CTA Heats Up with New FAQs, Government and Amicus Briefs and New Draft Legislation

The Corporate Transparency Act (CTA) is the gift that keeps giving. As affected entities and their advisers struggle to determine whether they are subject to the beneficial ownership information (BOI) reporting provisions of the CTA and, if so, how to report, there has been a flurry of activity:

• The Financial Crimes Enforcement Network (FinCEN), the U.S. Department of Treasury unit that oversees CTA reporting, issued 17 new FAQs on April 18, 2024.
• The U.S. Department of Justice (DOJ) filed two briefs on April 15, 2024, one with the U.S. Court of Appeals for the Eleventh Circuit, asserting that the CTA is constitutional, in its appeal of the National Small Business United v. U.S. Department of the Treasury decision (where the U.S. District Court for the Northern District of Alabama found Congress did not have constitutional powers to adopt the CTA). The other was with the U.S. District Court for the Western District of the Michigan, in response to the arguments made by plaintiffs in Small Business Association of Michigan v. Yellen where the plaintiffs, in addition to echoing the congressional powers arguments made in National Small Business United, asserted violations of the Fourth Amendment on the basis that the CTA constitutes an illegal search without a warrant and a violation of the Fifth Amendment on the basis that the CTA, a criminal statute, is unconstitutionally vague (particularly the substantial control test). Shortly thereafter, three amicus briefs were filed each recommending reversal of the National Small Business United decision. In short, the two government briefs and the amicus briefs argued that Congress has sufficient legislative power to enact the CTA, which was enacted to combat the use of anonymous shell companies that threatened national security, interstate and foreign commerce and U.S. tax interests.
• Members of the House of Representative introduced a bipartisan bill entitled the "Small Business Red Tape Relief Act of 2024" on April 15, 2024, to provide relief to entities covered by the CTA and requiring FinCEN to report to Congress on a quarterly basis the number of BOI Initial and Updated Reports filed with FinCEN.

This burst of activity did little to stem the numerous questions that stakeholders and their advisers have as to how to comply with the reporting provisions of the CTA. Practitioners are continuing to request answers from FinCEN, only some of which have been answered by the new FinCEN FAQs discussed below.

FinCEN FAQs

The FinCEN FAQs discussed below are organized in three categories: miscellaneous questions, access questions (which are not covered herein) and trust questions.

Miscellaneous Questions

• Do the BOI reporting requirements apply to an S-Corporation? Yes, the pass-through structure of an S Corporation for tax purposes does not affect its BOI reporting obligations.¹
• If a domestic corporation or limited liability company (LLC) is not created by the filing of document with a secretary of state or similar office, is it a reporting company? FinCEN noted that "in an unusual circumstance where a domestic corporation or LLC is created, but not by the filing of a document with a secretary of state or similar office, such an entity is not a reporting company."²
• Who is a beneficial owner of a reporting company? A beneficial owner is an individual who either directly or indirectly 1) exercises substantial control over a reporting company or 2) owns or controls at least 25 percent of a reporting company's ownership interests. A beneficial owner must be an individual, that is, a natural person and not a trust, corporation or other legal entity.³

Homeowner Association (HOA) Questions

• Is an HOA a reporting company? It depends. If an HOA is not created by the filing of document with a secretary of state, then it is not a domestic reporting company. An incorporated HOA that is a reporting company may qualify for an exemption from the reporting requirements if, for example, it is an IRC Section 501(c)(4) social welfare organization. If, however, an HOA does not qualify for one of the CTA's exempt status-based exemptions, it may be required to file BOI reports.

