Many corporations, limited liability companies, and other similar entities will soon be required to disclose their beneficial owners to the United States government. Currently, state law regulates what information is required to be disclosed when companies are formed or when fulfilling their reporting requirements – often, very little identifying information is required.
On January 1, 2021, H.R. 6395, the William M. (Mac) Thornberry National Defense Authorization Act for Fiscal Year 2021 (NDAA), became law. Incorporated within the NDAA is the Corporate Transparency Act (CTA).
In the CTA, Congress notes that there are over two million corporations and limited liability companies formed under the laws of the states each year and that most or all of the states do not require disclosure of the beneficial owners’ information when the entities are formed. The CTA states further that bad actors seek to conceal the ownership of corporations, limited liability companies, and other similar entities organized in the U.S. to facilitate illegal activities, including money laundering, terrorism financing, tax fraud, human and drug trafficking, securities and financial fraud, and acts of foreign corruption, harming the national security interests of the U.S. and its allies. It is also noted in the CTA that these bad actors conduct commercial transactions through various corporate structures (often consisting of multiple layers of entities) to evade detection.
The stated purpose of the CTA is to (1) set a clear federal standard for incorporation practices, (2) protect U.S. national security and commerce, (3) enhance national security, intelligence, and law enforcement efforts to combat money laundering, terrorism financing, and other illicit activities, and (4) bring the U.S. into compliance with international anti-money laundering and countering of terrorism financing standards.
Which Entities Must Disclose Beneficial Ownership?
Under the CTA, newly formed and existing corporations, limited liability companies, and other similar entities organized under state law, as well as entities formed under the laws of a foreign country seeking to become registered by a state, must identify their “beneficial owners” (as that term is defined in the CTA and discussed below) to the Financial Crime Enforcement Network (FinCEN). However, there are a number of notable exemptions from the beneficial ownership reporting requirements under the CTA.
The CTA exempts from the beneficial ownership reporting requirement corporations and limited liability companies with (1) twenty or more full-time employees, (2) gross receipts or sales as reported on a federal income tax return of over $5 million (including receipts of subsidiaries and other operating entities), and (3) an operating presence at a physical office within the United States. The CTA also exempts from the beneficial ownership reporting requirement charitable organizations, charitable foundations, charitable and split interests trusts, and U.S.-controlled entities that operate exclusively to provide financial assistance or governance of such charitable entities. If an exempt organization has an ownership interest in a company that is required to report, only the name of the exempt organization must be reported. In addition, various categories of corporations, limited liability companies and other similar entities already subject to certain governmental regulatory requirements, including publicly traded companies, banks, broker dealers and investment firms, securities exchanges, insurance companies, public utilities, and public accounting firms registered under Section 102 of the Sarbanes-Oxley Act, are exempt from the CTA’s beneficial ownership reporting requirements.
The Treasury Department, with the concurrence of the Departments of Justice and Homeland Security, is authorized to exempt by regulation from CTA reporting any other entities or classes of entities, if requiring reporting by those entities would not serve the public interest and would not be useful in detecting, preventing, or prosecuting money laundering, financing of terrorism, serious tax fraud, or other crimes.
Definition of Beneficial Owner
The CTA provides that the term “beneficial owner” means, with respect to an entity, any individual who directly or indirectly, through any contract, arrangement, understanding, relationship, or otherwise, exercises substantial control over the entity, or owns or controls 25 percent or more of the ownership interests of the entity. Certain individuals are excluded from the definition of “beneficial owner.” The term does not include, for example, an individual acting solely as an employee of an entity and whose control over or economic benefits from such entity is derived solely from that person’s employment status, individuals whose only interest in an entity is through a right of inheritance, a minor child (if the information of the parent or guardian of the minor child is reported), or an individual acting as a nominee, intermediary, custodian, or agent on behalf of another.
Until Treasury regulations are issued, we do not know how indirect ownership will be determined. It is possible one of several existing attribution regimes will be adopted, but a new regime could also be developed given the unique purposes of this law. In particular, we will be waiting to see whether beneficiaries of a trust are attributed beneficial ownership and what method is used to make that attribution.
What Information about Beneficial Owners Must Be Disclosed?
Corporations, limited liability companies, and other similar entities which are subject to the beneficial owner reporting requirements of the CTA will need to identify their beneficial owners by full legal name, date of birth, current residential or business address, and a unique identifying number from a non-expired passport, personal identification card, driver’s license, or one issued by FinCEN.
Maintenance and Security of Disclosed Beneficial Owner Information
The CTA directs the Secretary of the Treasury to maintain beneficial owner information in a secure, encrypted database using information security methods and techniques that are appropriate to protect nonclassified information systems at the highest security level. FinCEN is prohibited under the CTA from publicly disclosing beneficial ownership information. Information provided to FinCEN pursuant to the CTA is intended to be used primarily for law enforcement and national security purposes, with disclosures in certain instances (subject to conditions upon the use of that information) allowed only to other governmental agencies, financial institutions, and certain regulators.
Effective Date, Enforcement, and Penalties
The CTA mandates that the Treasury regulations take effect by January 1, 2022. Enforcement of the CTA will commence after the U.S. Treasury Department issues regulations detailing compliance requirements.
After the implementing regulations have become effective, newly formed entities subject to the beneficial ownership reporting requirements will be required to submit the required information to FinCEN at the time an entity is formed. Entities already in existence before the effective date of the regulations that are subject to the reporting requirements must submit the information required concerning their beneficial owners not later than two years after the effective date of the regulations. The CTA also provides that, in accordance with the regulations to be issued, entities subject to beneficial ownership reporting will be required to report to FinCEN any changes in the information concerning beneficial owners not later than one year from the date on which there is a change in that information.
An entity subject to the reporting obligations that willfully fails to submit the required beneficial ownership information, or that provides false or fraudulent beneficial ownership information may be subject to (1) a civil penalty of not more than $500 for each day that the violation continues, and (2) a fine of up to $10,000, imprisonment for up to two years, or both. If a person submits incorrect information, the CTA contains a safe harbor allowing that person to avoid civil and criminal penalties if the person did not knowingly submit inaccurate information with the original report and voluntarily submits a report containing corrected information within 90 days of submitting the original report.
The CTA’s reporting requirements introduce new filing requirements and will require small and mid-sized businesses, and other companies subject to the reporting requirements, to provide information about their beneficial owners that has not previously been required under U.S. law.
Due to the large number of companies that could be required to report beneficial owner information under the CTA, pending the release of regulations that might exempt certain additional classes of companies, it is likely that new bureaucratic structures will need to be developed to create and maintain a beneficial ownership database, share information among government agencies, and enforce reporting violations. Although the CTA does not specify the role that states will play in implementing and enforcing the new reporting requirements, the CTA directs the Secretary of the Treasury, to the greatest extent practicable, to establish partnerships with state and local government agencies in promulgating regulations. It remains to be seen whether the forthcoming regulations may require states to, for example, assist in the collection of the required information or verify that the CTA reporting requirements have been met during the entity formation process.
While the regulations are developed, companies should begin planning now to ensure that they have processes in place to facilitate the reporting required by the CTA once regulations are finalized.
We will continue to provide updates as regulations are developed and are available to help clients comply with the CTA’s requirements.