The Corporate Transparency Act (CTA), enacted on January 1, 2021, as part of broad anti-money-laundering and antiterrorism measures taken by Congress, is set to take effect January 1, 2024. The CTA requires certain business entities (each defined as a “reporting company”) to file, in the absence of an exemption, information on their “beneficial owners” and, in some cases, “company applicants” with the Financial Crimes Enforcement Network (FinCEN) of the U.S. Department of Treasury (Treasury). The information provided to FinCEN will not be publicly available, but FinCEN is authorized to disclose the information to certain agencies and other entities/persons.
At first blush, the CTA would not appear to have large-scale implications on attorneys whose practices focus on real estate or trusts and estates. Because of the large-scale use of holding companies involved in real property transactions and their common usage in holding assets indirectly owned by trusts, however, it is likely that the CTA’s reporting obligations will apply to many, if not most, of these holding companies. The following article provides a general summary of the component parts of the CTA, including which entities are considered reporting companies, how to identify a reporting company’s beneficial owners and company applicants, what information needs to be reported to FinCEN, when that information must be reported, and the penalties for noncompliance with the CTA.
All companies that fall within the scope of “reporting company” under the CTA and do not fall under an exemption (as discussed below) will be required to report information about the entity’s owners to FinCEN. These companies include both domestic reporting companies and foreign reporting companies. Unlike certain reporting obligations imposed by federal securities laws, the CTA’s obligations for reporting beneficial ownership information (BOI) fall on the company itself, not the beneficial owner.
A domestic reporting company is a corporation, limited liability company, or other entity created by filing a document with a secretary of state or similar office in the United States, District of Columbia, or U.S. territories, or with the office of an Indian tribe. A foreign reporting company is an entity formed under the laws of a foreign country and is registered to do business in any state or tribal jurisdiction by filing a document with a secretary of state or similar office. It is expected that (in addition to corporations and LLCs) the other types of entities that are likely to be considered “reporting companies” under the CTA will also include limited liability partnerships, limited liability limited partnerships, business trusts, and most limited partnerships, because these entities are generally created by a filing with a secretary of state or similar office. It is also likely that this definition will mean that sole proprietorships, most general partnerships, or other entities not necessarily created by a filing with a secretary of state or similar office will not be considered “reporting companies.” Therefore, with very few exceptions, nearly all business entities conducting business in the United States will be considered reporting companies unless they meet one of the exemptions enumerated under the CTA.
The CTA specifically exempts 23 categories of entities from the definition of “reporting company.” In this article, we will discuss three exemptions in which we expect many private, non-regulated businesses to be most interested, but a summarized list of all of the exemptions is provided below. For each of the below exemptions, the detailed requirements to meet the exemption are included at 31 U.S.C. § 5336(a)(11)(B):
To qualify under the “large operating company” exemption, an entity must meet all of the following requirements:
For purposes of meeting the large operating company exemption, a full-time employee is anyone employed an average of at least 30 hours per week or 130 hours per month. Further, the entity must be the employer of 20+ full-time employees—entities may not consolidate employees across affiliated entities for CTA purposes. The operating presence in the United States must be at a physical location (having a P.O. box or other principal address where no business is conducted will not be sufficient) owned or leased by the exempt entity and may not be shared (except with the entity’s affiliates). Unlike the employment requirement, an entity that is part of an affiliated group that files a consolidated tax return is permitted to aggregate the entirety of the affiliated group’s gross receipts or sales requirement for purposes of meeting the gross receipts or sales requirement. The requirement specifically references, however, that the $5 million test is determined based on the entity’s previous tax year’s tax return, so until the entity has a tax return meeting the above requirement, it will not be able to take advantage of the large operating company exemption. Further, this requirement specifically states that the source of receipts or sales must come from business conducted within the territorial boundaries of the United States, so any receipts or sales received by an entity outside of the United States will not be includable for purposes of meeting this requirement.
Businesses meeting the large operating company exemption should be wary: Should the entity no longer meet the above requirements at any time (such as if the business no longer has 20 full-time employees or sees US gross receipts or sales dip below $5 million), the entity will no longer qualify for the large operating company exemption, and if the entity does not fit under any other exemption, it would be required to file a BOI report with FinCEN within 30 days from the date the entity no longer is exempt.
