The Corporate Transparency Act: Summary and Key Observations
By Michael Sciascia and Tyler N. Ballew
On January 1, 2021, Congress passed into law the 2021 National Defense Authorization Act, which incorporated the passage of the Corporate Transparency Act (CTA). The CTA seeks to combat the laundering of criminal proceeds and other illicit funds through anonymously-governed business entities by requiring the disclosure of certain information to the Department of the Treasury’s Financial Crimes Enforcement Network (FinCEN). The U.S. has previously faced criticism from the Financial Action Task Force on Money Laundering, an international watchdog group, for failing to enact such safeguards. All European Union countries are presently subject to similar requirements.
Once promulgated, new reporting requirements will have the largest impact on small businesses and businesses that make frequent use of single-member special purpose entities, including real estate and renewable energy developers. The additional paperwork burden can be tempered in the forthcoming regulations by incorporating the reporting requirements into existing required state and federal filings, like tax returns or other annual corporate reports.
The CTA directs the Treasury to issue regulations implementing its provisions by no later than January 1, 2022. Once the Treasury has done so, each corporation, limited liability company, or “similar entity” that is either formed in or licensed to do business in the United States (each a “reporting company”), unless otherwise exempt, will be required to file reports with FinCEN identifying all individuals that either (1) directly or indirectly exercise “substantial control” over the reporting company or (2) own 25% or greater of the ownership interests of the reporting company, unless otherwise exempt (each a “beneficial owner”).
Beneficial owners must be real persons identified by name, address, date of birth, and a unique identification number, such as a driver’s license or passport number. Similarly, individuals filing to form or register a new reporting company (“applicants”) must be identified to FinCEN to these same standards. Companies frequently go through similar reporting or “know your client” obligations in connection with establishing bank accounts or other banking transactions. The CTA extends that type of beneficial owner reporting for federal tracking.
Reporting obligations will exist both at the point of formation or registration and annually to reflect changes in ownership status. The CTA imposes civil and criminal penalties for willful violations, including fines of up to $10,000 and up to two years in prison. Negligent violations, such as honest paperwork errors, are not punishable.
Who Must Report? And Who Must Be Reported?
The CTA includes exemptions for the types of entities required to file reports and the types of individuals that must be disclosed. These exemptions largely define the CTA’s overall scope notwithstanding the uncertain nature of the forthcoming implementing regulations.
Exempt entities include, among others, (1) those that file redundant reports with other agencies, such as publicly-traded companies who file relevant information with the SEC, and (2) those that are viewed as “lower risk,” such as private companies with demonstrable physical operations in the United States and more than 20 employees, government agencies, most financial services institutions, and nonprofit organizations. An individual is exempt from the term “beneficial owner,” and does not need to be reported if they are (1) a minor, (2) an individual acting on behalf of another as a nominee or other agent, (3) an individual acting as an employee whose control is derived solely from employment status, (4) an individual whose only interest in the entity is through inheritance, or (5) a creditor of the entity. Further, the Treasury is permitted in its forthcoming regulations to exempt other entities or entity classes, after approval from the U.S. Attorney General and the Department of Homeland Security, where their reporting would not serve the public interest.
While the precise scope and application of the CTA will be later addressed by the Treasury’s forthcoming regulations, clients potentially subject to its reporting requirements should be aware of the connected responsibilities and continue to monitor their own internal processes to ensure their ability to comply with the program and absorb necessary administrative burdens. Most small businesses should especially be aware given their likely non-exempt status under the CTA. Though exempt from reporting, financial institutions should also prepare to alter their due diligence processes in order to remain in conformance with the CTA.
While government regulations often target large players and exempt small ones, preventing money laundering requires an inverse reporting burden as smaller, less visible companies are better able to hide their activities. Unfortunately, this adds a layer of compliance obligations on small businesses. Hopefully, the implementing regulations will structure reporting procedures that make these obligations less burdensome, such as allowing the initial reporting to be included as part of state entity formation filings, with ongoing reporting wrapped into annual tax filings.