NY’s Almost There
Back in June of this year, New York’s legislature passed a bill that, if enacted, would create the first state-level public database with information regarding the ownership of limited liability companies (LLCs).[i]
Beneficial owners are of interest to governments, including taxing authorities, because of their economic status as the persons who own or control a company that operates within the government’s or authority’s jurisdiction.
Although it is based, by and large, upon the Federal Corporate Transparency Act[ii] (CTA), the bill’s reach is not as broad as the CTA’s; for example, it does not cover corporations.
That said, the bill goes beyond the CTA in one important respect: it requires that the secretary of state maintain a publicly available database on its website for each business entity organized in New York. The database must include, among other things, the name of the business entity, the current business street address and county associated with each business street address, and the full name of each beneficial owner.[iii] Before considering the New York bill, it behooves us to review the factors that motivated enactment of the CTA (and presumably, by extension, the bill), and to query whether Congress adequately accounted for the privacy rights of individual taxpayers.
The Problem
Not long ago, Congress found that more “anonymous” legal entities,[iv] such as corporations and LLCs, are formed in the U.S. than in any other jurisdiction.
It also determined that such legal entities are being used to a not insignificant degree by some bad folks to engage in illicit activities, to launder the proceeds from such activities, and to otherwise access and transact business in the U.S. economy to their benefit with relative impunity.
Congress observed that such activities are facilitated by the fact that the U.S. did not have a centralized or complete store of information about who owns and operates legal entities within the U.S.[v]
Moreover, the information about such entities that was readily available to law enforcement was generally limited to the information required to be reported when the entity was formed at the state level.[vi] Even then, however, most jurisdictions do not require the identification of an entity’s individual beneficial owners at the time of formation, and the vast majority of states require disclosure of little to no contact information or information about an entity’s officers.[vii]
Congress believed that criminals, being aware of the dearth of information regarding beneficial ownership, have exploited state entity formation procedures to conceal their identities when forming corporations or LLCs in the U.S., and have then used the newly created entities to commit crimes affecting commerce, including tax fraud.
Likewise, according to Congress, the lack of available beneficial ownership information impeded the efforts of law enforcement to investigate corporations and LLCs suspected of committing such crimes.
The CTA was enacted into law[viii] to remedy this perceived defect – and the abuse thereof by bad players – by requiring that every “reporting company” submit to FinCEN[ix] a report containing certain “beneficial owner” and “company applicant” information (together, “beneficial ownership information”). By requiring entities to submit such information to FinCEN, Congress intended to help prevent and combat money laundering, tax fraud, and other illicit activities.
Right to Privacy
Few would argue that the government does not have a legitimate interest in preventing or punishing tax fraud, money laundering, and other financial crimes. Of course it does.
That said, how does government balance its legitimate interest in enforcing the tax laws, for example – without which society cannot function[x] – against its obligation to protect the equally legitimate interests of its constituents[xi] in maintaining their privacy?
Hopefully, very carefully and deliberately.
According to the Office of Privacy and Civil Liberties at the U.S. Department of Justice, the Privacy Act of 1974[xii] was enacted “in the wake of the Watergate and the Counterintelligence Program . . . scandals involving illegal surveillance on opposition political parties and individuals deemed to be subversive.” The Act sought to “restore trust in government and to address what at the time was seen as an existential threat to American democracy.”[xiii]
According to the principal sponsor of the legislation, Senator Sam Ervin,[xiv] “[i]f we have learned anything in this last year of Watergate, it is that there must be limits upon what the Government can know about each of its citizens.”[xv]
The Privacy Act implemented a code of “Fair Information Practice Principles,” which:
“allow individuals to determine what records pertaining to them are collected, maintained, used, or disseminated by an agency; require agencies to procure consent before records pertaining to an individual collected for one purpose could be used for other incompatible purposes; afford individuals a right of access to records pertaining to them and to have them corrected if inaccurate; and require agencies to collect such records only for lawful and authorized purposes and safeguard them appropriately. Exceptions from some of these principles are permitted only for important reasons of public policy.”
