By Aaron Polak
Business owners, investors, attorneys, and accountants who help their clients form entities should be aware of the Corporate Transparency Act (CTA).
The CTA is an entirely new federal regulatory regime. The CTA mandates disclosing the ownership structure of a whole gamut of most US-based companies and any offshore company registered to do business in the US. The Act requires corporations, partnerships, and limited liability companies to report information regarding their “beneficial owners” to the federal government through the Financial Crimes Enforcement Network (FinCEN) and a new FinCEN IT system known as the Beneficial Ownership Secure System (BOSS).
Companies formed on or after January 1, 2024 (the Effective Date) must comply with the reporting requirements from the Effective Date unless they qualify as exempt. Companies formed before the Effective Date and not exempt must file by January 1, 2025. There are some exceptions.
Sounds Easy? It’s Not!
The CTA stipulates that a “reporting company” must file reports with FinCEN that identify two categories of individuals: the beneficial owners of the entity and individuals who created the entity or registered it to do business in any state.These requirements are intended to help prevent and combat money laundering, terrorist financing, corruption, tax fraud, and other illicit activity while minimizing the burden on entities doing business in the United States. Failure to report, or false reporting, may result in civil and criminal penalties on the part of the company, its officers, and those who formed the entity.
Why is this a radical departure from existing law?
Until this Act, the United States was one of the few countries that did not impose significant “know your client” responsibilities on those who formed entities, and in most states, there is no source of information regarding an entity’s ownership structure. Anyone can form a corporation or LLC in Delaware or any other state almost instantaneously, and until they file the first annual report, no information is available about its officers or directors. Even then, there is never information available about direct or indirect ownership or control. As described below, “beneficial ownership” is defined exceptionally broadly and includes not just 25% owners but senior officers, general counsels, and anyone exercising authority over the appointment or removal of any senior officer or a majority of the board of a reporting company. This obviously implicates shareholders but also sweeps in investors with smaller percentages who have meaningful veto rights.
How does it work?
Information reported to FinCEN through the BOSS system will be stored in a searchable registry available only to federal agencies involved in national security, intelligence, or law enforcement. It will also be available to state or local law enforcement agencies with court approval, financial institutions as part of their KYC/AML functions, and US regulators or foreign governments subject to certain approvals. The information is not available to the public, nor is it subject to FOIA (Freedom of Information Act) requests.
Will it even work?
CTA represents a tremendous operational challenge for the federal government. FinCEN has estimated that during the first year (2024), approximately 32 million reporting companies will be filing initial reports (equal to 1 company per second for the entire first year), with about 5 million new reporting companies each year after that. At the moment, FinCen, which is part of the Department of the Treasury (also where the IRS resides), has not released additional information on how the website or form filing process will work.
Who must report?
The obligation to report to FinCEN is imposed on reporting companies and those who form entities. Under the CTA, a reporting company is any entity formed by a filing with a secretary of state or any foreign entity registered to do business in the US. Reporting companies include corporations, LLCs, limited partnerships, and LLPs – any entity that requires a formal state filing.
There are many exemptions from the definition of a “reporting company.” These include entities in regulated industries, such as banks, credit unions, and depository institution holding companies; broker-dealers and investment advisers; investment companies; and registered money-transmitting businesses.
The proposed regulations also contain an exemption for “large operating companies,” which are defined as entities that: employ more than 20 full-time employees in the US, operate from a physical office in the US, and have filed a federal income tax or information return in demonstrating more than $5 million in gross revenue.
Reporting Changes
Note that every entity formed after January 1, 2024, must file an initial report, even if exempt, and must monitor their exemption annually. If, for example, an exempt company drops below 20 employees or $5m in gross revenue, it must then start reporting. Any reporting company that has a change in its beneficial ownership where an equity holder drops below 25% or increases above 25% must also update its filing, in each case, within 30 days of the change.
What must be reported?
