CTA Denial
“I am a sophisticated business owner, and I have never heard of this.”
The enactment of the CTA in 2021 came as a shock to many (to some, a much later aftershock). However, the CTA’s intent—to end the position of the United States as a haven for “shell” companies used in the commission of money laundering, terrorist financing, financial and tax fraud, and other domestic and international illicit activity and corrupt practices—was present in proposed federal legislation for decades.
The CTA marks a seismic shift in the legal landscape for businesses operating in the United States. Prior to the CTA, entity beneficial owner disclosure was solely (if at all) the purview of state or tribal law. Now it is a focus and purview of federal law enforcement agencies.
The CTA has largely flown under the radar to date, but it is now time to become educated on the actions that may be taken prior to the CTA’s January 1, 2024, implementation date, and after. The Act’s impact on and implications for businesses, particularly small businesses, are complicated and difficult to succinctly communicate, and the CTA has not received widespread mass media attention. In fact, federal lawmakers and industry groups have decried the lack of CTA public education undertaken by FinCEN to date.
Many professional advisers and business professionals have been caught off guard by this fundamental change in business entity law, now taking on a federal facet for the first time. Those that are aware have, by and large, taken a wait-and-see approach to either advising their clients and business associates or evaluating their own compliance profile. This is because much of the mechanics of compliance remains elusive. The ability for businesses to begin directly interfacing with FinCEN on filing and compliance continues to be in the future, giving those persons “in the know” little to offer as current action items—causing many to defer sounding the alarm bell until more is known from FinCEN. However, the wait must end, as there is limited and dwindling time remaining to take action before the window of opportunity closes at the end of 2023.
“I have a small business. The Corporate Transparency Act only applies to large businesses.”
The CTA’s impact on small businesses is counterintuitive to many business owners, who erroneously believe that their business is “too small” to be within FinCEN’s sights and the CTA’s purview. Quite the opposite: A business’s small size is precisely why such a business must comply with the Act! The Act is designed to cast a broad net to “catch” a small niche of nefarious actors hiding behind the “corporate veil.”
Unfortunately, the vast majority of business entities that now must comply with the CTA, including most small businesses, are unwitting and innocent bycatch in the CTA’s net. This is because they will not be able to meet the criteria to be a large operating company that is expressly excluded from CTA compliance. The CTA’s “large operating company” exception is an exception to the CTA’s reporting requirements for businesses that meet all three of the following criteria:
- The business must have a commercial, physical street address in the United States.
- The business must have twenty-one or more full-time employees (excluding full-time equivalent employees, part-time employees, independent contractors, and leased employees).
- The business must have filed a prior year’s federal income tax return demonstrating more than $5 million in annual, U.S.-only, gross receipts or sales.
All home-based businesses, and those with only a virtual (online) presence, will not meet the physical street address part of this three-part test. In addition, by necessity, every business entity formed on or after January 1, 2024, will not initially qualify for this exclusion because such business entities will not have the prior year’s tax return necessary to establish the gross revenue part of the test. The same will be true of virtually all business entities formed between January 1, 2023, and December 31, 2023. Further, many large portfolios of business entities will likely not meet this exception because employees of the portfolio’s operations are typically consolidated into one, or a few, of the portfolio’s business entities, with the remaining business entities not having employees, thus failing the employee prong of the test. Under FinCEN’s BOI Final Rule, employee head count may not be attributed across affiliated entities for purposes of meeting the employee count threshold—each business entity must stand alone in this respect.
“My industry’s lobbyists would never allow such a law to get passed.”
Lobbyists had staved off attempts to implement the CTA, and its predecessor bills, for decades. However, in December 2020, the U.S. Congress, majority-controlled by Republican lawmakers in both the House and the Senate, passed the CTA as part of the 2021 National Defense Authorization Act—which then-President Donald Trump vetoed (his sole veto during his term of office). On January 1, 2021, Congress, by a two-thirds vote in both the House and Senate, overrode Trump’s veto and passed the CTA into law.
Since the CTA’s adoption, the political landscape has changed. President Joe Biden and a Democratic-controlled Senate now hold office through at least 2024. A change of party control, if any, of the presidency or the Senate will not take effect until mid-January 2025—and control of the House may then also be uncertain. By that time, all existing business entities will have been required to file their initial CTA report into the BOSS, and a full year of newly formed entities will also have been required to comply with the CTA. In short, hopes of a conservative government sea change, with an overturning of the CTA, doesn’t account for the Act’s conservative lawmaker origins or the political cycle timing between now and the Act’s January 1, 2024, implementation.