Following the enactment of the Privacy Act, the Tax Reform Act of 1976 (the “TRA”) extended the right to privacy to a taxpayer’s tax returns and tax return information.[xvi] Specifically, the TRA made tax returns and return information confidential, and provided that no officer or employee of the U.S., any State, or any other person shall disclose any return or return information in connection with their duties.[xvii]
In general, the term “return information” is defined by the Code[xviii] as follows:
“a taxpayer’s identity, the nature, source, or amount of his income, payments, receipts, deductions, exemptions, credits, assets, liabilities, net worth, tax liability, tax withheld, deficiencies, overassessments, or tax payments, whether the taxpayer’s return was, is being, or will be examined or subject to other investigation or processing, or any other data, received by, recorded by, prepared by, furnished to, or collected by the Secretary with respect to a return or with respect to the determination of the existence, or possible existence, of liability (or the amount thereof) of any person under this title for any tax, penalty, interest, fine, forfeiture, or other imposition, or offense.”
Such term does not include data in a form which cannot be associated with, or otherwise identify, directly or indirectly, a particular taxpayer.
However, in recognition of the government’s legitimate interest in enforcing the tax laws, the TRA permitted disclosure of returns and return information to state tax officials in specified cases in connection with administration of state tax laws, tax return inspectors of the Department of the Treasury, the Department of Justice for preparation of proceedings or for investigations, and to Federal or State judicial or administrative proceedings under specified conditions, specified agencies for statistical purposes, to specified agencies for tax administration purposes, and to specified agencies for specified purposes other than tax administration.[xix]
The TRA also set forth required procedures for such disclosures of returns and return information, including records of such disclosures and measures for safeguarding returns and return information.
Everything considered, the TRA implicitly acknowledged how important the protection of taxpayer information is to our federal tax system, which basically relies on self-assessment – meaning that taxpayers themselves are responsible for determining the correct amount of tax they owe and completing the appropriate returns, rather than having the government determine the tax for them.[xx]
Self-Assessment
Under our system of taxation, each taxpayer (or each person required to collect and pay over the tax) is required to file a prescribed form of tax return which shows the facts upon which tax liability[xxi] may be determined and assessed. Generally, the taxpayer must compute the tax due on the return and pay such tax on or before the due date for filing the return.[xxii]
Audits
After tax returns are filed and processed in Internal Revenue Service Centers, some returns are selected for examination. If adjustments are proposed with which the taxpayer does not agree, ordinarily the taxpayer is afforded certain appeal rights. If the taxpayer agrees to the proposed adjustments and waives restrictions on the assessment and collection of the tax,[xxiii] the deficiency will be immediately assessed.
The information gathered by the IRS during the course of an audit – like the information provided by a taxpayer on their tax return – is treated as “return information” within the meaning of the Code’s confidentiality and non-disclosure rules, described above, regardless of whether the taxpayer provided the information in response to the government’s request therefor or the information was obtained from a third-party recordkeeper.
Implicit in the taxpayer’s cooperation with preparing their own returns or with the conduct of an audit of those returns is the understanding that their information will remain private, subject only to certain exceptions founded on important public policies.
“Technology”
Unfortunately, from the taxpayer’s perspective, we live in a time during which technology has enabled almost everyone who is predisposed – and seemingly oblivious of the associated risks – to share every facet of their lives with anyone who bothers to search the internet, including the taxing authorities.[xxiv]
Talk about fertile ground for someone interested in participating in the IRS’s Whistleblower Program – which the government encourages – the mission of which is “[t]o effectively promote voluntary compliance and reduce the tax gap by providing excellent service to whistleblowers, taxpayers, and other stakeholders.”[xxv]
But what about the “compliant” taxpayer, the one who has exercised ordinary care and prudence in determining and paying their tax liability, who has a history of good, if not perfect, compliance?
It appears that these folks may have as much to fear from technology as less compliant taxpayers. Just consider the private taxpayer information that is occasionally, albeit inadvertently, posted or released by the IRS, as was discovered last September only after such information had been accessible by the public for about a year.[xxvi]
The CTA
For now, the foregoing concerns may be less pressing because the CTA is the law[xxvii] and was enacted with bipartisan support, which says a lot, considering our dysfunctional government. A brief review of the federal law[xxviii] is in order before we look at New York’s proposed rules.
