Business Owners In The Crosshairs--No Hiding From Intrusive New Registry

[EDITOR'S Note: This article detailing the highly intrusive aspects of the Corporate Transparency Act first appeared on April 1. The law becomes effective on Monday, January 1.]

The 2023 Heckerling Estate Planning Institute in Orlando, Fla., last January was cruising along in a relaxed manner when—CAZART!—the Corporate Transparency Act (CTA) fell out of the sky and landed on everyone's head like the anvil in a Road Runner cartoon. CRUNCH! What the heck was THAT?

CTA is a “corporate transparency” disclosure law that goes into effect on January 1, 2024, and boy, is it a doozy. The CTA requires detailed filings about the ownership and control of ALL small U.S. operating businesses and ALL closely held U.S. financial holding companies not specifically exempted.

Basically, if you are a person who is a 25% owner or who otherwise exercises “control” over any corporation, LLC or “similar entity” formed or registered with the secretary of state of any U.S. state, and your company is not expressly exempted from the reporting obligation, then your business entity is required to report you to the scarily named Financial Crimes Enforcement Network (FinCEN) to be added to a new national registry of entities, applicants and owners. Likewise, if you are a lawyer or other person who forms and files one of these entities for a client, you also need to be reported to FinCEN in your capacity as an applicant.

Weirdly, the CTA has been on the books since early 2021 but somehow got lost in the craziness of the Covid emergency. Everyone is just now beginning to focus on this sprawling and intrusive monstrosity. In effect, the longstanding right to keep stock ownership private and secret is being abolished—at least between the owners of small or closely held U.S. companies and the United States government.

The CTA is intentionally broad and disturbingly vague, enforced by a sobering set of civil and criminal penalties. The law is predominantly aimed at small operating businesses (those with less than $5 million of gross receipts and 20 or fewer employees) but also apparently addresses privately owned investment funds and other non-operating businesses that are not otherwise specifically exempted.

The devil is always in the details (further explained below), but the bottom line is this: If someone owns a small operating business with less than $5 million of gross receipts and 20 or fewer employees—which would include many financial advisors as well as their clients—then the business will need to report their personal information to FinCEN starting in 2024. FinCEN estimates that a whopping 32.6 million entities will have to file reports in the initial year (2024), and that about 5 million entities will have to file reports every year thereafter.

The CTA is a BIG DEAL.

The Justification
The rationale for CTA is to create a national beneficial ownership registry to combat the use of U.S. business entities for money laundering, tax evasion and the financing of terrorism. Back in 2014 under the Financial Accounts Tax Compliance Act (FATCA), the United States strong-armed the rest of the world into providing details about any U.S. taxpayer who owned a bank account or other financial account in a foreign country. FATCA forced large foreign financial institutions to report the financial accounts of U.S. taxpayers (who, in the meantime, were also subject to expansive U.S. reporting requirements backed up by draconian penalties). But during and after FATCA's implementation, foreign countries justifiably complained that U.S. corporations were famously non-transparent and that foreign individuals frequently used U.S. entities to hide assets and income (not to mention money laundering). CTA is essentially a massive response—and arguably a huge over-response—to these criticisms. Under CTA the United States is imposing a major new financial disclosure requirement on small private U.S. corporations (as opposed to one on large foreign financial institutions): It is FATCA for the little guy.

The CTA requires that, starting in 2024, certain legal entities (called “Reporting Companies”) must provide FinCEN with identifying information about individual owners and other persons who control each entity (“Beneficial Owners”) and also information about the persons (“Company Applicants”) such as lawyers and paralegals who participate in entity formation. A new national registry will be created to list all Reporting Companies, Beneficial Owners, and Company Applicants.

Reporting Companies
The legal entities required to report private ownership information to FinCEN include all corporations, LLCs, and other entities that are created by filing a document (e.g., Articles of Incorporation) with the secretary of state or similar office of a U.S. state or Indian tribe as well as all foreign entities registered to do business in the United States.

Given this broad definition, the exemptions become critical. Companies exempt from reporting include (1) various specified companies already under federal regulation (e.g., SEC-registered entities, governmental authorities, banks, credit unions, bank holding companies, insurance companies, organizations exempt from tax under Internal Revenue Code Sections 501(c) and 501(a), 527(a), or 4947(a), and certain other entities), (2) “large operating companies” with an “operating presence” at a physical office in the United States that employ more than 20 people and have gross receipts exceeding $5 million, and (3) certain entities not engaged in an active trade or business and essentially moribund (less than $1,000 of activity).  