Hope for a legislative repeal or delay in the implementation of the CTA likely ended with the recent passage of the bipartisan Fiscal Responsibility Act of 2023 ( “debt ceiling bill”), which lacked provisions pertaining to the CTA. In mid-June 2023, subsequent to the passage of the debt ceiling bill, the Accountability Through Confirmation Act and the Protecting Small Business Information Act were each introduced in the House Financial Services Committee by Committee Chairman Patrick McHenry (R-NC). These bills are intended to effectively delay the date that the BOI reporting requirements go into effect and to “reform” FinCEN with requirements intended to increase transparency and accountability within the agency, while protecting individuals’ privacy and businesses’ sensitive information in the BOSS reporting regime. It bears noting that Representative McHenry was also the sponsor of the debt ceiling bill. With the current gridlock in Congress, these new bills seem unlikely to move beyond the House or to become laws.
Further, the Biden administration has shown no indication of delaying the CTA’s implementation, with the U.S. Department of Treasury and FinCEN expressing publicly, and repeatedly, that implementation of the CTA by the end of 2023 is a top priority. The stated goals of the CTA—combating the use of “shell” companies in the commission of money laundering, terrorist financing, financial and tax fraud, and other domestic and international illicit activity and corrupt practices—appear to align with the administration’s agenda. In other matters, the administration has shown a proclivity to support initiatives to reign in business rather than favor it.
The CTA mandated that FinCEN promulgate regulations under the CTA prior to January 1, 2022. On December 7, 2021, FinCEN published a proposed rule related to BOI under the CTA, with a public comment period extending through February 7, 2022. In response to this notice of proposed rulemaking (NPRM), FinCEN received over 240 formal comments, with submissions coming from a broad array of individuals and organizations, including members of Congress, government officials, groups representing small-business interests, corporate transparency advocacy groups, the financial industry and trade associations representing their members, law enforcement representatives, and other interested groups and individuals. In addition to these formal responses to the NPRM, FinCEN also received, accepted, and considered many additional comments and inquiries from the public. The extensive, thorough, detailed, and pointed feedback, often in direct opposition to the proposed implementation of the Act and to specific components of the Act, was considered, weighed, and utilized by FinCEN in its adoption of the CTA BOI Final Rule, issued on September 30, 2022. FinCEN went to great length in the Final Rule to describe, with specificity, the extreme vetting on each point in the Final Rule. That Final Rule, with limited exceptions, stayed true to the CTA and the proposed rule initially proposed. FinCEN did not exercise its discretion to expand the list or scope of the enumerated reporting company exceptions (in spite of numerous pleas to do so), nor did it show any reluctance to, or anticipate delay in, implementing the CTA. Based on this process, the implementation of compliance and enforcement of the CTA’s reporting obligations will most certainly begin January 1, 2024. Hopes that a “white knight” will ride in to thwart the CTA, or that a delay or elimination of this reporting obligation implementation would occur, were vanquished last year (in 2022) and confirmed by the CTA’s omission from the bipartisan debt ceiling bill.
“That can’t be constitutional.”
A lone small business advocacy group, National Small Business United (affiliated with the National Small Business Association), has filed suit against the U.S. Department of Treasury and FinCEN contesting the constitutionality of Congress’s actions in passing the CTA into law, as well as the CTA’s implementation by FinCEN. Three other advocacy groups (Transparency International U.S., Financial Accountability & Corporate Transparency Coalition, and Main Street Alliance) jointly authored an amicus brief in support of the government’s position and the CTA. This case remains in an early stage of pleadings. Pending the outcome of this case, the constitutionality of the CTA will be affirmed or better defined.
“I just won’t report.”
Statements similar to the foregoing are uttered by a shocking number of business owners with whom I speak about the CTA and its reach, application, and exposure. However, there are a number of factors uniquely associated with the CTA, its origins, and its implementation that make its enforcement and your possible noncompliance exceptionally problematic. Chief among these, at least for individuals, is that their refusal will be conspicuously noted on a reporting company’s filing with FinCEN. A checkbox is included on the BOI reporting questionnaire: “(check if you are unable to obtain any required information on one or more Beneficial Owners).” Once checked, this conspicuous omission will be a red flag to FinCEN, and other law enforcement agencies, for initial or further investigation.
Further, the Internal Revenue Service (“IRS”) recently announced its taxpayer enforcement initiatives, which include plans to hire nearly 87,000 new employees and invest $80 billion over the coming years to improve tax enforcement and customer service, with more than one-third of the new hires being enforcement staff. The agency also plans to hire more data scientists to complement traditional tax attorneys and revenue agents in using new data analytics technology to identify audit targets. FinCEN’s BOSS database, created under the CTA, will likely be a key component to such data analytics technology and will provide an inexpensive, efficient investigative tool and corroborating (or “red flag”) source of taxpayer information for the IRS. The IRS initiatives’ stated aims are to close the “tax gap” between taxes owed and those paid, and to rebuild the IRS’s audit capabilities and computer technology. The IRS’s stated goals also include expanding enforcement for taxpayers with complex tax filings and high-dollar noncompliance, including high-income and high-wealth individuals, complex partnerships, and large corporations.