Comment. An HOA that is subject to taxation under IRC Section 528 is a reporting company.⁴

• Who is the beneficial owner of a HOA? There may be instances where no individual owns or controls at least 25 percent of the ownership interests of an HOA; in that instance, it is necessary to determine whether the substantial control test applies, in which case individuals could be Beneficial Owners if: 1) an individual is a Senior Officer, 2) an individual has authority to appoint or remove certain officers or a majority of directors of the HOA, 3) an individual is an important decision-maker and 4) an individual comes within the "catch all" test because that individual has another form of substantial control over the HOA.⁵
• What address should a reporting company report if it lacks a principal place of business in the United States?
• Use the primary location in the U.S. where the reporting company conducts business. ⁶
• If a reporting company has no principal place of business in the U.S. and conducts business at more than one location in the U.S., the reporting company may report as its primary location the address of any of the locations where the reporting company receives important correspondence.
• If a reporting company has no principal place of business in the U.S. and does not conduct business functions at any location in the U.S., use the primary location of the person whom the reporting company has designated to accept service of process on its behalf.
• If a pre-2024 entity loses its exempt status between Jan. 1, 2024, and Jan. 1, 2025, how long does it have to file an Initial BOI report? An entity has the longer of 1) the remaining days left in the one-year filing period for existing pre-2024 companies or 2) the 30-day period for companies that lose their exempt status. FinCEN furnished the following helpful example. Assume a reporting company ceases to be exempt on Feb. 1, 2024, the entity would have until Jan. 1, 2025, to file its Initial BOI Report. However, if the entity were to cease to be exempt on Dec. 15, 2024, it would have until Jan. 14, 2025, to file its Initial BOI Report.⁷
• What penalties do individuals face for violating BOI reporting requirements? FinCEN stresses that a violation must be "willful," but does not define the term in its response.⁸ Willful violations are 1) for failure to file a BOI report, 2) filing a false BOI report or 3) failure to correct or update previously reported information. The civil penalty is up to $500 (increased by inflation now to $591) for each day the violation continues, and the criminal penalty is a fine of up to $10,000 or two years of imprisonment.⁹

Comment. FinCEN stated that “an enforcement action can be brought against … a beneficial owner or company applicant who willfully fails to provide required information to a reporting company.” However, in a situation where a recalcitrant beneficial owner refuses to provide the requisite information to a reporting company, FinCEN did not address whether the reporting company and its senor officer(s) would not be found liable for noncompliance because they did not act in a "willful" manner; i.e., not voluntary or intentional in regards to the non-compliance?¹⁰

• If under the large operating company exemption, the size of the reporting company fluctuates above and below the exemption threshold, does the reporting company need to file a BOI report? Yes, if a company were to become exempt, the entity should file a "newly exempt entity" BOI report. If, subsequently, the entity no longer is able to satisfy the large operating company exemption or any other exemption, it would be required to file an Updated Report within 30 days of the occurrence of the change.¹¹

Comment. While unstated, it appears that the FAQ covers a case where a company filed a report and then became exempt; thus, this FAQ does not expressly cover a pre-2024 company that has not yet filed its Initial Report. Note further, the "gross receipts test" is determined by reference to the entity's prior year tax return, while the number of full-time employees must be regularly tested during the year.¹²

Trust Questions

• Can a beneficial owner own or control a reporting company through a trust? Yes, either by exercising substantial control over a reporting company through a trust arrangement or by owning or controlling the ownership interests of a reporting company that are held in a trust.¹³
• Who are the reporting company's beneficial owners when individuals own or control the company through a trust? The individuals 1) who either exercise substantial control over a reporting company or 2) who own or control at least 25 percent of a reporting company's ownership interests. Substantial control or controlling ownership interests may be direct or indirect through any contract, arrangement, understanding, relationship or otherwise.¹⁴

Comment. The FAQ clarifies the conditions as to when an individual owns or controls ownership interests in a reporting company through a trust, as follows:

• First, a trustee, as well as any other individual, who owns or controls ownership interests and has the authority to dispose of trust assets is a beneficial owner.
• Prior to this FAQ, it was not clear whether any person who was designated a trustee was a beneficial owner merely because of that status. Now, that issue has been clarified that not all trustees are beneficial owners.
• For example, in a directed trust, if an administrative trustee does not have the authority to dispose of trust assets, the trustee will not be a beneficial owner.
• Second, a beneficiary is a beneficial owner if he or she 1) is the sole permissible recipient of income and principal from the trust or 2) has a right to demand a distribution of, or withdraw, substantially all the assets from the trust.
• With FinCEN stating that there may be other situations where individuals associated with a trust are beneficial owners (see below), it is not entirely clear when the beneficiaries of a trust with multiple beneficiaries might be reportable, particularly where a trust has separate shares for beneficiaries or multiple mandatory beneficiaries.
• Third, a grantor or settlor is a beneficial owner if such individual has the right to revoke the trust or otherwise withdraw the assets of the trust.

