Each year, more than two million corporations, limited liability companies (LLCs), and other entities are formed in the United States. Historically, formation of these entities required little to no disclosure of their beneficial owners. Though most people use these entities for lawful purposes, certain bad actors have taken advantage of this information void for illegal activities.
On January 1, 2021, the U.S. Congress passed the National Defense Authorization Act for 2021, which included the Corporate Transparency Act (CTA), requiring the disclosure of beneficial owners. While it is unclear how the CTA will affect your business, here is what we currently know.
1. What is the CTA?
The CTA is a federal law requiring “beneficial owners” of certain entities to be disclosed to the U.S. Treasury Department’s Financial Crimes Enforcement Network (FinCEN). The CTA intends to create a federal incorporation standard, protect national security and commerce, enhance enforcement efforts to combat illicit activities, and bring the United States into compliance with global standards of combating money laundering and terrorism financing.
2. What types of entities are affected?
The CTA requires “Reporting Companies” to comply with the Act. Reporting Companies include corporations, LLCs, partnerships, and other similar entities organized under state law. However, a number of entities are exempt from the “Reporting Company” requirements that may, depending on the regulations, exclude many entities commonly formed by high net worth families. Entities exempt from Reporting Company requirements include:
- Entities meeting all of the following criteria:
- 20 or more full-time employees;
- Gross receipts or sales above $5 million; and
- An operating presence at a physical office located within the United States.
- Dormant or otherwise inactive entities that meet certain criteria that include: not being engaged in an active business; not having changed ownership in the past 12 months; not having sent or received funds greater than $1,000; and not holding any type of asset.
- Charitable organizations and foundations.
- Charitable and split-interest trusts.
- Entities subject to certain governmental regulatory requirements (e.g., publicly traded companies, broker-dealers and investment firms, public utilities, and certain registered accounting firms).
3. When does the CTA take effect?
Enforcement will commence after the U.S. Treasury Department issues regulations detailing compliance requirements. Those regulations are required to take effect by January 1, 2022.
Reporting Companies (as defined in question #2) established after the effective date of the regulations are required to disclose beneficial ownership information upon formation. Reporting Companies in existence before the effective date have a two-year window after the regulations’ effective date to comply with the CTA’s reporting requirements.
4. What does the CTA require?
Reporting Companies must disclose information about the company’s beneficial owners to FinCEN. Specifically, the following must be disclosed with respect to each owner:
- Full legal name;
- Current residential or business address;
- Date of birth; and
- An identification number (e.g., driver’s license or passport number).
Additionally, a Reporting Company is required to file an updated ownership statement if there is a change to the beneficial ownership of the entity, including a change to an owner’s name or address.
5. Who is a beneficial owner?
The CTA defines a “beneficial owner” as an individual who: “directly or indirectly, through any contract, arrangement, understanding, relationship, or otherwise exercises substantial control over an entity, or owns or controls 25% or more of the ownership interests of the entity.”
However, there are exceptions to who is considered a beneficial owner, such as:
- An employee of an entity whose control is derived solely by employment status;
- A minor child, if the child’s parent or guardian’s information is reported; and
- An individual acting as a nominee, intermediary, custodian, or agent on behalf of another.
We do not yet know the impact of the CTA with respect to trusts holding interests in privately owned business entities. At this point it is unclear what information related to those trusts will need to be disclosed, such as the identities of trustees or beneficiaries.
6. Is information related to beneficial ownership subject to public disclosure?
No. The CTA protects beneficial ownership information from public access. Unlawful disclosure of beneficial ownership information is subject to criminal and civil penalties.
FinCEN is prohibited from disclosing beneficial ownership information to the public. Stored information can only be released upon compliance with specific protocols to a limited group of entities (e.g., governmental agencies, financial institutions, and certain regulators).
The CTA requires that beneficial ownership information be stored in a secure, encrypted database using techniques that protect non-classified information at the highest security level.
7. How will the CTA affect you and your business entity?
Existing entities that constitute Reporting Companies likely will be required to disclose their beneficial ownership information to FinCEN by sometime in late 2023.
The CTA leaves many ambiguities that hopefully will be resolved through regulations issued later this year, including defining “substantial control” and “indirect ownership,” calculating ownership, establishing whether partnerships and non-charitable trusts are exempt from reporting, and establishing whether beneficiaries of a trust are treated as beneficial owners.
Reporting Companies will need to have a mechanism to gather information from beneficial owners regarding changes that need to be reported under the CTA. It remains to be seen whether this will be addressed in the regulations, through partnerships between state and federal agencies, or monitored by Reporting Companies themselves.
Some states have already proposed new requirements in the wake of the CTA, requiring the disclosure of LLC managers’ names and addresses, which would be accessible by the public.
8. What are the penalties for noncompliance?
Any person intentionally failing to submit required beneficial ownership information or providing false or fraudulent beneficial ownership information may be subject to a civil penalty of up to $500 for each day that the violation continues and a criminal penalty of up to $10,000, imprisonment for up to two years, or both.
If incorrect information is submitted accidentally, an individual has 90 days from the date the incorrect information was sent to voluntarily submit a corrected report.
9. What can be done to prepare?
The CTA leaves behind more questions than answers about its impact on individuals using LLCs, trusts, and other entities. Until regulations are issued to clarify the CTA’s ambiguities, Reporting Companies should prepare to meet the CTA’s disclosure requirements, and individuals qualifying as beneficial owners should be aware that their identities may be disclosed.
Reporting Companies should take these steps to prepare:
- Consider what information must be disclosed;
- Identify who should be responsible for making the disclosure; and
- Determine whether the company is entitled to indemnification from an individual or entity for noncompliance.
Schiff Hardin will provide updates when there are further developments.