In general, the CTA requires each reporting company to submit to FinCEN a report identifying each beneficial owner of the reporting company and each applicant with respect to that company by: (1) full legal name, (2) date of birth, (3) current residential or business street address, and (4) unique identifying number from an acceptable identification document.[xxix]
In addition, the CTA prohibits any corporation, LLC, or other similar entity formed under the laws of a state from issuing a certificate in bearer form.
Applicant
The applicant is the individual who files the document that forms a domestic corporation or LLC under state law. They are required to file a list of a reporting company’s beneficial owners, along with certain identifying information, with FinCEN at the time the company is formed.[xxx]
Applicants are required to provide the aforementioned information even if they are not themselves beneficial owners.
Reporting Company
In general, a reporting company includes a corporation, LLC, or “other similar entity” that is created under state law by filing a document with the secretary of state (or a similar office) of the governing jurisdiction.[xxxi]
However, certain entities are not treated as reporting companies.[xxxii] Significantly, from the perspective of many closely held businesses, the term “reporting company” does not include any U.S. company that:
i. has more than 20 employees on a full-time basis in the U.S.,
ii. filed Federal income tax returns in the U.S. in the previous year demonstrating more than $5 million in gross receipts or sales in the aggregate (including the receipts and sales of other entities it owns or through which it operates), and
iii. has an operating presence at a physical office within the U.S.[xxxiii]
Beneficial Owner
The term “beneficial owner” means a natural person who, directly or indirectly, through any contract, arrangement, understanding, relationship, or otherwise:
i. Exercises substantial control over a company; or
ii. Owns or controls 25 percent or more[xxxiv] of the equity interests of a company.[xxxv]
Among others, the term “beneficial owner” does not include an individual acting as an agent, nominee, intermediary, or custodian on behalf of another individual; an individual acting solely as an employee of the company and whose control over or economic benefits from such entity is derived solely from the individual’s employment status; an individual whose only interest in the company is through a right of inheritance; or a creditor of a company.
Beneficial Owner Information
The principal purpose of the CTA is the identification of the beneficial ownership of reporting companies. The list of beneficial owners filed with FinCEN must include the following information: the full legal name, date of birth, current residential or business address, and a current identifying number from an acceptable identification document, such as a driver’s license or passport number, for each beneficial owner.[xxxvi]
Updates and Retention
A reporting company is also required to file updated information within one year after the date on which there is a change with respect to any beneficial ownership information that has been provided to FinCEN.
The CTA requires FinCEN to retain beneficial ownership information for at least 5 years after a reporting company terminates.
Privacy Protection
The statute provides protocols through which law enforcement agencies can access FinCEN’s beneficial ownership information, which shall otherwise be confidential – i.e., it will not be publicly available. In general, these are intended to:
i. Protect the security and confidentiality of any beneficial ownership information;
ii. Ensure that any law enforcement agency requesting beneficial ownership information from FinCEN has an existing investigatory basis for its request;
iii. Ensure that only authorized users at law enforcement agencieshave access to the database and that their authorized user status is verified through appropriate authentication mechanisms;
iv. Include an audit trail of every law enforcement agency’s requests for beneficial ownership information; and
v. Require annual audits by FinCEN and by each law enforcement agency that has access to the beneficial ownership database, to ensure that those agencies are using the beneficial ownership information appropriately.
Further, the CTA prohibits any beneficial ownership information provided to law enforcement agencies by FinCEN from being used for inappropriate reasons.[xxxvii]
New York
Having reviewed the Federal CTA, we can turn to the New York bill,[xxxviii] which adopts the same standards promulgated under the Corporate Transparency Act, but focuses its attention only on LLCs.[xxxix]
The memorandum accompanying the bill asserts that limited liability is a “legal privilege” conferred upon an individual by the state, and the receipt of such privilege should be conditioned on the identification of the individual benefiting from it.
Permitting anonymous LLCs to do business in New York, the memo states, was a “public policy mistake” that deserves correction because such entities are used to avoid taxes, launder money, and commit other crimes. Anonymous LLCs also hamper routine code enforcement, it stated.[xl]
The memo then explains that “the inaccessible nature of the new federal database [under the CTA] means that this information will serve no use for civil society or local government in New York, denying New Yorkers the many benefits that beneficial ownership transparency offers.”
