The 2021 Corporate Transparency Act included new reporting requirements that represent the most significant change in the formation of corporations in decades, and while it’s clear that the White House intends to use FinCEN regulations as part of its anti-financial crime pursuits, it may not be clear what that means for small companies.
In January 2021, Congress enacted the Corporate Transparency Act (CTA), as part of the National Defense Authorization Act (NDAA) and Anti-Money Laundering Act of 2020. The CTA requires legal entities to register with FinCEN and disclose their ultimate beneficial owners.
The CTA requires disclosure of the beneficial owners of corporations, limited liability companies (LLCs) or other business entities. Congress believes that wrongdoers may have used the legal entities to their benefits in the past to exploit American corporations for criminal gain. The CTA is intended to assist law enforcement in detecting, preventing and punishing terrorism, money laundering and other misconduct that involves U.S. corporations.
Beginning Jan. 1, 2024, barring an applicable exemption, all existing and newly formed companies will be subject to a new reporting obligation imposed by the CTA. Companies must report company information, certain personal information of their beneficial owners and personal information of the company applicants to FinCEN. Any reporting company in existence before that date will have until Jan. 1, 2025, to submit its initial report to FinCEN. Reporting companies formed or initially registered after Jan. 1, 2024, must submit an initial report to FinCEN within 30 days from the earlier date on which the company receives actual notice of the formation, registration or the date on which the secretary of state or similar office first provides public notice such as through the online registry.
New regulations will require companies to report accurate and up-to-date beneficial ownership information to the U.S. government. Keeping track of changes could prove to be a tall task. Miller & Chevalier’s Ian Herbert talks about what companies can do to stay compliant.
A (Beneficial) Owners Manual: Staying Compliant in Light of New FinCEN Rule
Who must report?
The CTA generally requires reports from U.S. companies, including corporations, LLCs, limited partnerships and business trusts. The CTA also requires reports from entities formed under foreign law and registered to do business within the United States.
However, the legislation targets small companies that are otherwise not regulated. Therefore, companies that are already subject to federal or state regulation are generally excluded from the reporting requirements. For example, financial institutions that registered and are subject to government oversight are generally exempt from the reporting requirements. That also applies to companies registered with the SEC, state insurance regulators and companies that operate in regulated industries, such as utilities.
Large operating companies are also exempt from the reporting requirements. A large operating company is any entity that employs more than 20 full-time employees in the United States, has an operating presence at a physical address in the United States and filed a federal income tax return for the previous year demonstrating more than $5 million in gross receipts or sales. CTA uses the IRS definition for employees, which is an employee employed on average at least 30 hours of service per week or 130 hours of service per month.
What information is required?
If a company is subject to the CTA, it must disclose company information, information relating to each beneficial owner(s) and company applicant information.
The company must report the full legal name of the reporting company, all trade names or DBAs regardless of whether the name is registered. Additionally, the company must disclose the street address of its principal place of business, state of formation and tax identification number.
Currently, the rule does not allow a P.O. box, the address of registered agent or the address of any other third party to be reported as the business address. However, nowadays, there are an increasing number of companies operating fully online without any physical address. At this time, it is uncertain how these entities will have to comply with the reporting obligation, but FinCEN indicated that they are aware of the problem and are working on a solution. It is anticipated that in the months before the reporting obligation takes effect, we will receive more guidance on the reporting obligations of companies that do not have physical addresses.
A beneficial owner is defined as an individual who, directly or indirectly, through any contract, arrangement, understanding, relationship or otherwise (i) exercises substantial control over the entity or (ii) owns or controls not less than 25 percent of the ownership interests of the entity. Substantial control is indicated by (1) service as a senior officer of a reporting company; (2) authority over the appointment or removal of any senior officer or dominant majority of the board of directors (or similar body) of a reporting company; and (3) direction, determination or decision of, or substantial influence over, important matters of a reporting company.
This purposefully broad definition requires disclosure of individuals who are beneficial owners of at least 25 percent of the company. The formula to calculate beneficial ownership percentage includes equity, option-convertible notes, SAFEs, profit interest and any other security that allows direct or indirect ownership in the company.
Furthermore, individuals who control the company must also be reported as beneficial owners, including directors and senior officers with some exceptions. Guardians and nominees do not need to be reported. Creditors do not need to be reported unless they control the company or obtain at least 25 percent ownership.
The final FinCEN rule defines “company applicant” as an individual who either (i) directly files the document to create a domestic reporting company or registers a foreign reporting company; and (ii) the individual who is primarily responsible for directing or controlling such filing if more than one individual is involved in the process. At most, a reporting company will have to provide information on two company applicants.
Essentially, it means that the incorporator of a corporation and the organizer of a partnership or LLC must disclose certain personal information. For law firms, for example, it means that the attorney or paralegal who forms the company and acts as an incorporator or organizer will be reported as the company applicant.
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What information is required?
Beneficial owners and company applicants must provide the following information:
- Full legal name of the individual.
- Date of birth of the individual.
- Residential street address of the individual.
- A unique identifying number from certain government documents issued to the individual.
- An image of the document that provided the unique identifying number that also includes a photograph of the individual. (Driver’s license, passport, etc.)
How to submit required information
FinCEN expects that companies at some point will report the information electronically. However, the online platform has yet to be developed, so it is unclear whether the electronic filing system will be deployed by next year. In the absence of the electronic filing solution, companies will have to do paper filing.
Updates
If any of the beneficial owner information reported to FinCEN changes, the reporting company will need to submit an update report. The deadline for submitting the update report is 30 calendar days after the information changes. The company applicant information does not need to be updated.
FinCEN identifier for lawyers, paralegals and others who engage in the business of company formation
The frequent disclosure of personal information for lawyers, paralegals and other professionals who routinely form companies would not only make reporting incredibly burdensome but also would discourage professionals from serving as incorporators or organizers, which would make the formation process more complicated. However, the company applicant can obtain a FinCEN identifier, which can be provided to FinCEN in lieu of other required information about the individual. A FinCEN identifier is specific to the individual or entity to which it is issued.
Gabor Szecsi is an attorney in the Capital Markets and Securities Practice Group in Haynes Boone’s Palo Alto office. His practice focuses on general corporate law, commercial contracts and emerging growth companies, mergers and acquisitions. Gabor also advises investors and funds on fund formation, federal and state regulatory compliance.