FinCEN notes that the forgoing criteria may not limit when an individual owns or controls ownership interests in a reporting company through a trust, adding that there may be other arrangements under which individuals associated with a trust may be beneficial owners of a reporting company in which the trust holds interests.

• How does a reporting company report a corporate trustee as a beneficial owner? FinCEN has provided a response to this often-asked question, as follows:
• The reporting company should determine whether any of the corporate trustee's individual beneficial owners indirectly own or control at least 25 percent of the ownership interests of the reporting company through their ownership interests in the corporate trustee. For example, if an individual were to own 60 percent of the corporate trustee of a trust, and that trust holds 50 percent of a reporting company's ownership interests, then the individual would own or control 30 percent (60 percent × 50 percent = 30 percent) of the reporting company's ownership interests and therefore would be a beneficial owner of the reporting company.
• The FAQ further explains that the reporting company may, but is not required to, report the name of the corporate trustee in lieu of information about an individual beneficial owner only if each of the following three conditions are met: 1) the corporate trustee is exempt from reporting requirements, 2) the individual beneficial owner owns or controls at least 25 percent of the ownership interests in the reporting company only by virtue of ownership interests in the corporate trustee and 3) the individual beneficial owner does not exercise substantial control over the reporting company.
• The FAQ stresses that the owners or individuals employed or engaged by the corporate trustee may exercise substantial control over the reporting company and may have to be reported.¹⁵

Comment. The initial, simple pass-through analysis articulated by FinCEN seems to oversimplify the ownership analysis. In the case of a trustee with fiduciary duties, mere ownership of the corporate trustee's equity should not, in and of itself, translate to a ratable ownership of the reporting company's equity interests because the trustee is acting in a fiduciary capacity with respect to the trust. Corporate trustees are likely to have far more complex governance controls as to their actions as trustee that would make the simple multiplication exercise inappropriate.

FinCEN emphasizes that trust company personnel could be in substantial control. The statute and regulations are not particularly helpful on that point, and it was hoped that FinCEN would clarify this issue. FinCEN, however, did not specify any distinction between a nonexempt trustee and an exempt "bank" trust company's employees having substantial control. This implies that a trust officer or trust committee member at an exempt bank could be in substantial control, and the reporting company would be required to report such persons as beneficial owners and file update reports if the personnel involved at the exempt bank were to change.

Further, FinCEN has not provided any direct clarification on whether an entity wholly owned by a bank, as trustee, qualifies under the Subsidiary Exemption. That said, the way that FinCEN essentially treats the corporate trustee as the actual owner (by looking through to the corporate trustee's owners as discussed above) could lead to the conclusion that a subsidiary entity held in a fiduciary capacity by an exempt corporate trustee should qualify for the Subsidiary Exemption. Assuming that is correct, it remains unclear whether reporting would be required if the reporting entity owned by the exempt corporate trustee also were to have beneficiaries who could be considered beneficial owners, as discussed above.

Government Briefs

The DOJ filed briefs in two of the CTA cases vigorously rebutting the arguments of the court in the National Small Business United case (holding the CTA as unconstitutional) and the arguments of the plaintiffs in Small Business Association of Michigan complaint with respect to the unconstitutionality of the CTA and the violation of the Fourth and Fifth Amendments.

In the National Small Business United case, the plaintiffs challenged the constitutionality of the beneficial ownership information reporting rule (BOIR Rule), asserting that although the BOIR Rule was well-intentioned in seeking to combat money laundering and other illicit activity, the BOIR Rule 1) would require law-abiding Americans to provide highly personal information to a government agency to be stored in a database for criminal enforcement purposes, violating privacy protections, 2) is vague and unduly burdensome on small companies and 3) infringes on states' powers to govern business.