Note: FinCEN agonized over the definition of “operating presence” and finally decided NOT to define that phrase in the CTA at all! Yes, your government dollars busily not at work. Therefore, it is not clear whether the exception for “large operating companies” applies to investment entities that engage solely in investment activities and do not carry on a “trade or business” within the meaning of the Internal Revenue Code.

Entities NOT created by filing a document with a secretary of state are outside the scope of the CTA. Such entities typically include general partnerships and sole proprietorships—but these entities are generally unpopular because they do not provide limited liability to owners. Likewise, trusts created under state law are not generally formed by filing with a secretary of state—although some observers question whether they might be considered a “similar entity” since they are generally created pursuant to a state statute and in some states file with the state courts. The current thinking is that trusts themselves are not yet on the hook, but the CTA calls for future study of partnerships, trusts, and other legal entities, so the other shoe may soon drop.

Note that even if private trusts are not currently classified as “reporting companies,” a trust will be subject to reporting as a Beneficial Owner if the trust holds 25% or more of a Reporting Company and/or if the trustees exercise “control” over a Reporting Company. A LOT of trustees will be among the Beneficial Owners reported to FinCEN in 2024, as well as many trust beneficiaries. The beneficiary reporting obligations include “if the beneficiary is the sole permissible recipient of income and principal from the trust, or if the beneficiary has the right to demand a distribution of, or withdraw substantially all, of the assets in the trust” or if the trust is a grantor trust.

Snide Aside: Charitable organizations (including private foundations) and political action committees or “PACs” are specifically exempt from the CTA reporting requirements. Congress concluded that these organizations can ALWAYS be trusted not to engage in financial shenanigans and fraud, but you cannot be. 

Beneficial Owner
For FinCEN reporting purposes the term “Beneficial Owner” means any individual who, directly or indirectly, either:

• exercises substantial control over a Reporting Company, or
• owns or controls at least 25% of the Reporting Company.

The final regulations provide considerable detail about who exercises “substantial control.” The list includes all individuals who:

1) are senior officers of the reporting company;

2) can appoint or remove any senior officer or a majority of the board of directors;

3) direct, determine or have “substantial influence” over important decisions made by the Reporting Company, including a) the sale, lease, mortgage, or other transfer of any principal assets of the Reporting Company, b) reorganization, dissolution or merger of the Reporting Company, c) major expenditures or investments, issuance of equity or incurrence of any significant debt, or approval of the operating budget, d) the selection or termination of the business lines or ventures, or geographic focus, of the Reporting Company, e) compensation schedule or incentive programs for senior officers, f) the entering into, fulfillment or termination of significant contracts, and g) the amendment of any substantial governance documents of the Reporting Company, including formation documents, bylaws or significant policies and procedures; and

4) has any other form of substantial control over the Reporting Company.[1]

The “direct or indirect exercise of substantial control” can include acting as a trustee of a trust and can be exercised through 1) Board of Directors representation, 2) ownership or control of a majority of the voting power, 3) right associated with any financing arrangement or interest in the Reporting Company, 4) control over intermediary entities that collectively exercise such control, 5) arrangements through nominees, or 6) any other contract, arrangement, understanding relationship, or otherwise.[2]

Note: Good luck trying to figure all this out in any moderately complicated corporate business arrangement where the participants have negotiated a sensible balance of power and control. FinCEN has assumed you can figure ALL this out on a budget of just $85—and surely your lawyers will be happy to cap their fees at this generous amount!

The term Beneficial Owner does not include: (1) minors who would otherwise be a Beneficial Owner (provided the parent or guardian’s information is reported), (2) nominees, intermediaries, custodians, or agents, (3) an employee (other than a senior officer) whose substantial control over or economic benefits from the Reporting Company are derived solely from employment, (4) an individual whose only interest in the Reporting Company is a future interest through a right of inheritance, and (5) a creditor of a Reporting Company.[3]

When a trust either holds a 25% or greater interest in a Reporting Company or otherwise exercises substantial control, the persons treated as Beneficial Owners include (1) the trustee(s) or any other individual (if any) with authority to dispose of trust assets, (2) a trust beneficiary who either (a) is the sole permissible recipient of income and principal or (b) can demand distribution of or withdraw substantially all of the trust assets, and (3) a trust grantor or settlor who has the right to revoke the trust or otherwise withdraw all of the trust assets.[4] The final regulations confirm that multiple parties may be Beneficial Owners of a trust.[5]

Company Applicants
Perhaps the most intrusive element of this obnoxious law is the requirement that Reporting Companies must also report the “Company Applicant,” who is the individual that files the document that creates the entity. The IRS for years has sought to identify “rogue preparers” who file inaccurate (meaning intentionally fraudulent) tax returns for numerous clients, and often audit many or all of a rogue preparer’s customers. In this vein, the CTA is looking to make connections through the lawyers and other parties that form entities. 

