HIGH PRIORITY: Small Businesses must comply with new federal mandatory disclosure laws or face steep fines or imprisonment
Small businesses will now be required to disclose all “beneficial owners” to a newly-created law enforcement agency or face daily penalties or possible imprisonment. The new reporting scheme is largely unprecedented. The reporting requirements themselves are not extensive, but the constancy of updating disclosures will likely chill business formation.
Introduction
The Corporate Transparency Act (CTA) is a landmark piece of legislation that aims to increase the transparency of beneficial ownership information for certain entities in the United States. Signed into law by former President Donald Trump as part of the National Defense Authorization Act (NDAA) for Fiscal Year 2021, the CTA will require certain corporations, limited liability companies (LLCs), and other similar entities to report their beneficial ownership information to the Financial Crimes Enforcement Network (FinCEN) of the Department of the Treasury. In this blog post, we will discuss the key provisions of the CTA, its implications, and how it will affect businesses and individuals.
Background
The United States has been criticized for having weak laws regarding the disclosure of beneficial ownership information. Prior to the passage of the CTA, there was no federal requirement for companies to disclose their beneficial owners, except for certain industries such as banking and securities. This, according to Congress, allegedly made it easy for criminals and other bad actors to use the United States as a haven for illicit financial activity.
Individual states set standards on what amount of ownership information needed to be disclosed. Alabama, for instance, only required that an incorporator represent that there was, in fact, an owner of the company. No other disclosures about the owners were required. This allowed for the formation of “blind companies,” where the actual ownership of the company was not identified to the public. There were a number of legitimate reasons for permitting this, such as a current employee preparing to go out on their own and investing in businesses what may have exposed an owner to unnecessary criticism or rebuke.
Key Provisions of the Corporate Transparency Act
The Corporate Transparency Act requires certain corporations, limited liability companies (LLCs), and similar entities to file reports with the Financial Crimes Enforcement Network (FinCEN) of the Department of the Treasury that identify their” beneficial owners.” The information will be maintained in a confidential database accessible only by authorized law enforcement and national security personnel.
The following are the key provisions of the CTA:
Reporting Requirements
The CTA requires certain companies to report to FinCEN their beneficial ownership information. These include corporations, LLCs, and other similar entities that are created or registered under state law or that are formed under the laws of a foreign country but do business in the United States. The reporting requirement applies to both new and existing companies. “Beneficial ownership” refers to the natural person(s) who ultimately own or control a company or other legal entity, as opposed to the legal entity itself. A beneficial owner is defined as any individual who directly or indirectly owns 25% or more of the ownership interest in a company, or who exercises substantial control over the company.
Beneficial Ownership Information
The CTA requires companies to disclose the name, date of birth, current address, and unique identifying number of each beneficial owner (such as Social Security Number, Driver’s License Number, or Passport Number). The registrant must also include an image of the beneficial owner’s photo ID. Companies must also report the name and address of a "reporting company" which is an entity that is required to file a report under the CTA.
Exemptions
Certain entities are exempt from the reporting requirements under the CTA, including publicly traded companies, certain regulated entities, and entities that have $5 million in annual revenues, more than 20 employees in the US, have filed income tax returns with the IRS and other agencies, as necessary.
Penalties
Failure to comply with the reporting requirements under the CTA can result in civil and criminal penalties, including daily $500 fines of up to $10,000 and imprisonment for up to two years.
Implications of the Corporate Transparency Act
The Corporate Transparency Act has several implications for businesses and individuals in the United States.
Increased Transparency
The CTA will increase the transparency of beneficial ownership information for certain companies. This will allegedly help law enforcement and national security agencies to detect and prevent illicit financial activity, such as money laundering and terrorism financing.
Compliance Costs
Companies that are subject to the reporting requirements under the CTA will incur additional compliance costs to gather and report beneficial ownership information to FinCEN. This includes the costs of developing and implementing new compliance programs, training employees, and preparing and filing reports. Because of the way the exemptions are managed, this burden will fall almost entirely on small businesses, as large businesses are explicitly exempt from the CTA.
Privacy Concerns
Some have expressed concerns about the privacy implications of the CTA. The disclosure of personal information such as names and addresses of beneficial owners could potentially put them at risk of identity theft, cyber attacks, and other forms of fraud. While the FinCEN database will only be accessible to authorized law enforcement and national security personnel and will be subject to strict confidentiality and data security requirements, the data retention necessary to process claims directly and indirectly through third parties greatly increases the potential failure points for data breach.
Implications for Small Businesses
The CTA could have a significant impact on small businesses, particularly those that are owned and operated by a small number of individuals. These businesses may not have the resources to comply with the reporting requirements under the CTA and may find it difficult to navigate the complex legal and regulatory landscape. The civil and criminal liabilities are significantly greater than existing compliance requirements. Currently, failure of small businesses to meet corporate formalities might result in the loss of liability limitation. The CTA now makes that failure a possible felony. This will significantly chill business formation activity.
Implications for Service Providers
Service providers to small businesses also have significantly increased liability under the CTA. Businesses, including law firms, that form new businesses will also be required to submit disclosures, such that anyone involved with the formation of a new company, from a lawyer that prepares the documents to a paralegal that simply submits the documents for registration, will have to submit their own personal information to FinCEN. This will greatly increase the cost and liability of forming new businesses.
Agency Costs
FinCEN anticipates that the first-year costs of maintaining the disclosures will top $22 billion dollars in taxpayer money. Afterwards, it estimates roughly $5 billion per year to maintain the database. FinCEN does not disclose its current estimates of how much illicit activity is occurring in the US financial system, so it’s difficult to calculate the cost-benefit of the program.
International Implications
The CTA could also have international implications. The disclosure of beneficial ownership information could make it easier for foreign law enforcement and regulatory authorities to investigate and prosecute cross-border financial crimes. It could also impact the use of the United States as a haven for illicit financial activity by foreign entities.
Conclusion
The Corporate Transparency Act is a unprecedented development in the United States’ ongoing War on Terror. The CTA seeks to help law enforcement and national security agencies to detect and prevent illicit financial activity. However, the CTA also poses challenges and potential risks for businesses and individuals, particularly with regards to compliance costs and privacy concerns. It remains to be seen how the CTA will be implemented and enforced, and how it will affect the broader financial system in the United States and internationally.
My biggest worry with the CTA is simply ignorance. It’s hard enough to maintain compliance in a small business, and the CTA criminalizes what used to simply be an administrative inconvenience. Considering that few people are even familiar with the CTA, including many practicing attorneys, I fear that millions of Americans could face massive criminal and civil liabilities effectively overnight.