Pulling Back the Curtain with the Corporate Transparency Act

After experiencing an inability to pass as a standalone bill, the Corporate Transparency Act (“Act”) now finds itself tacked to the National Defense Authorization Act for Fiscal Year 2021, being passed by both the House and Senate with veto-proof majorities, 335-78 in the House and 84-14 in the Senate.[1] Following presidential veto, the Senate voted to pass the Act anyway overriding President Trump’s veto.

The original version of the Act (Corporate Transparency Act of 2019), presented in both the House and Senate as a standalone bill never made it to the President’s desk.[2] Now, it seems the Act will likely be law in the very near future. With the Act comes new reporting requirements as to beneficial ownership of entities, including small businesses.

Purpose of the Act

The Act, being potential new law under Title 31, is part of a package for anti-money laundering purposes, including assisting law enforcement in detecting, preventing, and punishing terrorism, money laundering, and other misconduct involving United States corporations and limited liability companies.[3] Section 6402 provides some background of the “Sense of Congress” elaborating on the reasoning and justification for the Act. Specifically, the Act cites that there are nearly 2,000,000 corporations and limited liability companies formed in the United States each year and, in many cases, there is little information required by states as to beneficial ownership of these entities. Analogizing tiered entity structuring as Russian nesting “Matryoshka” dolls, Congress expressed concern as to the government’s ability to detect and address concealed illicit activity, including money laundering, terrorism financing, proliferation financing, “serious” tax fraud, human and drug trafficking, counterfeiting, piracy, securities fraud, financial fraud, and acts of foreign corruption.

The original version of the Act went further, stating that formation of entities generally requires less information than opening a bank account or getting a driver’s license. Citing a 2006 report by the Financial Action Task Force on Money Laundering (“FATF”), of which the United States is a member, the Act notes criticism of the United States for failing to comply with an FATF standard with respect to the collection of beneficial ownership of entities and urged correction by July 2008. In December 2016, FATF criticized the United States again regarding the little progress made toward compliance following the 2006 report citing the “lack of timely access to adequate, accurate, and current beneficial ownership information” as a fundamental gap in the United States efforts to combat money laundering and terrorist finance. The Act, as passed by the House and Senate, failed to mention the FATF reports.

Lastly, Section 6402(6) provides that the information gathered under the Act is “sensitive” information and will be directly available only to authorized government authorities, subject to effective safeguards and controls. The Secretary is given broad authority in the implementation of the Act, its safeguards, and use of the information gathered. Being under Title 31 of the U.S. Code (Money and Finance), the government agency involved would be the Department of the Treasury.

While, historically, the beneficial owner verification burden has fallen on financial institutions by virtue of the Bank Secrecy Act’s customer due diligence and know your customer (commonly known as KYC) requirement, this new Act brings Treasury and the Federal government into the fold.

Required Information Reporting

Sec. 6403(a) of the Act provides for the addition of § 5336 as part of Title 31. Acting through definitions, the Act defines certain major terms such as “reporting company,” “beneficial owner, and “acceptable identification document.”

The Act requires a “reporting company” to submit certain information to FinCEN with respect to a “beneficial owner”, including (i) full legal name, (ii) date of birth, (iii) residential or business address, and (iv) unique identifying number from an “acceptable identification document.” Such acceptable identification documents include driver’s licenses, passports, or other state issued identifications. A “beneficial owner” includes an individual, directly or indirectly, through contract, arrangement, understanding, relationship, or otherwise – (i) exercises substantial control over the entity, or (ii) owns or controls not less than 25% of the interests of the entity and excludes minors, those acting as nominee or agents for individuals, employees, and in most circumstances, creditors of such entities.

Who is Required to Report?

“Reporting company” is defined broadly to include any “corporation, limited liability company, or other similar entity” that is created by the filing of a document with a state or Indian Tribe as well as foreign entities registered to do business in the United States. The definition of “reporting company” works to broadly capture almost any type of entity then exclude specific entities. Among the excluded entity types are publicly traded, regulated, non-profit, and government entities. Many small businesses will enjoy another exemption from reporting if they (i) have more than 20 full-time employees in the United States, (ii) report more than $5 million in gross receipts or sales to the IRS, and (iii) have an operating presence at a physical office within the United States.[4] Generally speaking, if there is already some sort of regulatory oversight or reporting requirements, entities will most likely find themselves exempt from reporting.

