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Beneficial Ownership Reporting Under the Corporate Transparency Act

March 9, 2021

By

Thomas E. Rutledge, Member
Stoll Keenon Ogden PLLC
(502) 560-4258
thomas.rutledge@skofirm.com

You may be surprised to learn that Title 64 of the National Defense Authorization Act of 2021 is titled the “Corporate Transparency Act.” While you and your business typically are not directly affected by the annual defense appropriation bill, most closely held businesses will be impacted by this new law, which will require a new federal filing disclosing the “beneficial owners” of your business. 

Under the Corporate Transparency Act (the “CTA”):

  • The Treasury Department has one year to issue implementing regulations;
  • Once those regulations are effective, nearly every newly organized corporation, limited liability company or “other similar entity” upon formation must file information as to its “applicant,” i.e., the person who files the formation documents with the Secretary of State and each “beneficial owner,” i.e., each person who owns 25% or more of the entity and each person who exercises “significant control” over the entity;
  • Within two years after the effective date of the regulations, every existing corporation, LLC or “similar entity” that is a “reporting company” must file a similar report; and
  • Thereafter, unless the Secretary of Treasury elects to require a shorter window, each entity must within one year report any changes in its beneficial ownership.

These filings will be made with the Financial Crimes Enforcement Network of the Department of the Treasury (“FinCEN”) and maintained in a database. Dormant companies are exempt from having to file a report of beneficial ownership, but that exemption lasts only so long as the company does not engage in activity and there is no change in its beneficial ownership.

These requirements apply not only to entities organized in the United States, but also to non-US entities that qualify to transact business.

Who Is and Is Not a “Reporting Company”?

The statute contains a long list of classes of entities, e.g., publicly traded entities, banks, registered broker-dealers, and utilities, that by the nature of their business are exempt from the beneficial ownership reporting requirements. Most are in or related to the financial services industry and are already subject to oversight as to their ownership and senior management. Accounting firms are exempt only if they are registered with the Public Company Accounting Oversight Board.

In addition to the companies that are exempt from the reporting requirement due to the nature of their business, companies that satisfy all of the following requirements are exempt:

  • More than $5 million in revenues in the prior year;
  • More than 20 employees; and
  • A physical presence in the United States.

The $5 million revenue threshold is determined by reference to the prior year’s federal income tax return. Because a newly formed business will not have filed a federal income tax return, even if it has a physical presence, more than 20 employees and recognizes more than $5 million of revenue in its first year, it will at formation still be subject to “reporting company” requirements. Also, certain businesses operated as LLCs taxed as partnerships are not required to file a tax return. Whether and how those companies can satisfy this requirement will hopefully be addressed in the regulations.

The statute does not specify how or when the 20 employee element is to be measured. We will be asking that the regulations to be issued by the Treasury Department address this point.

An interesting point as to the 20 employee threshold is how many companies it will sweep into the beneficial ownership reporting requirement. Generally, the Small Business Administration treats as a small business any venture with 500 or fewer employees, which businesses total some 28.43 million in number. Of that total, 88% have 20 or fewer employees. Thus, some 25 million companies will not be able to use this exemption from beneficial ownership reporting.

Who Is a Beneficial Owner?

A beneficial owner is an individual, i.e., a natural person, who directly or indirectly either:

  • Exercises “substantial control” over the entity; or
  • Owns 25% or more of the entity.

We will be seeking significant clarification of these requirements. Open questions include:

  • What constitutes “indirect” control or “indirect” ownership;
  • What does it mean to exercise “substantial control,” example being whether the mere ability to preclude a quorum constitutes substantial control; and
  • Explanation as to what it means and how there is to be measured 25% of an entity.

What Is Filed in the FinCEN Database?

For each “beneficial owner” (which, remember, includes both the applicant and each “beneficial owner”), there must be reported to FinCEN:

  • Full legal name;
  • Date of birth;
  • Business or residential address; and
  • Unexpired driver’s license or passport (or FinCEN identifier) number.

Penalties

The statute imposes fines of $500 a day (measured from a date not yet determined) with a cap of $10,000 and two years in prison in connection with any “willful” failure to file. We do not know how that will work. The obligation to file is upon the reporting company, and a corporation or LLC is not subject to being thrown into jail. These penalties also apply to beneficial owners who willfully provide false information to a reporting company. A curious gap in the statute is that it does not expressly require beneficial owners to provide to the reporting company the information required to make the required report; most companies are not going to have the driver’s license or passport numbers of shareholders and members. Yet another point that will hopefully be addressed in the regulations.

Access to the Beneficial Ownership Database

The beneficial ownership database will be maintained by FinCen and is not to be made publicly available. The CTA imposes significant penalties for unlawful disclosure of reported information. In keeping with its purpose, however, the CTA allows FinCEN to disclose beneficial ownership information, upon request, to:

  • Federal law enforcement agencies, including those requesting information on behalf of a non-U.S. law enforcement agency;
  • With the consent of the reporting company, to certain financial institutions; and
  • State, local, and tribal law enforcement agencies pursuant to court order.

Although in the course of litigation access to the FinCEN database will not be available to litigants, no doubt, in the context of litigation involving closely held businesses, there will arise a practice of requesting copies of all information submitted to the database.

Why?

Why, you may (legitimately) ask, is this new reporting obligation being imposed, especially upon only the smallest business ventures? This is all part of an effort by FinCEN to collect information to fight narcotics trafficking, money laundering, terrorism financing, etc. In congressional testimony, FinCEN would continuously lament that they would be investigating and would be led to an LLC or corporation only to be stymied in finding out who was in control of the company because no beneficial ownership information was publicly available. FinCEN has statutory authority to get this information from the IRS, but they said that was not good enough for their purposes. FinCEN’s talking point was that in most jurisdictions you have to give more information to get a library card than you do in order to set up a new corporation or LLC. Of course, one could argue that people who engage in narcotics trafficking, terroristic financing, and human trafficking are not likely to be the sort who will file complete and accurate beneficial ownership reports (around a decade ago, the author of this piece wrote an article on this topic titled in part “Burdensome, But At Least It’s Ineffective”), but FinCEN asserted that, by means of their data mining capabilities, incomplete or inaccurate information could lead them to good information.

The Regulations

The author of this piece, working with his colleagues at the American Bar Association and its constituent bodies, plans to (i) submit to the Department of the Treasury a list of items that need to be addressed and clarified in the forthcoming draft regulations; and (ii) once the draft regulations are released, provide further comments responsive to the draft. SKO plans to update this Insider and publish new ones to apprise you of developments as they take place.

What Now?

Even while we await the regulations and the (hoped for) greater specificity with respect to the filing obligations:

  • Starting now, we will be including in organizational documents a covenant that each director/officer/shareholder/member/manager (and probably each general partner of a limited partnership) will submit all of the information required for the company to file a complete and accurate beneficial ownership report; and
  • Provide in those same organizational documents a clear and unambiguous penalty, including but not limited to expulsion from the venture, for failure to satisfy the obligation to provide beneficial ownership information.

For existing companies, we will be preparing suggested language to the same effect, but only after we discuss your particular situation with you and you engage us to do so. There is no “one size fits all” provision that will work for all existing companies.

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