On Jan. 1, the new Corporate Transparency Act (“CTA”) came into effect and imposes reporting obligations on domestic and foreign entities that are within the scope of the definition of “reporting company” under the statute. Entities that do not fall within one of the CTA’s categories of exemptions will be required to file a beneficial ownership information report (“BOI report”) with the U.S. Treasury Department’s Financial Crimes Enforcement Network (“FinCEN”).

Clark Hill previously published an overview of FinCEN’s final regulations under the CTA, outlining the key regulatory changes and reporting requirements. This alert will provide our clients and contacts that organize their operations through multiple entities with more focused guidance on the large operating company exemption and the subsidiary exemption as they implement the CTA’s reporting requirements across their structures.

While FinCEN estimates that there will be approximately 32 million companies subject to the CTA in 2024, it will largely impact only smaller and unregulated companies. One exemption that is expected to be heavily relied on is the large operating company exemption.

What Constitutes a Large Operating Company?

To qualify, an entity must meet all three of the following criteria:

1. Employ more than 20 full-time employees in the U.S. (generally working at least 30 service hours per week);
2. Maintain an operating presence at a physical office within the U.S. that is not shared other than with the reporting company’s affiliates; and
3. Have filed a prior year federal income tax return reporting over $5 million in gross receipts or sales. For entities filing consolidated returns, the entities must use the amount reported on the consolidated return for the group.

Scenario #1

A parent corporation (“Parent”) is the sole owner of two subsidiaries, OpCo and AssetCo (Parent, OpCo, and AssetCo, collectively, the “Group”). Each company has its headquarters in Delaware. Parent, OpCo, and AssetCo each have seven employees and collectively reported more than $5 million in gross receipts or sales in the previous year’s consolidated tax return.

Analysis

Parent meets the place of business prong (Delaware headquarters) and the $5 million prong (reported in the previous year’s consolidated tax return). What about the employee prong? Some commentators asked FinCEN if such an entity can aggregate its employees across common ownership for purposes of meeting the 20-plus employee requirement. If so, Parent would collectively have 21 employees across its companies. However, FinCEN stated in its final rule (“Reporting Rule”) that a company may not consolidate employees across affiliated entities to meet the 20-plus employee prong. The exemption requires that the entity itself employ more than 20 full-time employees in the United States. Thus, not all requirements of the large operating company exemption are met, and Parent must submit a BOI report to FinCEN. OpCo and AssetCo each will also have to submit a BOI report to FinCEN.

Scenario #2

Parent is the sole owner of two subsidiaries, OpCo and AssetCo. Each company has its headquarters in Delaware, and the Group collectively reported more than $5 million in gross receipts or sales in the previous year’s consolidated tax return. OpCo itself employs 21 employees, while Parent and AssetCo each employ seven employees.

Analysis

Here, the initial facts are similar to Scenario #1, except OpCo now has 21 employees. OpCo meets the place of business prong (Delaware headquarters), the $5 million prong (reported in previous year’s consolidated tax return), and the 20+ employee prong, and thus meets the large operating company exemption and does not have to file a BOI report with FinCEN. Parent and AssetCo, however, must each still file their own separate BOI reports.

The Subsidiary Exemption

Entities, the ownership interests of which are controlled or wholly owned, directly or indirectly, by certain categories of exempt entities (including the large operating company exemption above) are also exempt from the reporting requirement. Once a parent entity qualifies as an exempt entity by reason of the large operating company exemption, its wholly owned subsidiaries (whether or not corporate entities) generally should also be exempt from the reporting requirement under the subsidiary exemption. For non-wholly owned entities, the analysis of the subsidiary exemption is more complex, as it hinges on whether the equity interests of the entity are directly or indirectly “controlled” by an exempt entity, and neither the CTA nor the Reporting Rule provide a clear definition of “control.”

Scenario #3

Parent is the sole owner of two subsidiaries, OpCo and AssetCo. Each company has its headquarters in Delaware, and the Group collectively reported more than $5 million in gross receipts or sales in the previous year’s consolidated tax return. While Parent itself employs 21 employees, neither OpCo nor AssetCo currently has any employees.

Analysis

Here, the initial facts are similar to Scenario #1, except Parent now has 21 employees, while OpCo and AssetCo have no employees of their own. Parent meets the place of business prong (headquarters in Delaware), the $5 million prong (reported in previous year’s consolidated tax return), and the 20-plus employee requirement, and thus Parent meets the large operating company exemption and does not have to file a BOI report with FinCEN. HoldCo and AssetCo are wholly owned by an exempt entity (Parent meets the large operating company exemption), so each subsidiary qualifies for the subsidiary exemption and neither has to file a BOI report with FinCEN. Note that no one in the Group needs to notify FinCEN that it qualifies for an exemption. Reporting obligations are only triggered when a reporting company is formed, or when an exempt entity ceases to qualify for an exemption.

We will continue to write on this topic to provide insights into this new rule. Our next installment will cover charities and nonprofit entities and how they can stay compliant.