Nonprofit organizations described in Section 501(c) of the Internal Revenue Code (IRC) and tax-exempt under IRC Section 501(a), as well as trusts described in IRC Section 4947(a)(1) and (2), are also exempt from the CTA’s reporting obligations. When seeking to qualify for an exemption involving tax-exempt status, however, entities need to be aware of potential CTA reporting obligations during the period after formation of the entity but before the entity receives its tax-exempt status from the Internal Revenue Service. The exemption requires both that the entity be an entity that meets the requirements of IRC Section 501(c), but also that the entity is tax-exempt under IRC Section 501(a), which, for many nonprofits, will not occur until after they submit their application, and the IRS approves of, the entity’s tax-exempt status. During this period, unless the entity falls under another one of the CTA’s exemptions, the entity will be required to file a BOI report with FinCEN.
A third exemption to the CTA’s definition of “reporting company” is for subsidiaries of exempt entities. Entities owned 100 percent (directly or indirectly) by one or more entities meeting an exemption to the definition of reporting company are also exempt. Such subsidiaries will not qualify for the subsidiary exemption, however, if the parent entity or entities are themselves exempt only under the CTA’s exemptions for (1) pooled investment vehicles, (2) money transmitting or money services businesses, (3) entities assisting tax-exempt entities, or (4) inactive entities.
An example of an entity qualifying for this exemption is a subsidiary of a large operating company. The parent company (the large operating company) will itself be exempt from the “reporting company” definition, and therefore its subsidiary will be exempt as well. If the subsidiary is not owned entirely by one or more exempt entities, however, it will not be exempt under the subsidiary exemption. For example, if an exempt entity owns 99.99 percent of the subsidiary and an individual or other nonexempt entity owns just 0.01 percent of the subsidiary, the subsidiary will not qualify under this exemption.
If an entity is a “reporting company” under the CTA, the first step is to identify the entity’s “beneficial owners.” A beneficial owner is any individual (natural person) who, directly or indirectly:
An individual will be considered a beneficial owner of a reporting company if the individual exercises “substantial control” over the entity. An individual exercises substantial control over an entity if the individual serves as a senior officer of the entity, has authority over the appointment or removal of any senior officer or a majority of the board of directors (or similar body) of the entity, or directs, determines, or has substantial influence over important business decisions for the entity.
For purposes of the CTA, the term “senior officer” means any individual holding the position or exercising the authority of president or chief executive officer, treasurer or chief financial officer, secretary or general counsel, chief operating officer, or any other officer (regardless of title) performing a similar function. Important business decisions of the reporting company include, but are not limited to, decisions regarding:
The “Final Reporting Rule” issued by FinCEN set out a nonexhaustive list of examples in which an individual may exercise substantial control over a reporting company, including by way of:
In addition to exercising substantial control over a reporting company, an individual will be considered a beneficial owner if that individual directly or indirectly owns or controls at least 25% of the ownership interests of the reporting company. “Directly or indirectly” is very broad language, as the individual may have an ownership interest through any contract, arrangement, understanding, or relationship.
“Ownership interests” is defined broadly in FinCEN’s Final Reporting Rule to include any equity, stock, or similar instrument; any preorganization certificate or subscription; any transferable share of (or voting trust certificate or certificate of deposit for) an equity security; an interest in a joint venture; and a certificate of interest in a business trust. Additionally, “ownership interests” includes any capital or profits; instruments convertible into any share or instrument described previously; any right to purchase, sell, or subscribe to a share or other interest; any put, call, or other option (except to the extent the option is held by a third-party unknown to the reporting company); and any other instrument, contract, or arrangement used to establish ownership.
For CTA reporting purposes, debt instruments will be considered ownership interests if the holder of the instrument has the ability to exercise the same rights as a holder of one of the equity (or other) instruments described above. For example, the holder of a convertible note would have an ownership interest, but the holder of a simple security interest would not.
The challenging step in determining whether an individual is a beneficial owner of a reporting company is calculating the person’s ownership interests. The following standards will govern whether an individual has met the 25 percent ownership or control threshold to qualify as a beneficial owner.
First, total ownership interests owned or controlled are calculated as a percentage of the total ownership interests of the reporting company. At the time of calculation, any options or similar interests held by the particular individual will be treated as exercised. Next, if a reporting company issues capital or profits interests, the ownership interests of the individual at issue will be calculated by taking their capital or profits interests in the reporting company as a percentage of the total outstanding capital or profits interests of the company.
