Introduction:
Limited liability entities and corporations operate under their own names and have the tremendous advantage of limiting the exposure faced by the owners of the entities. It can also allow hiding of the actual persons engaged in the business, particularly if they utilize other entities they own to be the shareholders or owners of the limited liability entity.
Thus, organized crime enjoys the use of such limited liability entities in laundering money and engaging in various legitimate businesses. It also can allow avoidance of taxation of entities in different tax jurisdictions are utilized, reporting income in the lower tax jurisdiction.
Recognizing this danger, the United States Treasury Department has enacted regulations, effective January 1, 2024, requiring most entities doing business in the United States to report information about the entities and individuals who ultimately own and/or control the entity. The name of the act is THE CORPORATE TRANSPARENCY ACT (hereafter “CTA”) and it provides for both criminal and civil penalties for those failing to comply.
This article shall outline the basics of the CTA.
The Basic Requirements:
The Financial Crimes Enforcement Network Bureau of the US Treasury adopted rules to require “Reporting Companies” to file “Beneficial Ownership Information Reports (“BOIR”) describing its “Beneficial Owners.”
This BOIR need not be filed annually but is a one-time filing unless the information needs to be updated or corrected in which case it needs to be promptly filed again.
The information is confidential but may be reported to any other governmental entity.
Definitions:
REPORTING COMPANY is a corporation, limited liability company or other similar entity that is created by filing a document with a secretary of state or equivalent office under the law of a state or formed under the law of a foreign county and registered to do business in the United States. Note that there are exemptions to this definition relating to large, already regulated companies, such as those registered with the Securities and Exchange Commission or subject to like government regulation.
WHAT INFORMATION IS REQUIRED? The Reporting Company must submit information describing itself, such as names and address of all offices and information about the individuals who formed the company and its “Beneficial Owners.”
WHAT IS A BENEFICIAL OWNER? The Beneficial owner is an individual who, directly or indirectly, through any contract, arrangement, understanding, relationship or otherwise exercises substantial control over the entity or owns or controls not less than twenty five percent of the ownership interests of the entity.
WHAT IS SUBSTANTIAL CONTROL? A person exercises substantial control over an entity if the individual meets any of the following four criteria:
Is a senior officer;
Has authority to appoint or remove certain officers or a majority of directors of the Reporting Company;
Is an important decision maker; or
Has any other form of substantial control over the Reporting Company.
WHAT IS NOT A BENEFICIAL OWNER? A Beneficial Owner does NOT include:
A minor child if the child’s parent or guardian is reported.
An individual acting as a nominee, intermediary, custodian, or agent on behalf of another individual.
An individual acting solely as an employee of the entity and whose control over or economic benefits from such entity is derived solely form the employment status of that person.
An individual whose only interest in the entity is through a right of inheritance.
A creditor of the entity unless the creditor exercises substantial control over the entity or controls at least twenty five percent of the ownership interests.
Reports for existing entities are due January 1, 2025. For newly created entities, they are due ninety calendar days after receiving the documents back from the State creating the entity.
The penalties for failure to file can be both civil and criminal and the same penalties apply for providing false or fraudulent information. The civil penalty is a fine of up to five hundred dollars for each day that the violation exists. There is no upward limit. The criminal penalty includes imprisonment of up to two years and fines of up to ten thousand dollars.
Thoughts:
There was a challenge to the new law filed in the Northern District of Alabama and on March 1, 2024, that Court held that the law was unconstitutional and issued an injunction against the Treasury Department in enforcing the law. The Treasury Department has appealed. The injunction only applies to the named plaintiffs in the case and to members of the National Small Business Association. Most of us still must comply during the appeal period.
The wording of the law is extremely broad as to definition of what is a “beneficial owner” and what is “substantial control.” Mere contractual rights and ownership does not, alone, eliminate one from that possible class of persons since any “important decision maker” can be so defined. That vague term could conceivably apply to a mere advisor to the company or a consultant. By use of the term “important decision maker” they have created a definition that is so broad it could be anyone whose advice is considered by the entity.
The rationale of the rule is to ensure the government is aware of who is running the entity or owning the entity “directly or indirectly,” and the law was written precisely to avoid the type of evasion that sophisticated members of organized crime, with legal and accounting advice, use to avoid being found.
In that respect, organized crime is now international in scope, engages in billions of dollars’ worth of transactions a year, and is capable of hiring the best minds in law and accounting firms to create structures that can hide actual ownership.
But like so much of the world of regulations, a valid purpose casts a massive net over many who are not seeking to break any law and forces disclosure of information to potentially the entire government that may have no legitimate reason to know it.
And the penalties for failure to comply are potentially massive. Five hundred dollars a day becomes a ninety thousand dollar fine if only six months late and that is merely the civil penalty. When one considers the possible jail time if the Treasury Department seeks to enforce the matter criminally, one faces what amounts to a felony conviction.
Which means that, like it or not, it makes sense to comply with the reporting requirements even if one finds the law inappropriate. When in doubt, rather than seek to avoid the definitions, simply assume that one is a beneficial owner and file the report. The downside is such that ignoring the law will not be worth it.
If there is a legitimate reason to wish to avoid revealing an identity, then seek legal and accounting advice before making any decision to evade or ignore the law. One should assume that the cost to fight an enforcement action commenced by the government will be in the hundreds of thousands of dollars, so be very careful in determining how to react to this new regulation.