The court framed the issue for decision as whether "the Constitution give Congress the power to regulate millions of entities and their stakeholders the moment that obtain a formal corporate status from a State?" The court found that the CTA is unconstitutional because it exceeds the Constitution's limits on Congress' powers, rejecting the arguments of the government that the BOIR Rule was constitutionally supported by Congress' broad powers to oversee foreign affairs and national security, regulate interstate commerce and impose taxes and related regulations.

In its brief in the National Small Business United case, the DOJ, as an initial matter, focused on the fact that the CTA "effectuates prohibitions on financial crime by regulating commercial enterprises, "plays an essential role in the federal government's larger program to combat financial crime" and represents a conventional legislative response to enforcement challenges."¹⁶ The DOJ argues that the CTA is a valid exercise of congressional powers because 1) Congress has broad authority to enact economic regulations, 2) the CTA effectuates prohibitions on financial crime and 3) the district court's approach misunderstands governing precedent and the CTA itself.¹⁷ The DOJ also strongly argues that the CTA is within the Necessary and Proper Clause to make all laws which shall be necessary and proper for carrying into execution its other enumerated powers.¹⁸

In the Small Business Association of Michigan brief, the DOJ made similar arguments regarding constitutional power while also addressing the CTA's constitutionality under the Fourth and Fifth Amendments asserted by the plaintiffs. In that regard, the DOJ argued that the Fourth Amendment was not violated because the "Fourth Amendment's proper function is to constrain, not against all intrusions as such, but against intrusions which are not justified in the circumstances."¹⁹ Under the CTA, there was not a violation of privacy or an unreasonable search or seizure because the information is sufficiently described and limited in nature and sufficiently related to a tenable congressional determination as to improper use of transactions of that type in interstate commerce,"²⁰ and hence is reasonable.

With respect to the Fifth Amendment, the DOJ argued that the CTA was not unconstitutionally vague, noting, inter alia, that "[u]nconstitutionally vague statutes are those that are not subject to reasonable interpretation.²¹ The DOJ further points out that an economic regulation is subject to a less strict vagueness test and that the scienter requirement mitigates the alleged vagueness.²² The DOJ argued that the plain text of the law allows ordinary people to understand what it requires and that the CTA is not vague under applicable precedents.

The DOJ also rebutted the plaintiff's argument that the CTA penalty provision's application to "any person," contained in 31 U.S.C. Section 5336(h)(1) is unclear whether a "person" is the beneficial owner or the entity that incurs liability when the beneficial owner refuses to supply required personal information. The DOJ argued that the penalty provision is clear: It applies to any "person," legal or natural, who "willfully" fails to report or provides false information in a report.²³ Accordingly, the penalty could apply to a beneficial owner who refuses to provide information or to an entity that refuses to report. Of note, the DOJ states that if an entity's failure to report is not voluntary or intentional, then it has not willfully violated the CTA.

Amicus Briefs Supporting Government in National Small Business United

On April 19, 2024, Transparency International U.S., the Foundation for Defense of Democracies, and Director of the Kleptocracy Initiative and a Fellow at the Hudson Institute Nate SIbley filed an amicus brief urging the reversal of the district court's order because Congress' foreign affairs powers are sufficient to adopt the CTA.

On April 22, 2024, Sens. Sheldon Whitehouse (D-R.I.), Ron Wyden (D-Ore.), Elizabeth Warren (D-Mass) and Jack Reed (D-R.I.) along with Rep. Maxine Waters (D-Calif.) filed an amicus brief urging the reversal of the district court's order on the basis that Congress has robust Article I authorities²⁴ and that the CTA is a legitimate exercise of Congress's authorities (related to foreign affairs, the commerce clause and taxing power). Further, the Necessary and Proper Clause of the Constitution makes clear that the Constitution grants of specific federal legislative authority are accompanied by broad power to enact laws that are convenient, or useful or conducive to the authority's beneficial exercise.²⁵

The Tax Law Center at NYC filed an amicus brief on April 22, 2024, urging the reversal of the district court's order on the basis that the CTA is a constitutional exercise of Congress' taxing power because it is "in aid of a revenue purpose" (rebutting the plaintiff's assertion that taxation was an "afterthought to Congress.")

