An Introduction to the Corporate Transparency Act (CTA)

“An Introduction to the Corporate Transparency Act,” that’s the subject of today’s ACTEC Trust and Estate Talk

Transcript/Show Notes

This is Travis Hayes, ACTEC Fellow from Naples, Florida. The Corporate Transparency Act was enacted into law on January 1st, 2021 as part of the National Defense Authorization Act. The Corporate Transparency Act represents the most significant reformation of the Bank Secrecy Act and related anti-money laundering rules since the US Patriot Act. All wealth planning and tax practitioners will need to understand the compliance obligations under this Act. ACTEC Fellow Glenn Fox from New York City and ACTEC Fellow Raj Malviya from Grand Rapids, Michigan will offer an overview of what professionals need to keep in mind. Welcome, Glenn and Raj.

Introduction: Background of the Corporate Transparency Act

Glenn Fox: Thank you. This is Glenn Fox from New York. With that introduction, why don’t we just get right into what some of the motivations were for the CTA? As was noted, it represents the most significant reformation of the Bank Secrecy Act that we’ve had. Essentially, when you get right down to it, it was to get to the issues of what was considered “dirty money” being used to purchase real estate in all-cash deals. There was also a lot of media attention on U.S. money launderers, and things such as the Panama Papers, the Paradise Papers, and the FinCEN Papers. And just this general concept that there was a lack of beneficial owner information with respect to many U.S. structures.

And all of this, I think, emanated from the U.S. effectively getting a bad grade, one of the lowest grades, from the Foreign Action Task Force set up by the OECD (Organization for Economic Co-operation and Development), which effectively grades countries on whether they have adequate beneficial ownership information with respect to the structures created in their jurisdictions. I think that’s the background. I think now I’ll pass this over to Raj and he can give you a sense of how the CTA legislation works, at least from a bird’s eye view, and what the CTA legislation is about.

Purpose of Regulation

Raj Malviya: Thank you, Glenn. I think the big picture here for practitioners in the U.S. is what FinCEN and Treasury feel are now putting the U.S. on the same playing field as our foreign counterparts trying to monitor anti-money laundering and bad actors in setting up these entities. The CTA (Corporate Transparency Act) is an example of that. It’s here. It’s a big deal. We have to worry about it now in private practice. As we are advising our clients, who are setting up entities, as all wealth practitioners do, there’s going to be some sort of entity at some point in time, in the work that you do.

And we’ll get to in a little bit how this impacts trusts, and how trusts might get sucked into some of the reporting requirements of the CTA; but again, the big picture is that we have legislation and now need to prepare ourselves for the rules on reporting, what types of entities the rules apply to and what information is needed and, of course, time deadlines on the reporting. So, we got a nice summary from Travis at the beginning on how the CTA was enacted. And since that date of enactment, which was January 1, 2021, almost a year later, we got proposed regulations from the Financial Crimes Enforcement Network, also known as FinCEN, an agency of the Treasury that’s responsible for these rules. Those proposed rules came out in a notice of proposed rulemaking on December 7, 2021.

ACTEC Fellows like Glenn, me, and many others have been very active in trying to understand the rules and lay them out in a fashion that practitioners can understand. So, if we want to dig right into it, here’s what we are focused on.

General Requirements of the Corporate Transparency Act

Raj Malviya: General requirements of the CTA: we need to understand that the general requirements apply to a reporting company. We’re trying to find a reporting company and these reporting companies – once we classify a reporting company – have to disclose specific information about the reporting companies: “beneficial owners” and “company applicants”. So, we’ll get to what those two terms mean in a moment, but the CTA was designed to capture smaller, less regulated entities. 

There are many exceptions to the definition of a “reporting company.” There are 23, in fact, under the legislation. An easy way to think about it is if you’re an NBA basketball fan and you follow the Chicago Bulls, just remember Michael Jordan, number 23. There are 23 exemptions. That’s how I think about it and a lot of the entities that we practitioners create for our clients, manage for our clients, or advise on, will likely fall outside of these 23 exemptions, just because of the nature of our practice. So, once we identify a reporting company, we’re going to be looking a little bit deeper to identify “beneficial owners,” which has a definition based on a percentage of ownership or control. Glenn will speak about that in a moment.

CTA Reporting Companies

Raj Malviya: And we’re going to identify company applicants, which is going to be a bit unsettling once we get through that definition because of its breadth. And we have to include information about the reporting company itself. That’s going to be disclosed to FinCEN. So, reporting companies, really quick, think about the companies, the entities, that we form as practitioners for our clients, or we direct for the formation of – that’s going to be an entity filed with the applicable state jurisdiction or Indian tribe. In order for the entity to be classified as a reporting company, there has to be the filing of a document.

