The Corporate Transparency Act Requiring Reporting of Beneficial Ownership

BACKGROUND 

In 2021, the Corporate Transparency Act (the “CTA”) was enacted to substantially expand upon existing anti-money laundering (commonly referred to as “AML”) as well terrorism deterrence provisions under federal regulations.  For many years banks and other financial institutions and investment firms were required by federal AML regulations as well as the USA PATRIOT Act to maintain records, file reports and obtain identification from customers.

For most entities formed on or after January 1, 2024, the CTA requires the entity to electronically file a report with the Department of Treasury’s Financial Crimes Enforcement Network (“FinCEN”) containing information regarding the entity, those that formed the entity, and the beneficial owners of and those that control the entity. For 2024, the entities will have 90 days after they are formed to report; however, beginning in 2025 and going forward, that timeframe is reduced to 30 days.

For most entities formed before January 1, 2024, the information must be reported by January 1, 2025.

ENTITIES REQUIRED TO REPORT 

The CTA uses the concept of a “reporting company” to identify the entities required to report.  This term should not be confused with the same term often used to describe publicly held corporations which file reports with the Securities and Exchange Commission under the Securities Exchange Act of 1934 (in fact, most of those reporting companies are exempt under the CTA from filing).

Domestic Reporting Companies can be a corporation, limited liability company, or other similar entity that is created or qualified by filing a document with a state’s office (most commonly the Secretary of State) or a federally recognized Indian Tribe (for convenience, such offices are hereinafter referred to as a “Secretary of State”).

Foreign Reporting Companies are similar entities formed under laws other than of one of the United States which, to qualify to do business in a state (or on tribal lands), has filed a document with a Secretary of State.

Some entities are created by an agreement rather than by a filing with a Secretary of State.  These include trusts and partnerships (other than limited partnerships and general partnerships which, to qualify for limited liability, must file a document with a Secretary of State).  In addition to creating a trust by an agreement, trusts can be created by a Will or another estate planning device.  The fact that the trust must make a filing with the IRS to obtain a taxpayer identification number or file reports with the state’s charities division or with a court does not make them a reporting company.

ENTITIES EXEMPT FROM REPORTING

Some entities that would be either a Domestic Reporting Company or a Foreign Reporting Company may qualify for an exemption from filing reports and other obligations under the CTA.  The CTA exempts 23 specific types of entities.  Many of the exemptions are based on the entity already being subject to regulatory oversight.  These include:

• • Publicly traded entities which file reports with the Securities and Exchange Commission;
  • Banks and credit unions chartered with a state or the United States and their holding companies;
  • “Broker Dealers,” “Securities Exchanges” and “Clearing Agencies” as those terms are defined in the Securities Exchange Act of 1934;
  • Federally registered investment companies and investment advisers; and
  • Accounting firms, but only if they are registered with the Public Company Oversight Accounting Board (established under the Sarbanes-Oxley Act of 2002).

Certain of the remaining 23 exemptions are addressed below:

Exemption for Large Operating Companies. An entity qualifies for this exemption if all the following apply:

1. 1. The entity has more than 20 full-time employees in the United States;
   2. The entity has an operating presence at a physical location within the United States; and
   3. The entity reported more than $5,000,000 in gross receipts or sales on its prior year federal tax return, excluding gross receipts or sales from sources outside the United States.

Exemption for Inactive Entities. An entity qualifies for this exemption if all the following apply:

1. 1. The entity was in existence on or before January 1, 2020;
   2. The entity is not engaged in active business;
   3. The entity is not wholly or partially owned, directly or indirectly, by a non-U.S. person;
   4. The entity has not experienced a change in ownership in the prior 12-month period;
   5. The entity has not sent or received funds in an aggregate amount greater than $1,000 in the prior 12-month period; and
   6. The entity does not otherwise hold any kind or type of assets, whether inside or outside the United States, including ownership interest in any corporation, LLC, or other similar entity.