The Small Business Red Tape Relief Act of 2024

Bipartisan legislation was introduced on April 15, 2024, by Reps. Zach Nunn (R-Iowa) and Henry Cuellar (D-Texas) to relieve small businesses of burdensome red tape and to hold the Treasury Department accountable for educating "Main Street" businesses on reporting responsibilities to prevent small businesses from being penalized for not complying with the new BOIR Rule requirements when potentially in-scope entities have yet to be informed of their potential reporting obligations.

The bill would require the Treasury Department to improve education for small businesses on the CTA's reporting requirements and to submit quarterly accountability reports to Congress stating the number of CTA reports being filed.²⁶

Takeaways

• Although the additional FAQs issued by FinCEN clarify several open issues, there are numerous other questions that require answers. The uncertainty of the answers has caused some stakeholders with pre-2024 entities to defer reporting in hopes that FinCEN will issue more definitive guidance before the reporting deadline.
• The court cases are underway. There will be an expedited hearing at the Eleventh Circuit.
• In the latest development, on April 26, 2024, the U.S. District Court for the Western District of Michigan in the Small Business Association of Michigan case denied plaintiffs' motion for a Preliminary Injunction blocking enforcement of the CTA against a plaintiff who was required to file an Initial Report on April 28, 2024, because he was not prepared to say the plaintiff's constitutional challenges were likely to prevail. It was reported that the judge further mentioned that although he did not know where he stood on Congress' authority to enact the regulations, he shared some of the plaintiff's concerns with respect to the privacy concerns under the Fourth Amendment – that the federal government collected large amounts of personal date "to put on a shelf" for law enforcement to use when needed. He also commented that Congress has "an awful lot of power" to regulate the nation's businesses, adding that he needed a better understanding of the limits of that power.²⁷

^

^Notes

¹ FAQ, C. 8.

² FAQ, C. 9.

³ FAQ, D. 1.

⁴ FAQ, C. 10.

⁵ FAQ, D. 1 3.

⁶ FAQ, F. 1 2.

⁷ FAQ G. 6.

⁸ The CTA statute defines “willfully” as the “voluntary, intentional violation of a known legal duty.” 31 U.S.C. Section 5336(g)(6). An act is done "willfully" if done voluntarily and intentionally and with the specific intent to do something the law forbids. There is no requirement that the government show evil intent on the part of a defendant in order to prove that the act was done "willfully."

⁹ FAQ, K. 2.

¹⁰ See sentence accompanying note 23.

¹¹ FAQ, L. 7.

¹² Final Rule, at p. 59,542.-59, 543.

¹³ FAQ, D. 14.

¹⁴ FAQ, D. 15.

¹⁵ FAQ, D. 16.

¹⁶ National Small Business United brief at. p. 12 and p. 13.

¹⁷ The DOJ argued that the district court erroneously regulated the "act of incorporation." National Small Business United brief, at p. 26.

¹⁸ National Small Business United brief, at pp. 15 16.

¹⁹ Small Business Association of Michigan brief, at p. 25

²⁰ Id.

²¹ Small Business Association of Michigan brief, at p. 28

²² Id.

²³Small Business Association of Michigan brief, at p. 31

²⁴ Article I of the Constitution, inter alia, deals with the powers that Congress has.

²⁵ U.S. Const. Art. I § 8, cl. 1.

²⁶ More specifically, after the first quarter that begins after the date of enactment (2024) and each quarter thereafter, the FinCEN Director will be required to submit to the Committee on Banking, Housing, and Urban Affairs of the Senate and the Committee on Financial Services of the House of Representatives a report that includes the number of reporting companies that submitted a report required under the CTA with respect to 1) pre-2024 reporting companies, 2) reporting companies formed in 2024 and thereafter and 3) updated reports for changes in beneficial ownership for reporting companies identified in 1) and 2) hereof.

²⁷ Carolyn Muyskens, Mich. Biz Groups Can’t Block Corporate Transparency Act, Law 360, April 28, 2024.