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Legislation to Watch: Corporate Transparency Act

Legislation to Watch Corporate Transparency Act Columbus, OH

There is a major change on the horizon that will impact filing requirements for the vast majority of our small business clients. In January of 2021, Congress passed the Corporate Transparency Act (CTA), which amended the Anti-Money Laundering Act of 2020 (AMLA), to crack down on the use of shell companies to launder money.

You may be wondering, what does money laundering have to do with my small business? Unfortunately, shell companies are often used to hide who really owns a business and ultimately to hide assets, whether for tax evasion, to fund terrorism or other criminal activities, or to evade other financial obligations like child support. The CTA will require “reporting companies” to provide information about the “beneficial owners” of the company to FinCEN (the U.S. Treasury Department’s Financial Crimes Enforcement Network).*

What is a “Reporting Company” under the Corporate Transparency Act?
The CTA defines a “reporting company” as:

  • Any corporation, limited liability company, or other entity created by filing a document with the secretary of state; OR
  • Formed under the laws of a foreign country and registered to do business in the U.S.

This definition encompasses nearly every business in the U.S., regardless of size. There are some exceptions, but many of these will not be applicable to our small business clients:

  • Publicly traded companies
  • Companies with more than 20 full-time U.S. employees, operating from a physical office in the U.S., AND whose tax return demonstrates more than $5 million in gross revenue (For these purposes, a physical office will not include a residence or space sharing arrangement, unless the space is only shared with affiliated entities.)
  • Dormant companies which have been in existence for more than 1 year, who are not actively engaged in business, AND who are not owned (directly or indirectly) by a non-U.S. individual
  • Businesses in certain heavily regulated industries, such as banks and insurance companies
  • Tax-exempt organizations

Who is a “beneficial owner” under the Corporate Transparency Act?
A “beneficial owner” is any individual who directly or indirectly exercises “substantial control” over the reporting company OR holds or controls at least a 25% ownership interest in the company.

Under the proposed regulations implementing the CTA, the goal is to identify the individuals who are behind each company and have the ability to direct its actions. Thus, the regulations consider whether an individual:

  • is a senior officer;
  • has the authority to appoint or remove senior officers or a majority of the board of directors (or similar governing body);
  • Directs, determines, decides, or has substantial influence over important matters, i.e., selling, leasing, or transferring company assets, entering into or terminating company contracts, investing company funds or making major expenditures, or setting compensation for senior officers; or
  • Has “[a] ny other form of substantial control over the reporting company.”

Similarly, the proposed regulations define “ownership interest” as broadly as possible. This will include any interest in a business entity, no matter how defined (including options to acquire an interest), as well as ownership interests in another entity that you control. Thus, layering your ownership interest in a business in multiple other business entities or holding your interest in a trust will not allow you to hide your identity or interest in the business. Nor will you be able to divide up your ownership interest into multiple different forms to get below the 25% threshold. Your true interest in the business must be aggregated to determine whether you have a large enough stake to be reported.

The only individuals that will not be treated as a “beneficial owner” for reporting purposes are:

  • Minors (instead, the parent or guardian must be reported);
  • Employees acting solely as employees and not as senior officers;
  • Individuals whose only interest is a future interest through inheritance rights; and
  • Creditors of a reporting company.

What information will I have to report under the Corporate Transparency Act?

The CTA will require reporting companies to provide each beneficial owner’s full name, date of birth, residential or business street address, and a unique identifying number from a government-issued (non-expired) form of identification (i.e., a passport or driver’s license number). Reporting companies will also be required to report the business’s name (and any alternatives such as DBAs), business street address, jurisdiction of formation, and unique ID number such as the EIN.

Under the proposed regulations, this information will also have to be reported by “company applicants,” i.e., the individual who files the formation document with the secretary of state. While so-called formation agents, i.e. attorneys, accountants, or online business formation services that regularly file formation documents for their clients/customers, will be able to use their business address, it appears that most other beneficial owners will be required to report their residential street address.

The proposed regulations also suggest that FinCEN may require reporting companies to upload a scanned copy of each beneficial owner’s identification document to create a useful database for law enforcement.

When will my business have to register under the Corporate Transparency Act?

The final timing of the new registration requirements will depend on when the final regulations are implemented by the Treasury Department. FinCEN released its proposed regulations on December 7, 2021, but we don’t yet know when the regulations will be finalized or whether there will be any significant changes from what we’re reporting here. But under the current proposed rules, new companies will have to file their initial report within 14 calendar days of the company’s formation. Existing companies will have 1 year from the effective date of the regulations to comply. And corrected reports will be due within 30 days of the date on which the company becomes aware of or has reason to know that anything in the report has changed, including, for example, a member withdrawing from an LLC or the death of a business partner. (Inaccuracies in a report must be corrected within 14 days.)

What are the implications for small businesses?

  • Major Penalties for Non-Compliance: The CTA will impose a penalty of $500 per day for individuals who fail to comply with the reporting requirements. The CTA also contemplates a $10,000 criminal fine and imprisonment of up to 2 years for individuals who willfully provide or attempt to provide false or fraudulent information or willfully fail to comply with the regulations.
  • Business Partner Disputes and Divorces: Compliance with FinCEN registration could potentially be used as evidence in the event of a dispute over who actually owns a business or whether one of the business partners had in fact left the business. It will be incredibly important to maintain the accuracy of your business’s FinCEN registration when the identity of your business partners changes, or if you find yourself needing to withdraw from a business for any reason.
  • Banking: It would not be surprising if banks begin requiring small businesses to show proof of compliance with the CTA prior to opening a business bank account or before changing information on the account, i.e., who has an ownership interest in the business and therefore should have access to the account. Compliance with the CTA will likely be used to assist financial institutions in meeting their due diligence requirements under so-called “Know Your Customer” regulations.

​We will continue to monitor how this impacts our small business clients and what the next steps will be. In the meantime, this is a good time to make sure your company operating agreement and other corporate documents accurately reflect the ownership interests in the business, and while you’re at it, consider whether those documents need legal review and/or updating.

​*Access to the FinCEN database will be limited to federal government agencies, state and local law enforcement (with a court order), and financial institutions (with the reporting company’s permission or to investigate fraud). To be clear, while there are some obvious privacy concerns, this information is not expected to be publicly available or even subject to Freedom of Information Act requests. And the American Bar Association has raised concerns about the apparent requirement for business attorneys to report potentially sensitive information about their clients.

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