On January 1, 2021, Congress enacted the 2021 National Defense Authorization Act. In an effort to strengthen the fight against money laundering and the funding of terrorist activities, it included broad amendments to the U.S. Anti-Money Laundering Act, the most significant of which was the Corporate Transparency Act (CTA). The CTA will greatly impact the way businesses are formed and how they operate, and it will require regular reporting practices that businesses need to prepare for before the CTA takes effect. Below are five fundamentals of the CTA that small businesses need to understand now.
- What is the CTA?
The CTA is legislation that requires privately held U.S. businesses to report certain identifying information for all beneficial owners of such businesses to the U.S. Department of the Treasury’s Financial Crimes Enforcement Network (FinCEN). The CTA was passed to identify and prevent formation of shell companies with no legal U.S. connections that were created solely for illicit financing purposes, including money laundering and terrorist organization funding. To provide greater transparency into who owns and controls small businesses in the U.S., the CTA will require each beneficial owner of qualifying entities to report his or her 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, to FinCEN, unless exempt. Under the CTA, a “beneficial owner” is any individual who directly or indirectly owns or controls at least 25% of the ownership interests of, or exercises substantial control over, a qualifying entity.
Some of the individuals exempt from beneficial owner reporting include:
- Creditors of entities unless the creditor independently qualifies as a beneficial owner;
- Employees of entities if the “control” over the entity is based solely on their employment status;
- Minor children, if their parent / guardian information is reported; and
- Those who own or control interest in an entity solely through inheritance.
- Who is subject to the CTA?
All privately held business entities either formed or registered to do business under the laws of any State or jurisdiction in the U.S., unless exempt, will be subject to the CTA reporting requirements.
A few examples of exempt entities include:
- Non-profit organizations;
- Publicly traded companies, banks, credit unions, and other financial institutions heavily regulated by government agencies, such as the Securities and Exchange Commission; and
- Companies with over twenty (20) full-time employees with reported gross receipts or sales over $5 million on the previous year’s tax returns and an operating physical office address in the U.S.
- When does it go into effect?
The start date for reporting requirements under the CTA are tied to when the Treasury adopts regulations under the CTA, which must take place no later than January 1, 2022. All qualifying U.S. business entities formed after the regulations are adopted will be required to report at the time of formation. Qualifying business entities formed before the regulation adoption date will be required to submit reports no later than two (2) years after the regulation adoption date. All businesses, whether formed before or after the regulations are adopted, will be required to update any change in their previously reported information within one (1) year of such change.
- How will this affect businesses?
The most obvious answer is that qualifying entities will need to completely and correctly submit required beneficial owner information to FinCEN within the applicable reporting window and ensure that any changes in the previously reported information are updated in a timely manner. In many instances, business entities will need to start collecting the required information from beneficial owners well in advance of the reporting deadline. All qualifying entities will need to build beneficial owner information collection into their regular operations with the realization that, where there are multiple qualifying beneficial owners, the reporting and update deadlines might be logistically burdensome. Similarly, future business transactions, such as mergers and acquisitions, may need to include additional due diligence and representations and warranties specific to a target entity’s CTA reporting.
- Why is it important, and what should you do to prepare?
Under the CTA, failure to report beneficial owner information, reporting incorrect information, or failure to update previously reported information will have serious consequences. These may include civil penalties up to $500 per day until the violation is corrected, as well as criminal fines up to $10,000 and imprisonment up to two (2) years. While CTA regulations are not mandated until January 1, 2022, business entities should stay informed about regulatory insights released before the regulation adoption date to ensure that all required information is properly collected and submitted when reporting is due. Finally, there are still ambiguities in several critical aspects of the CTA, including how ownership and control will be determined, as well as what the reporting requirements will be for certain partnerships and trusts. Because of these ambiguities, privately held business entities should work with legal counsel in advance of the CTA regulation adoption to fully understand whether they will be subject to the reporting requirements, and if so, what those reporting requirements will be.