    • Place a note in your calendar for early January 2024 to connect with your lawyer to get this done — and to remember to comply with CTA on future-created entities.
    • Dissolve or merge any entities that are not being used. It’s a hassle, but much cheaper than a $10,000 fine.
    • Consider Series LLC structure (learn more on Series LLCs here), which is considered as “one” entity, albeit with the benefit of liability protection among various businesses/assets.

Attorney Michael R. Rasor assists business owners concerning formation of new entities and compliance with applicable laws. Reach him at [email protected].