By Anthony Diosdi
The Corporate Transparency Act (“CTA”) was enacted on January 1, 2021, as part of the National Defense Authorization Act (“NDAA”). It effectively creates a national beneficial ownership registry. The CTA requires certain business entities to report beneficial owners and “applicants” to FinCEN. CTA is intended to strengthen anti-money laundering laws and countering terrorism financing. Section 6403(a)(b) of the CTA requires that, starting in 2022, newly formed U.S. corporations, limited liability companies, and certain other entities classified as a “reporting company” must report their beneficial ownership to Financial Crimes Enforcement Network of the U.S. Department of the Treasury (“FinCEN”) at the time of formation or registration. Pre-existing reporting companies (those formed before the effective date of the CTA regulations), likely will start reporting in 2024, two years after the effective date of the CTA regulations. Changes in reporting information will also be subject to the reporting requirements.
The Definition of a Reporting Company under the CTA
CTA Section 6503(a)(11) defines a “reporting company” as a corporation, limited liability company, or “other similar entity” that is created by the filing of a document with a secretary of state or similar office under the law of a U.S. State (including any U.S. commonwealth, territory or possession of the U.S.) or Indian Tribe or formed under the law of a foreign country and registered to do business in the U.S. by the filing of a document with such office. Extensive exceptions are provided, including corporations, LLCs or similar entities with an operating presence at a physical office within the U.S., with over 20 full-time employees in the U.S., that filed in the previous year federal income tax returns in the U.S. demonstrating more than $5 million in gross receipts or sales. See 31 U.S.C. Section 5336(a)(11)(B)(xxi). In addition, certain entities acting with government authority; banks; credit unions; bank holding companies; registered money transmitting businesses; broker/dealers; exchange or clearing agencies; other SEC registered entities; investment companies and investment advisors (as defined in the Investment Company Act and Investment Advisors, respectively); insurance companies and producers; certain commodity futures merchants; certain public accounting firms; public utilities, financial market utilities and pooled investment vehicles; organizations exempt from tax under Sections 501(c)(3) and 501(a), 527(a) or 4947(a); certain entities owned or controlled by other exempt entities; and certain entities with no active trade or business are also exempt. Another exception is provided for an inactive company not owned by any foreign person, and subsidiaries of exempted companies are exempt while parent exemption is effective. Common law trusts are not covered by the CTA definition of Reporting Company since such trusts are not created by the filing of a document with a secretary of state or similar state office. It is possible, however, that statutory trusts which are created by such a filing may be covered if they are found to be “similar entities” to corporations LLCs.
The Definition of a Beneficial Owner as Per the CTA
For CTA purposes, a beneficial owner of an entity is defined in Section 6403(a)(a)(3) as any individual who, directly or indirectly (including through contract, arrangement, understanding, relationship, or otherwise) exercises “substantial control” over the entity or owns or controls not less than 25 percent of the ownership interests in the entity. The term “substantial control” is not defined in the CTA. Every Reporting Company will need to prove FinCEN the following information for each beneficial owner and applicant: their full legal name, date of birth, current address (home or work), and a unique identification number. The identification number is any of the following: non-expired U.S. passport, non-expired U.S. or state government identification, non-expired driver’s license from a state or a foreign passport. The beneficial owner definition excludes the following:
1. Minors (provided the parent or guardians information is reported);
2. Nominees, intermediaries, custodians, agents;
3. An individual who is an employee of a Reporting Company and whose control or economic benefits over the Reporting Company is solely from his or her employment;
4. An individual whose only interest in a Reporting Company is through a right of inheritance; and
5. A creditor of a Reporting Company (unless the creditor is a beneficial owner in his or her own right).
Filing Due Dates
Any reporting company that is existing at the time that regulations are effective must file the report within two years of the effective date of the regulations. On April 5, 2021, FinCen released advance notice of proposed rulemaking, requesting comments by May 5, 2021, about regulations to be issued to implement the CTA. Any reporting company formed subsequent to the effective date of the regulations must file the report on the formation of the entity. Every reporting company must file a report within one year of the Beneficial Ownership information changing. Reporting is required for the following changes: 1) substantial control of the Reporting Company; 2) a Beneficial Owner or Applicant’s contract details changing, and 3) beneficial ownership exceeding or dropping below 25 percent.
Penalties for Failing to Comply with the CTA Rules and Regulations
Any person who willfully provides, or attempts to provide, false or fraudulent beneficial ownership information, including a false or fraudulent identification photograph or document, or fails to file complete and accurate reports or fails to provide updated reports will face penalties of up to $10,000 (accruing at $500 per day that the report is outstanding) and/or imprisonment for up to two years. See 31 U.S.C. Section 5336(h)(3).
Questions that Remain Unanswered for the Pending REgulations
The pending CTA regulations have left some important questions unanswered as to the definition of a reporting company. The CTA regulations define a reporting company as a corporation, limited liability company, or any “other similar entity that is created by the filing of a document with a secretary of state or a similar office under the law of a state or Indian tribe.” Under this definition, it is possible that limited partnerships will be classified as a reporting company. This is because general partnerships are typically not created by filing a document with the secretary of state. The pending regulations also do not appear to classify a foreign entity that is only holding U.S. real estate as a reporting company. Section 6043(a)(11)(ii) of the CTA defines a reporting company as an entity “formed under the law of a foreign country that registers to do business or applies for a certificate of authority to transact business in a state or for a similar business license from an Indian Tribe.” FinCEN’s request for comments used slightly different language: “registered to do business in the United States by the filing of a document with a secretary of state or a similar office under the laws of a state or Indian Tribe.” But what if a foreign entity simply fails to register or apply for a certificate of authority when required? The CTA’s definition of a reporting company does not seem to cover that circumstance. See Corporate Transparency Act to Have Major Impact on Clients and Attorneys, The Florida Bar Journal/November/December 2021, Jonathan Warner.
Tax professionals should review the new CTA rules and watch for evolving CTA regulations. Tax professionals should also familiarize themselves with the new reporting requirements of the CTA.
Anthony Diosdi is one of several tax attorneys and international tax attorneys at Diosdi Ching & Liu, LLP. Anthony Diosdi focuses a part of his practice on criminal tax enforcement, broad-based civil tax compliance and white collar matters generally. He also advises clients on the IRS voluntary disclosure program, with particular focus on disclosure related to offshore banking accounts.
Anthony Diosdi is a frequent speaker at international tax seminars. Anthony Diosdi is admitted to the California and Florida bars.
Diosdi Ching & Liu, LLP has offices in San Francisco, California, Pleasanton, California and Fort Lauderdale, Florida. Anthony Diosdi advises throughout the United States. Anthony Diosdi may be reached at (415) 318-3990 or by email: firstname.lastname@example.org.
This article is not legal or tax advice. If you are in need of legal or tax advice, you should immediately consult a licensed attorney.