The definition of Company Applicant is as follows:
1. For a domestic reporting company, the individual who directly files the document that creates the domestic reporting company …;
2. For a foreign reporting company, the individual who directly files the document that first registers the foreign reporting company …; and
3. Whether for a domestic or a foreign reporting company, the individual who is primarily responsible for directing or controlling such filing if more than one individual is involved in the filing of the document.[6]

Note: The original proposed definition of Company Applicant was so broad that it was unclear whether it included paralegals, secretaries, legal assistants, lawyers and/or whole law firms! The final definition is supposedly intended to narrow the definition of Company Applicant to only one or two individuals. The preamble to the final regulations provides as an example that the attorney “primarily responsible” for overseeing the preparation and filing of incorporation documents and the paralegal who “directly files them” with a state office to create the Reporting Company would be the two Company Applicants reported.[7] (The legal secretaries and mail room clerks are off the hook, at least for now—whew!)

FinCEN originally a considered requiring the names of Company Applicants for all Reporting Companies, including entities formed decades or even hundreds of years ago, which would have been genuinely crazy, but the final regulations narrowed the reporting requirement to Company Applicants of Reporting Companies formed on or after January 1, 2024. The final regulations also eliminated the need to update Company Applicant information, so information about Company Applicants is only due in the initial report.

Beneficial Ownership Information Reports
In its initial Beneficial Ownership Information Report (“BOIR”), the Reporting Company must identify its full legal name, any trade name or “doing business as” name, current address, jurisdiction of formation, and IRS taxpayer identification number, and must report four pieces of information about Beneficial Owners (and, for companies created on or after January 1, 2024, about the Company Applicants who created the entity): (1) full legal name, (2) birthdate, (3) complete current address, and (4) a unique identifying number and the issuing jurisdiction from one of the following identification documents: a) a non-expired passport issued by the U.S., b) a non-expired state, local government, or tribal identification document, c) a non-expired driver’s license from a U.S. state, or d) if you have none of the preceding three, then a valid foreign passport, together with an image of the applicable document from which the identifying number is obtained.

To simplify this staggeringly burdensome procedure, the regulations provide that if an individual provides the four required pieces of information to FinCEN directly, that individual can obtain a “FinCEN Identifier,” which can then be provided to the Reporting Company for inclusion in the BOIR in lieu of endless deliveries of repetitive information.

Note: As an attorney who typically forms dozens of new Reporting Companies each year, the Author has almost no choice but to obtain a FinCEN Identifier for himself (and also for any paralegal he uses) to include in the BOIRs that he then anticipates helping clients prepare and file. The amount of additional time and paperwork this BOIR requirement entails just to set up a series of new and usually poorly capitalized startup businesses is genuinely concerning.

FinCEN is notably defensive about the burden of these CTA filing obligations, and the final regulations include a very detailed set of cost estimates. For companies with simple management and ownership structures—which FinCEN estimates to be about 59% of reporting companies—the alleged cost will be approximately $85 apiece; for intermediate structures it will be $1,350.00 per report; and for complex structures will be $2,614.87 per report. [8]

Comment: Maybe these estimates are accurate, but permit me a degree of doubt. Many new business entities are formed before the parties have even agreed on who will ultimately be owners, who will contribute money versus services, and other fundamental structuring information necessary to evaluate Beneficial Ownership status. This seems like a huge time suck of the first order for many startup companies. 

The Reality Of Filing A Report
The question not answered by FinCEN’s 99 pages of final regulations is “Who the heck is going to file all these reports?” Someone has to evaluate the ownership structure, chase down the owners, ask for addresses and birthdates and copies of their passport and driver’s licenses, and then put together the BOIR accurately and file it within 30 days after filing of the Articles of Organization. My best guess is that the poor sucker who is going to be assigned this task will be the Company Applicant—which is to say, folks like me.

At the moment I advise clients that I can set up a corporation or a limited liability company in less than an hour, using a corporate services intermediary to file in Delaware or Massachusetts (or elsewhere if required), after which we can pull an EIN number from the IRS website, open a bank account, and have the new business up and running in a day or so. But in many cases the clients have not even figured out who the owners are yet, who will hold the offices or management positions, and certainly not the final ownership percentages. Getting all that straightened out, and then documented and filed in 30 days is going to make the formation process dramatically more time consuming and—at lawyer’s hourly rates or even at paralegal’s hourly rates—a heck of a lot more expensive than $85.