Exemption for Tax-Exempt Entities. An entity qualifies for this exemption if any of the following apply:

1. 1. The entity is an organization described in section 501(c) of the Internal Revenue Code of 1986, as amended (the “Code”) and exempt from tax under section 501(a) of the Code;
   2. Such a 501(c) organization which lost its tax-exempt status fewer than 180 days ago;
   3. The entity is a political organization (as defined in section 527(e)(1) of the Code that is exempt from tax under section 527(a) of the Code); or
   4. A charitable trust or a “split interest” trust (one that divides distribution between charitable and non-charitable purposes, such as a charitable remainder trust) described in paragraph (1) or (2) of section 4947(a) of the Code.

INFORMATION TO BE REPORTED TO FinCEN

With respect to the reporting company, a reporting company must provide to FinCEN:

• • its full legal name and any trade or assumed names under which it does business;
  • address of its current principal place of business in the United States;
  • the jurisdiction of formation or registration;
  • S. federal tax identification number (a “TIN”) (for a foreign reporting company which does not have a U.S. TIN, the identification number issued by the company’s foreign jurisdiction and the name of such jurisdiction is to be provided);
  • identification of each “beneficial owner” (see certain exceptions below); and
  • identification of each “company applicant” (see certain exceptions below).

With respect to each “beneficial owner” and “company applicant” listed on its report about the reporting company (note the exception stated below regarding reporting of company applicants for reporting companies before 2024), a reporting company must provide to FinCEN:

• • their full legal name;
  • their date of birth;
  • their street address (residential, except for company applicants who form entities as part of their business or employment, then the business address);
  • the unique identifying number and the issuer of a non-expired identification document; and
  • an image of such identification document such as:
    • U.S. passport
    • State driver’s license
    • Other Identification document issued by a state, local government or tribe; or
    • Non-U.S. passport if the individual does not have any of the foregoing.

Who are “beneficial owners” to be Reported?  A “beneficial owner” is an individual who:

• • exercises “substantial control” over the reporting company; or
  • owns or controls 25% or more of the ownership interest in the reporting company.

Who Exercises Substantial Control? An individual exercises “substantial control” if the individual:

• • is a senior officer of the reporting company (e.g., they are named or exercise the authority of chief executive officer, president, chief financial officer, general counsel, or chief operating officer);
  • has authority to appoint or remove any senior officer or a majority of the governing board of the reporting company (note, the governing board typically as a board appoints the senior officers and thus the reporting company would not identify each member of such board as a controlling person solely based on being part of the “committee” that appoints the senior officers);
  • is an “important decision-maker” able to direct or determine major matters affecting the reporting company (as with appointment of senior officers, the governing board would collectively be an important decision-maker; however, there needs to be an individual who singularly has the authority to make such decisions and not only as a member of the governing board); or
  • has any other form of substantial control over the reporting company (this is a situational “catch-all” whereby the individual has some sort of unusual allocation to them to control a material aspect of the reporting company).

Who owns a 25% or More Ownership Interest? An individual may hold or beneficially own an interest in the reporting company by way of:

• • equity interests in the company (which may be shares of stock of a corporation or management rights and rights to participate in the profits of a limited liability company or partnership);
  • right to vote equity interests in the company held by someone else;
  • rights to receive equity interests on conversion or exercise of the rights; or
  • any other right or arrangement that involves some “ownership” of the reporting company.

“Pealing the Ownership Onion.” Ownership structure in a reporting company may be complicated with intermediate levels of ownership by entities.  The CTA is ultimately seeking identification of individuals rather than entities that may be owners (looking for the “owner of the owner”).  Determination of levels of ownership will involve:

• • Preparing an ownership chart showing percentage of ownership by the intermediary holding entities in the reporting company;
  • Then showing the percentage ownership of the intermediary holding companies (this may involve multiple layers of intermediary holding companies);
  • Continue until the chart reaches the final “indirect individual owners;”
  • Based on the respective percentages in the reporting company and in the one or more intermediary holding company, determine the percentage held by the indirect individual owners (for example, if an intermediary holding company holds 75% of the reporting company and three individuals hold one-third of the intermediary holding company, then each is deemed to hold 25% of the reporting company); and
  • Determine if an indirect individual owner has ownership in more than one intermediary holding company, and if they do, then add their respective indirect holdings to determine their total indirect holdings (if we changed the above example from 75% to 60%, then the three indirect individual owners would each hold 20%, but if one of them was a 15% owner of the other intermediary holding company, that 15% of the 40% would result in an additional 6% bringing them to 26%).

