The Corporate Transparency Act (CTA) has been a hot topic for small business owners since its inception. As we approach its effective date on January 1, 2024, it’s crucial to understand CTA’s implications for small businesses. Below, attorneys in PilieroMazza’s Business & Transactions Group offer guidance to small business owners and their senior officers on CTA compliance and potential criminal and monetary penalties for failure to report information required by the CTA. PilieroMazza attorneys will also present “Understanding the Corporate Transparency Act: Implications and Compliance Strategies,” a webinar covering this important topic. Visit this link to register.

Background

As reported by PilieroMazza, the CTA is legislation enacted by Congress in 2021 that requires privately held U.S. businesses to report certain identifying information for all “beneficial owners” of such businesses to the Department of Treasury’s Financial Crimes Enforcement Network (FinCEN); the result of the reporting will be a central registry of beneficial owners that can be searched by various governmental entities.

While the CTA was passed with the noble goal of identifying and preventing money laundering through shell companies, its cumbersome reporting and compliance requirements will impact nearly every small business entity in the country. Also, as is typical with new legislation, many of the key details of the CTA were not initially clear. While the CTA waters remain murky, continue reading below for important updates on the CTA and its applicability to small businesses.

Nearly All Small Businesses Must File a Report

Over the last two years, FinCEN clarified many issues through subsequent rulemaking and provided a helpful Small Entity Compliance Guide on beneficial ownership information reporting. During this time, it became more clear which entities must file a Beneficiation Ownership Information (BOI) report: nearly all small businesses. In fact, FinCEN estimates that more than 32 million entities will be required to file a BOI report in the first year of the program.[1]

Ownership Interests are Broadly Interpreted, and Aggregated

As discussed above, nearly every small business is required to file a BOI report, but the next step is to determine which individuals must be included in the report. Since the CTA’s inception, it is clear that the BOI report must include any individual who directly or indirectly owns or controls at least 25% of the “ownership interests” of the entity. It is important to note that “ownership interests” includes:

1. shares of equity, stock, units, or voting rights;
2. convertible instruments, phantom stock, profits interests, each of which will be treated as if exercised or converted; or
3. any other arrangement that could be interpreted to establish ownership.

Of course, each individual’s ownership interests across these categories will be aggregated to calculate the total interests.

Keep in mind that this also applies to so-called “indirect” owners. By way of example, many small businesses are owned by one or more trusts; FinCEN provided guidance that the following individuals must be reported as beneficial owners where a trust owns 25% or more of a company:

1. the trustee or other individual with the authority to dispose of trust assets;
2. a beneficiary who is the sole permissible recipient of trust income and principal or who has the right to demand a distribution of or withdraw substantially all of the trust assets; or
3. a grantor or settlor who has the right to revoke or otherwise withdraw trust assets.

As this example of “indirect” ownership demonstrates, there could be a long list of indirect owners in a complex business structure, and careful consideration should be given to identifying individuals who might be considered indirect owners.

Beneficial Owners Includes Non-Owners with “Substantial Control”

The original definition of a “beneficial owner” also included individuals who exercise “substantial control,” but the full extent of that requirement only recently became clear. New guidance provides that an individual must be included in the BOI report if the individual meets any of the following general criteria:

1. senior officers (for example, President, CEO, CFO, COO, General Counsel);
2. important decision-makers (for example, the board of directors or managers);
3. any individual with authority to appoint or remove certain officers or a majority of directors (for example, minority investors with outsized control over leadership decisions); or
4. any individual with any other form of substantial control over the reporting company (a “catch-all” provision).

Of course, FinCEN is expected to broadly construe the “control” category to ensure transparency, expressly stating that “FinCEN’s approach is designed to close loopholes that allow corporate structuring that obscures owners or decision-makers.”[2] After all, the name of the legislation is the Corporate Transparency Act. When in doubt, any individual with substantial control should be included in the BOI report, with a consistent goal of transparency.

Limited Exceptions

Thankfully, there are exceptions to the reporting requirements. Common examples of businesses that do not need to report include certain publicly traded companies, some tax-exempt entities, and what are termed “large operating companies.” It is important to note though that “large” is a relative term and so this may be the largest and widespread exemption.  If you are a business with 20 or more employees and $5M in revenue you are likely exempt from this rule.  There is a little nuance but that is the general basis for the largest exemption. Additionally, not all “beneficial owners” are required to be included, thanks to limited exceptions that were further defined by FinCEN since the CTA’s inception. The five (and only five) exceptions to the reporting rule for beneficial owners are summarized as follows:

1. a minor child (per state or Tribal law), if a parent or legal guardian’s information is reported in lieu of the minor child’s information;
2. a reported beneficial owner’s nominee, intermediary, custodian, OR agent (note: this exception appears limited to providers of ordinary advisory services, such as tax professionals);
3. employees whose substantial control is based solely on their employment, and who are not senior officers (see above for examples);
4. the individual’s only interest in the reporting company is a future interest through a right of inheritance, such as through a will providing a future interest in a company; or
5. creditors of the reporting company, whose only interest in the company is derived through payment of a predetermined sum of money.

Whether any of these exceptions apply to a given business or individual is a tricky determination, based on interpretation of legal terminology and industry standards.

Reporting Requirements and Enforcement

As a sign of the uncertainty surrounding the CTA, FinCEN has not yet published the reporting tool, which will be known as the Beneficial Ownership Secure System (BOSS). BOSS is expected to open on January 1, 2024, at which point all qualifying entities are expected to begin filing their BOI reports. Each beneficial owner of qualifying entities must report their full name, date of birth, current address, and unique identification number, such as social security number, passport ID number, or driver’s license ID number; further, each beneficial owner must also provide a copy of such identifying document.

Importantly, FinCEN has a powerful enforcement mechanism: the willful failure to report, complete, or update beneficial ownership information to FinCEN—or the willful provision of or attempt to provide false or fraudulent beneficial ownership information—may result in civil or criminal penalties. Civil penalties include up to $500 for each day that the violation continues or criminal penalties including imprisonment for up to two years and/or a fine of up to $10,000.[3] Senior officers of qualifying entities of an entity that fails to file a required BOI report may be held accountable for that failure.[4]

Takeaways

Small business owners and their senior officers must take immediate steps to prepare for compliance with the CTA. For example, while much of the reported information is often readily available in corporate records, it is expected that many individuals will be hesitant to participate in the reporting. In circumstances where an individual does not want to be included, now is the time to evaluate the ownership and control mechanisms to proactively limit the applicability of the CTA. Further, understanding and correctly applying the limited exceptions to BOI reporting will help the company (individually, through its owners and senior officers) avoid staggering penalties for failure to comply. It is essential to work closely with legal professionals who can guide you through the process effectively and ensure legal compliance.

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[1] Available at this link. 

[2] Available at this link.

[3] 31 U.S.C.S. § 5336(h).

[4] Small Entity Compliance Guide, FinCEN, p. 15, available at this link.