It gets worse and quickly. In most startup companies, the owners want to minimize legal and other expenses and therefore are likely to “volunteer” to file the BOIR themselves. Great. What are the chances they will make a mistake interpreting the “substantial control” test—maybe intentionally, because they don’t want to name themselves in the BOIR, or even through a good faith mistake? How many mistakes would it take for FinCEN to decide that this particular lawyer/Corporate Applicant needs a little further investigation—as well as every other client in the lawyer’s practice? I predict that some lawyers may decide NOT to help set up new business entities, and maybe refer that task to someone whose practice evolves into a professional Company Applicant. This law is likely to have a far-ranging impact on the practice of law—and that is before we even begin to talk about client confidentiality issues.

Effective Date
The law was originally supposed to take effect in 2023! But the final regulations now provide an effective date of January 1, 2024. This delay was deemed necessary to provide time needed for secretaries of state and reporting companies to understand, receive notice of, and comply with the new rules. It also gives FinCEN time to design and build the Beneficial Ownership Secure System (BOSS) as a national registry of the reported information and to seek appropriated funds to implement the new rules.

Filing Due Dates
Reporting Companies in existence on January 1, 2024, have one year to file the Report—meaning by January 1, 2025.

Reporting Companies created on or after January 1, 2024, must file the BOIR within 30 days of the “earlier of the date on which it receives actual notice that its creation has become effective or the date on which a secretary of state or similar office first provides public notice, such as through a publicly accessible registry, that the domestic reporting company has been created.”[9]

Updated And Corrected Reports
An Updated Report must then be filed for any change to information previously reported concerning a Reporting Company or its Beneficial Owners within 30 days after the change occurred. A Corrected Report must also be filed to report any inaccuracies in a prior report within 30 days from when the Reporting Company becomes aware or has reason to know of the inaccuracy.[10]

Practical Observation: The filing of an initial BOIR is a quantum leap in the paperwork burden of forming a business entity in the United States, and chasing down the drivers’ licenses or passports and other information will be a huge hassle. But then requiring Beneficial Owners to report to FinCEN each time they move within 30 days of such move seems guaranteed to create massive non-compliance. Just look at the penalties described below and one can immediately foresee the entirely predictable non-compliance mess that is going to be created.

Penalties
Willful failure to report complete or updated beneficiary ownership information will make you liable for a civil penalty of not more than $500 for each day that the violation continues or has not been remedied, and you may be fined not more than $10,000, imprisoned for not more than two years, or both.[11] Any person who willfully provides false ownership information is subject to similar penalties. The final regulations make clear that individuals who supply information to Reporting Companies may have liability if that information is false or fraudulent:

“The accuracy of the database may therefore depend on the accuracy of the information supplied by individuals as well as reporting companies, making it essential that such individuals be liable if they willfully provide false or fraudulent information to be filed with FinCEN by a reporting company.”

Security Of The Database
CTA also provides that penalties can be imposed on anyone who makes an unauthorized disclosure of information about Applicants or Beneficial Owners.[12] However, to be candid, the security and trustworthiness of the federal government in keeping secrets has not been overly impressive in recent years. All kinds of appallingly unethical disclosures have gone uninvestigated and/or not successfully prosecuted, and a database this large and with this level of highly sensitive information is ripe for abuse. A realistic concern is that distrust of this system may start at a relatively high level and grow worse, leading to a cascade of non-compliance.       

The Man From U.N.C.L.E.
To me, the Financial Crimes Enforcement Network sounds eerily similar to the United Network Command for Law Enforcement—U.N.C.L.E.—the fictitious multi-national secret intelligence agency invented by the iconic 1960s television show “The Man from UNCLE,” starring Robert Vaughn as American sleuth Napoleon Solo and David McCallum as his Russian counterpart Illya Kuryakin. The show was aired during the Cold War but had a strikingly anti-Cold War premise: There was an organization called THRUSH that was bent on conquering the world and was so terrible that even the Americans and Russians agreed to cooperate and work together to fight these bad guys. According to the U.N.C.L.E. novels by David McDaniel, THRUSH stood for Technological Hierarchy for the Removal of Undesirables and the Subjugation of Humanity. They were definitely the bad guys.

In that more trusting era, it was easy to imagine that a large inter-governmental investigative agency could be created to fight the bad guys—and not actually be the bad guys. In these more cynical times—and especially given the monumentally intrusive nature of the CTA—it seems to me that presumption is far less automatic.

Joseph B. Darby III, Esq., is an adjunct professor at the Boston University School of Law and the founding shareholder of Joseph Darby Law PC, a law firm that concentrates on sophisticated tax and estate planning for individuals and businesses.