A reporting company must disclose information about itself and two distinct categories of individuals: Company Applicants and Beneficial Owners.
The reporting company must disclose the following:
- the reporting company’s full legal name;
- any trade or D/B/A names;
- current street address;
- the jurisdiction of formation;
- the taxpayer identification number issued by the IRS; and
- information regarding Beneficial Owners and Company Applicants.
The Definition of Beneficial Ownership is Exceptionally Broad
A Beneficial Owner is an individual who directly or indirectly exercises substantial control over the reporting company or owns or controls, directly or indirectly, at least 25 percent of the ownership interests of the reporting company. A person is considered to have substantial control over a reporting company by serving as a senior officer; holding authority to appoint or remove a senior officer or a majority of the board of directors (or similar body); and/or otherwise directs, determines, or has substantial influence over important decisions made by the reporting company.
Direct or indirect ownership can be measured by holding significant debt, convertible notes, options, or other forms of equity. This includes equity in the reporting company and other types of interests, such as capital or profit interests (including partnership interests) or convertible instruments, warrants or rights, or other options or privileges to acquire equity, capital, or other interests in a reporting company. Debt instruments will be included if they enable the holder to exercise the same rights as one of the specified types of equity or other interests, including if they enable the holder to convert the instrument into one of the specified types of equity or other interests.
Mysteries Remain
How do you quantify the equity ownership of a convertible note or a SAFE? A profits -interest? Only time will tell, but FinCen specifically stated that even if an instrument is not immediately convertible, the potential conversion of the instrument at a later time provides significant opportunities for exerting influence and maintaining an economic interest tantamount to ownership.
A Beneficial Owner must provide the following information:
- full legal name;
- date of birth;
- residential (not business!) street address; and
- a copy of a non-expired identification document (non-expired passport, driver’s license, etc.).
Beneficial Owners may be able to obtain a unique “FinCEN identifier.” Thereafter, a reporting company would only need to provide BOSS that Beneficial Owner’s FinCEN identifier on future reports rather than the four pieces of information.
Professional Advisors, Be Aware!
Attorneys, paralegals, accountants, and anyone who helps form entities should pay close attention. The Company Applicant is the individual who filed the formation or registration document for the reporting company and the individual “primarily responsible for directing or controlling such filing.” This could be, for example, a paralegal who submits the formation document to the secretary of state and the attorney who asked the paralegal to make that submission.
Each Company Applicant must also disclose personal information, including their name, business or residential address, date of birth, and a unique identifying number from a passport, driver’s license, or another identifying document.
What are the filing deadlines?
Under the final FinCEN regulations, reporting companies created before the Effective Date must file their initial report with FinCEN no later than January 1, 2025. This includes any entity that will be exempt (e.g., by having more than 20 employees). Those formed from the Effective Date forward must file an initial report within 30 calendar days.
If reported information changes, an updated report must be filed within 30 days of that change (regardless of when the reporting company learns of the change). There’s also an obligation to file a corrected report no more than 30 days after the reporting company knows or has reason to know of an inaccuracy.
Ramifications and Penalties
Failure to file or to provide the required information can be liable for a civil penalty of up to US$500 for each day a violation continues and may be fined up to US$10,000 and imprisoned for up to two years for a criminal violation.
Companies will not only have to monitor their exemptions and reporting requirements; they will likely have to ensure that the provided personal identification remains current. The new reporting requirements are a significant update to US anti-money laundering laws. Companies will have to develop internal policies to determine their reporting obligations initially and on an ongoing basis to avoid penalties. Regarding M&A activity, an acquiring company will want to determine whether the target company complies with these regulations. Any company or (even fund) that has multiple entities will have to track and determine the reporting requirements for each of their affiliated entities.
The team at Rooney Law has assisted numerous companies (both foreign and domestic) with the complexities of corporate formation. If you need help or have any questions, please call us at +1 212 545 8022 or click here to learn more about our capabilities.
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