The applicable percentage for corporations (as well as entities taxed as corporations and other reporting companies issuing shares) is the greater of (i) the total combined voting power of all classes of ownership interests of the individual as a percentage of the total outstanding voting power of all classes of ownership interests entitled to vote and (ii) the total combined value of the individual’s ownership interests as a percentage of the total outstanding value of all classes of ownership interests. An important note when calculating ownership interests is that if the calculations cannot be made with reasonable certainty, an individual owning or controlling 25 percent or more of any single class or type of ownership interest will be deemed to have exceeded the 25 percent ownership interest threshold.
If an ownership interest in a reporting company is held through a trust, the following individuals are deemed to have an ownership interest in the reporting company:
The CTA provides five exemptions from the definition of “beneficial owner.” The first is a minor, as defined by the laws of the state under which the company was created or registered. Nonetheless, the company must report information for the minor’s parent or guardian and submit an updated report when the minor reaches the age of majority. The next exemption is for nominees, intermediaries, custodians, and agents on behalf of another individual. The BOI of a nominee need not be reported, but the company will still need to report the BOI for the individual on whose behalf the nominee acts.
An important exemption from the definition of “beneficial owner” is for employees who—while they may exercise substantial control over or economic benefits from the reporting company—(i) have their control or benefits derived solely from their employment status; and (ii) are not senior officers (as discussed above). Heirs (individuals whose only interest in the company is a future interest through an inheritance right) are also exempt.
Finally, certain creditors of a reporting company will not be considered beneficial owners. These are creditors holding only a right to be paid a predetermined sum of money, who meet the “beneficial owner” definition only by way of a loan covenant (or similar right) associated with a right to repayment intended to secure such right or enhance the likelihood of the repayment of debt. For example, a creditor holding a security interest in assets of the reporting company would not be considered a beneficial owner by virtue of such security interest.
In addition to submitting beneficial ownership information for beneficial owners, reporting companies must also submit beneficial ownership information for individuals known as “company applicants.” A company applicant is an individual who either:
For the second prong of this analysis, FinCEN intends only for a reporting company to list at most two individuals as company applicants. In FinCEN’s Final Reporting Rule, it provided the following example to specifically illustrate identifying company applicants if a law firm is involved in the filing of any formation documents: If a supervising attorney oversees the preparation and filing of a reporting document and a paralegal or associate files the document with the state filing office, the reporting company must list both the supervising attorney and the paralegal or associate as company applicants.
Reporting companies formed or registered to do business in the United States before January 1, 2024, do not need to report information regarding company applicants in their initial BOI report. Additionally, in any subsequent BOI report correcting or amending reported information, reporting companies do not need to report any change to the required information regarding company applicants, unless such information was not correct when initially reported.
FinCEN’s Final Reporting Rule clarified several situations regarding company applicant reporting requirements. First, employees in the filing office processing formation or registration documents (e.g., secretary of state) are not the filers of these documents and are thus not considered company applicants. Another grey area sure to arise concerns the use of business formation services. Such services may provide software or written guidance for forming entities. The employees of these services are not company applicants by virtue of providing the software or guidance. To the extent these employees are personally involved in the filing of a formation or registration document for a reporting company, however, they would meet the definition of “company applicant” under the CTA.
A reporting company must disclose the following regarding each of its individual beneficial owners and, in the case of a company created or registered on or after January 1, 2024, its company applicants:
The CTA regulations also provide that, as an alternative to providing the above information, an individual may provide a FinCEN identifier, which is an identification number an individual can obtain from FinCEN by providing the same information listed above.
If a reporting company has beneficial owners who are themselves exempt from the CTA’s reporting requirements, the reporting company may elect to list the name of the exempt entity rather than provide the beneficial ownership information.
Further, a reporting company must disclose the following information about the company itself:
Entities must submit beneficial ownership information for each of its beneficial owners to FinCEN in the entity’s initial report and in any updated reports. Reporting companies created (or which become foreign registered companies) before January 1, 2024, have until January 1, 2025, to file an initial BOI report. Reporting companies created (or that become foreign registered companies) on or after January 1, 2024, must file an initial BOI report within 30 days of the earlier of the date on which:
If, after the filing of the initial report, there is any change to information regarding the reporting company or any of its beneficial owners, an updated report must be filed by the reporting company within 30 days of such change.
The CTA provides both civil and criminal penalties. These penalties include fines of up to $10,000 and, for any person who willfully provides or attempts to provide false or fraudulent information or willfully fails to report complete or updated information, up to two years of imprisonment. Importantly, these penalties can be levied against any of the “senior officers” (see definition above in the section entitled “Substantial Control”).