Thus, the bill requires that the same information filed with FinCEN also be filed with New York’s Department of State. In fact, companies subject to the Federal reporting requirements may submit a copy of their federal registration to New York’s Department of State in order to minimize the burden of such reporting.
To protect genuine privacy interests that some individuals may have, a waiver process is created, with specific protections for whistleblowers, for example, who use LLCs to file false claims act lawsuits.
This bill aims to end the practice of anonymous ownership of limited liability companies in New York by defining beneficial ownership, requiring the disclosure of the identities of beneficial owners upon company formation or registration, and – in contrast to the Federal CTA – publishing beneficial owners of limited liability companies in New York’s publicly searchable business entity database.
The bill requires that LLCs include an initial report, including a list of beneficial owners, with the documents submitted to the Department of State when organizing an LLC in New York. Exempt companies must indicate which exemption(s) they are claiming against their obligation to file such an initial report. The exemptions that may be claimed are the same as those promulgated under the CTA.
The bill also requires that updates and corrections to information provided in an initial report be filed with the Department of State.
Next, the bill enumerates the information that must be disclosed by an LLC when identifying one of its beneficial owners. The list of items is identical to the information that must be disclosed to the Treasury Department pursuant to federal law.[xli]
Finally, the bill requires that the secretary of state maintain a publicly available database on its website for each business entity – not limited to LLCs – organized in New York and each foreign business entity with authority to do business in the state.
This database must include, among other things, the name of the business entity, its history of name changes, the current business street address and county associated with each business street address, the entity’s duration or date of dissolution, and its filing history. If the entity is an LLC that is a reporting company, the database will also include the full legal name(s) of each beneficial owner. The Secretary of State is required to establish rules and regulations to allow beneficial owners to apply for confidentiality waivers.
Good or Bad?
Like it or not, reporting companies that are organized or doing business in the U.S. will have to comply with the CTA.
If the governor signs New York’s LLC Transparency bill, reporting companies in the state will have to contend with a public database that will identify their beneficial owners.
Query whether this will affect how otherwise compliant taxpayers view their ongoing presence in or association with New York. After all, there are bona fide business reasons why an investor may want to keep the fact of their ownership interest in another business confidential.[xlii]
Will these owners and their businesses choose to organize or reorganize elsewhere? Will they decide to do business or invest elsewhere?
If I had my druthers, New York would merely tag-along with the Federal CTA. Why take the further, extraordinary step of compromising individuals’ legitimate privacy concerns by maintaining a readily accessible public database?
[i] A3484A. The “LLC Transparency Act.” It has been waiting for the Governor’s signature for two months.
[ii] It is Title LXIV of the National Defense Authorization Act for FY 2021, Pub. L. 116-283, which added 31 U.S.C. Sec. 5336.
[iii] See Sec. 9 of A3484A. which adds new Section 100-b to the Executive Law.
[iv] Anonymous in the sense that the ownership of such entities is not a matter of public record – their owners are anonymous.
[v] In contrast to the U.S., member countries of the European Union are required to have corporate registries that include beneficial ownership information.
[vi] An entity that opens an account at certain financial institutions may be required to provide certain beneficial ownership information.
[vii] As one Committee report put it:“A person forming a corporation or limited liability company within the United States typically provides less information at the time of incorporation than is needed to obtain a bank account or driver’s license and typically does not name a single beneficial owner.” https://www.congress.gov/congressional-report/116th-congress/house-report/227/1.
[viii] It passed the Senate in December 2020 with a veto-proof majority of 84-13 before being signed by the President.
[ix] The Financial Crimes Enforcement Network (FinCEN) within the Treasury.
[x] Taxes represent the capital calls made upon the members of society to fund the operations of their government. Depending upon the purpose for which they are being collected, if the tax revenues are insufficient, the government must either modify or eliminate such purpose or it must tap into another source of revenue – debt. Until now, the latter course has somehow been politically more expedient.
[xi] I.e., the members of society whom the government serves, at least in theory. Back to the social contract. Too many members of our nation’s political elite need to be reminded of their role. In the end, they are employed by us. When an employee gets too big for their britches, it’s time for them to go.