Exceptions Excusing Identification of a 25% or more Owner. There are five exceptions which allow an otherwise reportable owner to not be identified:

• • when the owner is a minor under the applicable law of the minor’s residence, they may be omitted from disclosure until the reach the age of majority;
  • where the owner is acting only on behalf of the beneficial owner or as such beneficial owner’s agent, custodian or nominee (absent an exemption applying to the beneficial owner, such beneficial owner is likely to be a reportable beneficial owner);
  • where the ownership is due to being an employee of the reporting company, the individual is not a senior officer, and their ownership is solely related to such employment and would end upon the termination of such employment;
  • where the only interest is a future interest via an inheritance or pursuant to the terms of a trust (upon the ownership becoming owned by the individual, they would be reportable absent another exemption being applicable); and
  • a creditor with rights to acquire ownership if the debt obligation is not satisfied.

“Short Form Reporting” for Beneficial Owners and Company Applicants. An individual, who would otherwise need to have information about them, as well as an image of the supporting identification documents, filed by one or more reporting company, may request from FinCEN a FinCEN Identifier.  It is a unique identifying number for the individual which a reporting company may include in its report in place of the information and image of the identification document for a beneficial owner or company applicant.

Who are “company applicants” Subject to Reporting? A “company applicant” is an individual who files the applicable formation or registration documentation of the entity with the Secretary of State (as defined above) to bring the reporting company into existence or qualify it as a limited liability entity or, for a foreign reporting company, to do business in a state or within a federally recognized Indian Tribal land.

If another individual directs or controls the filing of such documentation, that individual must also be listed as a company applicant.

Exceptions Excusing Identification of a Company Applicant. If the individual would otherwise be a company applicant, they need not be identified if the entity is formed or first registered to do business within a state or upon land of a federally recognized Indian Tribe on or after January 1, 2024.  The reporting company, however, should make it clear in the report that the reporting company was organized before 2024.

HOW IS THE INFORMATION REPORTED?

FinCEN is to maintain an online reporting system which has been announced to begin accepting reports on January 1, 2024.  A reporting company may use a third-party service provider to submit the filings; however, such third-party will need to be provided with information to be submitted, which can be extensive should the ownership structure be complicated.

UPDATING INFORMATION

In addition to the filing of initial reports, reporting companies are to update and correct information.  The same applies to individuals who obtain a FinCEN identifier.  Updates to information are to be filed with FinCEN within 30 days of the change.  Death of a beneficial owner, however, may defer the report until the decedent’s “estate is settled.”

WHAT TO DO TO BE READY TO FILE?

In general:

• • For Potential Reporting Companies.  Determine if your entity qualifies for an exemption and, if you do, document your determination in the company’s record.
  • If You are Not Exempt:
    • Identify individuals who may be considered a beneficial owner and collect current information (and associated images of supporting identification documents) for those beneficial owners.
    • Develop a record keeping process to collect, store, monitor, and track information required for the CTA reporting (note, this includes updating passports and driver’s licenses when they are reissued as well as to report a previously exempt minor when they reach the age of majority).
    • Consider dissolving any inactive entities before December 31, 2023.
    • Consider forming a new entity before January 1, 2024, in order to delay CTA reporting.
  • If Your Business Involves Formation of What Will be Reporting Companies:
    • Have members of your staff obtain and maintain their FinCEN identifier.
    • Promptly after the FinCEN’s reporting portal is activated, become familiar with how to use it.

WHAT ARE THE PENALTIES FOR FAILING TO REPORT?

While there is no filing fee, failure to comply with the CTA and the related regulations may result in civil and criminal penalties. A violation could result in a civil penalty of up to $500 per day and criminal penalties of fines up to $10,000 or imprisonment for no more than 2 years, or both. The penalties may also apply to senior officers and directors of reporting companies that violate the CTA.