That is the key aspect, or key requirement, in order to bring us into this definition. Filing of a document: LLCs, LLPs, Corporations, and Business Statutory Trusts, these are the types of entities that nationwide require the filing of a document with the applicable office. What’s not included? Well, the proposed regulations that came out at the end of last year made it clear – entities or de facto entities that are created without the need to file a document with the state or jurisdiction like revocable living trusts, irrevocable trusts, sole proprietorships, general partnerships – these types of entities do not need a document to be filed to be recognized, so those are excluded from the definition.

And so if we’re focused on the filing requirement, then we know we have a reporting company. And we won’t get into detail in this discussion today, but there’s a domestic reporting company and a foreign reporting company. And the only difference is – for foreign reporting companies, which are going to be brought into this definition of the reporting company, we’re not looking at the types of definition we, as wealth planning practitioners, think about when we’re creating foreign entities for tax purposes. Whether it’s CFCs, or PFIX, or foreign disregarded entities, there are special rules in play there to classify those types of entities for tax purposes.

What we’re focused on, or what the CTA and the proposed regs tell us, which is that you need an entity formed under the law of a foreign country and that entity has to be registered to do business in the United States through the filing of a document with the applicable jurisdiction. And that can be a very broad scope, which could create some issues as we try and implement and advise clients on the CTA. But, those are the two types of entities. So, Glenn, why don’t we turn to you and maybe tell us a little bit about, once we have a reporting company, tell us about beneficial owners and the company applicant and what we need to know there.

CTA Beneficial Owners and Company Applicants

Glenn Fox: Thanks, Raj. So, the party that has to report is the company itself. And you would assume its officers are going to be in that role to make sure the report gets filed. But what are they reporting? It’s information on the beneficial owners. And the beneficial owners include people with substantial control, people with ownership interests (indirect and direct), and company applicants. So even though we hear the term “owner”, parties that are being reported are not necessarily people that we would traditionally think of as owners. So, first, what is a person with substantial control? That could be an officer of the reporting company or a director.

And the indicia of “substantial control” is a facts and circumstances analysis. Does the person have the ability to merge or dissolve the company? Does he or she control major expenditures, the selection of business lines, compensation schemes, or entry into contracts? Things of this nature. If a party has that power, whether they have an ownership interest, as in shares of stock or a member interest, is irrelevant. They are a beneficial owner for purposes of reporting. The other types of parties are actual or direct or indirect owners, whether it’s joint ownership of an interest in the company, or ownership by way of, obviously, shares of stock or a membership interest. Or, a trust if you have an interest through the trust.

And the proposed regulations only show us two types of trust that are definitely included. In a trust where the beneficiary is the sole permissible recipient of income or has a right to demand distribution, that type of beneficiary would have to be reported as an owner. Or, where the grantor or the settler has a right to revoke, they would have to be reported as an owner, if the trust owns an interest in the company. Or a trustee of a trust that owns an interest in the company, if they have authority to dispose of the trust assets. But these are clearly not the only type of beneficiaries and parties of trust that have to be reported as owners because the regulations, the proposed ones, say: “including, but not limited to.”

So, we have a whole host of trusts out there that could own interests in reporting companies with discretionary provisions for beneficiaries and multiple beneficiaries. It’s very possible that those types of trusts could cause the beneficiaries to have to be reported, but we don’t know. And that’s one of the open issues with the proposed regs. What we do know is that whenever beneficiaries are reported, we somehow have to get to the conclusion that they have at least a 25% ownership interest, if they don’t, then they’re not a reporting party. The problem is, how do you determine if one of many beneficiaries of a discretionary irrevocable trust, perhaps, owns a 25% interest?

We don’t have clear guidance on that yet. The last party that has to be reported under the ownership information is actually an applicant. Again, they’re not an owner, but, in terms of what the regs and the CTA itself say if you apply for the company to be formed, in other words, if you signed the certificate of formation with a certificate of incorporation, you have to be reported by the company. If you are, let’s say, a partner in a law firm and you direct your paralegal to apply for the application and sign the application for the certificate of incorporation, the person who directed the paralegal, the partner, is an applicant, and so you can imagine there’s a whole chain of people that could end up being considered applicants.

The party at the corporate service provider that actually files the application is an applicant. This type of information is going to be required, and it could be very difficult for reporting companies to secure the information that Raj will talk about in a moment, in terms of what has to be reported by the reporting company with respect to these individuals. So, I’ll turn it over to you, Raj, to give that background.