[xii] Pub Law No. 93-579, 88 Stat 1896 (Dec. 31, 1974), codified at 5 U.S.C. § 552a (2018).
[xiii] Are we repeating history today?
[xiv] From North Carolina. “Just a country lawyer,” he would say. He chaired the Senate Watergate Committee. It was watching his committee hearings on television that inspired me to pursue the law. The broadcast of those hearings also introduced me to anchors Robert MacNeil and Jim Lehrer. (They don’t make them like that anymore.)
[xv] S. Comm. on Gov’t. Operations & H.R. Comm. on Gov’t. Operations, 94th Cong., Legislative History of the Privacy Act of 1974 S. 3418 (Public Law 93-579): Source Book on Privacy at 4 (Comm. Print 1976) [hereinafter Source Book], https://www.justice.gov/opcl/paoverview_sourcebook.
[xvi] Pub. L. 94-455.
[xvii] IRC Sec. 6103. Over time, the disclosures allowed under this provision have been amended; they have also been fleshed out by regulation.
[xviii] IRC Sec. 6103(b)(2).
[xix] The TRA also permitted disclosure to members of a partnership, shareholders holding one percent of the outstanding stock of a corporation, heirs and estate administrators, trustees, and specified Congressional committees (provided identifying information is removed if such committees are not in executive session), among others.
[xx] Compare taxes that are collected by withholding at a prescribed rate at the source.
[xxi] The IRS is directed to assess the tax liability that a taxpayer shows as owing on their tax return. IRC Sec. 6201(a)(1). This tax is said to have been “self-assessed.”
[xxii] Reg. Sec. 601.103.
[xxiii] I’m referring to the income tax. Reg. Sec. 601.105(b)(4),
For example, some folks will post on the internet photos of their expensive vacations, of their boats and second homes, and of the lavish parties or dinners they attend decked out in all their sparkling finery. Meanwhile, these same folks file tax returns under penalty of perjury that belie the economic wherewithal that finances their lifestyles.
Remember the scene from the film American Gangster in which Denzel Washington’s character, Frank Lucas, scolds his brother for his flashy clothes and warns him that he should avoid drawing attention to himself?
[xxv] https://www.irs.gov/compliance/whistleblower-office.
[xxvi] https://www.npr.org/2022/09/04/1121061081/irs-data-mistake-public-congress. The mistake was repeated two months later.
[xxvii] In general, it takes effect on January 1, 2024.
[xxviii] This post will not consider the regulations.
[xxix] With respect to a U.S. individual, such documents include a U.S. passport, an identification document issued by a state or local government, or a driver’s license.
[xxx] The CTA requires states to notify each applicant seeking to form a company in the state of its obligation to file a list of its beneficial owners with FinCEN.Existing companies are provided two years from the issuance of regulations to report.
[xxxi] What about limited partnerships?
[xxxii] For example, those registered under the Securities and Exchange Act.
[xxxiii] Also excluded is any entity that is owned or controlled by an entity qualifying for this exclusion.
[xxxiv] Query how this will be applied to LLCs with complicated allocations and waterfalls.
[xxxv] An earlier proposal included someone who receives “substantial economic benefits” from the entity.
[xxxvi] Specific rules are provided with respect to beneficial owners who are foreigners.
[xxxvii] Strict penalties are provided for misuse or unauthorized disclosure by government employees of beneficial ownership information collected by FinCEN.
[xxxviii] Which would become effective one year after enactment.
[xxxix] N.B., the income tax treatment of the entity – as a disregarded entity, a partnership, or as an association taxed as a corporation – appears to be irrelevant.
[xl] The memorandum adds: “Meanwhile, the anonymous ownership of a significant portion of real estate in New York hampers policymaking and upends centuries of precedent by obscuring the answer to the question: who owns what? In response to exposes such as the Panama Papers and the Pandora Papers, which highlighted the massive, global nature of illicit activity fostered by anonymous shell companies like LLCs.”
[xli] An LLC may file an identical copy of the report it filed with FinCEN with the New York Department of State in order to satisfy state reporting requirements.
[xlii] For example, the business may be transacting with competitors of the investor. Or an investor may, for personal reasons, want to keep the investment concealed from members of their family.