What is Required to be Reported?

Information described in Section 6403(b)(2) of the Act is required to be reported by each reporting company. This information will be in the form of a report identifying each beneficial owner of the reporting company and each applicant with respect to that reporting company and include their full legal name, date of birth, address (business or residential), current as of the date the report is delivered, and one of (i) a unique identifying number from an acceptable identification document (ex. Employer identification number), or (ii) a FinCEN identifier to be issued upon request by an individual on behalf of such individual or entity which has reported beneficial ownership information to FinCEN. No individual or entity will have more than one FinCEN identifier.

Therefore, pending regulations to be issued by Treasury, the significant reporting may only have to occur once and following such reporting and a subsequent request for and issuance of a FinCEN identifier, a FinCEN identifier may be used to expedite and ease the burden of compliance in subsequent reports.

When is a Reporting Company Required to Report to FinCEN?[5]

Reporting obligations arise generally upon formation. However, as many entities pre-exist the Act, there are certain events in which reporting companies will be required to report. For existing entities falling under the definition of reporting company, the deadline will be within two years following the effective date of the regulations. For entities formed after the effective date of the regulations to be issued under the Act being reporting companies, the report will be required at of the time of formation (ex. Upon filing of articles of incorporation) in accordance with to be issued regulations. Lastly, pursuant to to-be-issued regulations, upon change of beneficial ownership of a reporting company, a report must be made in a timely manner, not to exceed one year following the change in ownership.[6]

Use of Collected Information

FinCEN is required to retain beneficial ownership information collected for no less than five years following termination of any reporting company. FinCEN is to keep collecting information confidential and to disclose the information in certain limited circumstances. These circumstances require that a request be made and certain conditions met, such conditions generally pertaining to the identity of the requesting party and use of the requested information. Specifically, Federal and state government agencies involved with law enforcement, national security, and intelligence. State governmental agency requests must be authorized by a court of competent jurisdiction. Also included are Federal agencies on behalf of foreign countries in certain cases and domestic (?) financial institutions for customer verification. Other Federal regulatory agencies may request the information as well, but will be required to meet certain requirements similar to the requirements which will be required for financial institutions.[7]

The Act continues to further limit use and access to the information of beneficial ownership and require appropriate protocols and security measures to protect the information. Further, penalties exist for unauthorized disclosure of such information, including civil penalties, fines of up to $250,000, imprisonment for up to five years, and further enhanced penalties for repeated violations or violations in conjunction with violation of another law of the United States.[8]

Penalties for Failure to Report

Penalties include a $500 per day civil penalty for continued violation, a fine of up to $10,000, and/ imprisonment of up to 2 years. However, a safe harbor exists for filers if they believe a report contains inaccurate information and, pursuant to regulations, voluntarily and promptly, and in no case later than 90 days after the submission of the original report, submits an updated report containing the updated and corrected information. This exception does not apply for any person who knowingly, at the time of filing, files a report containing inaccurate information.

Going Forward

Once (and if) the law goes into effect and regulations are issued, the clock begins to tick for existing entities that meet the definition of a reporting company as they will have 2 years from the date of the regulations to file their report. Further, a compliant and consistent FinCEN reporting process should become part of the formation process for new entities. Lastly, reporting companies should have a compliance plan in place to ensure continued compliance upon changes of beneficial ownership and such changes take place.

[1] See Sec. 6401-6403 of H.R. 6395: National Defense Authorization Act for Fiscal Year 2021, 116th Congress (2019-2020)

[2] See H.R. 2513 116th Congress (2019-2020) and S. 1978 116th Congress (2019-2020).

[3] See original opening text from H.R. 2513.

[4] See H.R. 6395 Section 6403(a)(11)(A) for the broad sweeping definition and (B) for the long list of exclusions.

[5] Treasury is required to issue regulations within one year of the passage of the Act.

[6] Treasury is given significant deference as to the reporting requirements for changes in beneficial ownership.

[7] See Section 6403(c)(3)

[8] See Section 6403(h)(3).