Hopes that the CTA is nothing more than another pro forma survey data collection initiative by the government are naïve and misguided. FinCEN’s BOSS database will be a critical point of diligence for investigation by federal government agencies. Your business entity’s conspicuous absence from the BOSS database, or your personal omission from a reporting company’s CTA filing, will most certainly be discovered—and will spearhead other federal investigations into you and your business practices.
“If I get caught, I’ll just pay the fine.”
The CTA provides for civil fines of $500 per day, up to $10,000, per violation of the Act. The Act also provides for a criminal penalty of up to two years’ imprisonment for CTA violations. It is important to note that the fine is per violation—not simply for violating the Act. The Act has requirements for filing report corrections and amendments based on changing circumstances, and CTA violations will likely involve multiple instances of noncompliance before FinCEN comes knocking on your door. Each reporting obligation also has a very short window (thirty calendar days) within which to make the required filing, making inadvertent violations of the CTA highly likely. Further, with only twenty days needed to reach the maximum fine of $10,000 per violation, many violations will likely come with the maximum $10,000 price tag.
These factors, in combination, could cause a simple act of not reporting to turn into the accrual of tens of thousands of dollars, or even hundreds of thousands of dollars, in fines by the time FinCEN identifies the violation and pursues collection. This will be particularly true in the first year of implementation, when 32.6 million reporting companies are projected to require reporting, with five million additional reporting companies being added each year thereafter.
Also, did I mention prison time? Noncompliance could be a costly proposition—far in excess of an initial $10,000 price tag.
“CTA responsibilities do not implicate fiduciary duties.”
Persons with “substantial control” over a reporting company under the CTA not only will be required to disclose their own PII as “beneficial owners” of the reporting company but will also, in many instances, owe fiduciary duties to the reporting company as well as to the (other) owners of the reporting company to properly comply with the CTA. Any decision by a reporting company’s management not to report under the CTA, or to partially report or to inaccurately report, will directly implicate actionable duties owed to the reporting company, its owners, and possibly third parties. Further, such actions may constitute “for cause” termination events with respect to such “substantial control” person, as the act or omission may constitute gross negligence, willful misconduct, fraud, material misrepresentation, or an illegal act with respect to the reporting company. A “substantial control” person’s evasion of the law could also implicate denial or cancellation of the reporting company’s directors and officers (D&O) insurance coverage for the event in question, and expose the individual to uncovered personal liability for the action in question. Further, grievous failure to comply with the CTA could result in imposition of a criminal sentence of up to two years in federal prison for the offending individual.
Under most states’ business statutes, the concept of fiduciary duties is prevalent and applies to the behavior of officers, managers, directors, and other governing and management parties to the business entity itself and, in some instances, to the owners of the business entity directly. Principal among the fiduciary duties is the “duty of care.” The duty of care requires that a person act with the prudence that a reasonable person in similar circumstances would use. If a person's actions do not meet this standard of care, then the acts are considered negligent and may result in actionable damages enforceable against the individual. However, a fiduciary may discharge the duty of care by exerting appropriate diligence and informed consideration with respect to the action in question. Further, in most instances, a fiduciary may discharge its duty of care on a subject by hiring a professional adviser that the fiduciary reasonably believes has the necessary experience and expertise to advise on the subject and by relying on such advice in making the business decision. Thus, “substantial control” persons may insulate themselves against duty-of-care claims by retaining legal counsel to evaluate and advise on the reporting business decisions in question. Further, to the extent that a waiver of fiduciary duties is permitted by the applicable state and included in the applicable business entity’s charter documents, such waiver will not extend to the fiduciary duty of good faith, which could be implicated by a failure to file a CTA report.
Conclusion
The Corporate Transparency Act is a seismic shift in the beneficial owner reporting regimes in the United States, disturbing long-established norms. Beginning January 1, 2024, tens of millions of unwitting and innocent U.S. business entities, and their beneficial owners, will become bycatch in FinCEN’s dragnet designed to catch nefarious actors hiding behind the “corporate veil.” Whether you like it, hate it, or are indifferent, the CTA has been thoroughly vetted and is here to stay. Compliance is both mandatory and advisable. Just as anonymity in the business entity structure has been pierced by the CTA, so has anonymity in the Act’s compliance, with various touch points and red flags aiding in FinCEN’s ultimate enforcement regime, including FinCEN’s discovery of those choosing not to comply.