CTA Required Information and Timeline

Raj Malviya: Thanks, Glenn. That’s scary stuff, right? And we’re thinking as practitioners, how are we going to keep track of this? And it may vary on the size of our organization, employer, or firm. Maybe there’s a third party that comes into play in a business, that handles some of this due diligence for reporting companies. Who knows? It remains to be seen but, talking about just getting down to the guts of what needs to be reported by the reporting company and due dates, well, this is pursuant to the CTA statute and the proposed rules.  But FinCEN is going to need everything under the sun. They’re going to need information about the reporting company itself, its name, and obviously its owners.

This gets into the beneficial owners and the applicants. FinCEN is going to need, as disclosed by the reporting company, the legal name of these individuals, they are individuals as listed under the statute, dates of birth, residential addresses for the beneficial owners, business addresses for the professional applicants, residential addresses for other applicants. There’s going to be a unique identifying number likely from a passport, or FinCEN will have an identifier that will be assigned. And, in the proposed rules, it goes as far as to say that there’s going to need to be a scanned copy of a driver’s license, or an acceptable form of identification, which is creating some additional issues as to privacy rules and confidentiality.

So, there’s going to be a lot required in the report. We do not have a form document yet from FinCEN. We anticipate one will be issued to make things a bit easier for practitioners. I mentioned that the reporting companies are going to have information on its entity that needs to be handled, so jurisdiction, entity, name, business address, again, the unique identifier number. This is a lot. When are the due dates? This is really the scary part. And when Glenn and I have talked about this topic in other venues and with other practitioners who have joined us, this is where we get that deer in headlights moment from the audience and the due dates for this reporting by the reporting company: one year from the effective date of the regulations.

So, we can interpret that to be “final regulations,” which we haven’t seen yet. In our circles, we’re anticipating that will come sometime this year. I think there is a lot of pressure on FinCEN to get final rules issued. But one year. So, reporting companies in existence, that already exist, have one year to get their ducks in a row and complete the appropriate disclosure forms. And to Glenn’s point, identify all of its beneficial owners. So, think about that. How far back in time do we really need to go? What if we can’t find these paralegals or attorneys or other administrators in the office who helped and assisted in filing the legal documents to form the entity?

Where do we track this information down? So, there are a lot of unanswered questions that I think are presenting some challenges in implementing this reporting. And then for existing entities – 14 days, 14 calendar days from the effective date of formation. So, once we have final regulations, an entity is formed, you’ve got two weeks to get the information reported to FinCEN. And then when there are changes or, let’s say, a nonexempt entity, one of those entities we talked about, they’re within one of the 23 exemptions, which we haven’t had a chance to cover, becomes a nonexempt reporting company. Then we have 30 days to report. So, really scary stuff. And I’m going to turn this over to Glenn to scare us a little bit more on some of the penalties that will apply if we fail to report what is required within these time deadlines.

Conclusion: Penalties for Not Reporting within Deadlines

Glenn Fox: Thank you, Raj. We’ll finish up with just these two points. First, on the penalties, you’re subject to the penalties by willfully providing, or attempting to provide, false or fraudulent beneficial owner information. So, obviously there’ll be exceptions if they’re just mistakes. If you could not prove that you just made a mistake and this was intentional, it’s a penalty of $500 a day, up to $10,000, and possible imprisonment for up to two years. My sense is those will be rare, but there will be a lot of people trying to figure out how they prove that they were not willful, and we don’t have real guidance on that at this point.

I’ll finish up by noting that all of the problems that Raj and I have identified on this podcast have been identified by ACTEC in comments that were submitted to FinCEN just a month ago. We were not alone. There were 230 other organizations, and I presume individuals, who also submitted comments to the proposed regulations. So, this is not something that will be static. I am sure we will see more in the news about potential changes to the proposed regs, and hopefully have some indication before the final regulations are actually published, as to what the changes will be. And we will hopefully be in a position to update everybody when that time arises.

Travis Hayes: Thank you, Glenn and Raj, for speaking with us about the Corporate Transparency Act.

You may also be interested in:

• ACTEC submits comments pursuant to Notice of Proposed Rulemaking (NPRM), Docket Number FINCEN-2021-0005 and RIN1506-AB49 the Corporate Transparency Act FinCEN Notice of Proposed Rulemaking of Regulations for Beneficial Ownership Information Reporting Requirements Questions 15, 16, 17, 20, & 21(February 4, 2022)
• The Law, Professional Responsibility and the Future of T&E
• New Corporate Transparency Act
• Truth, Transparency, and the Right of Privacy | Part 3 of 3

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