Privately-owned companies in the U.S. have long enjoyed a great degree of privacy about their internal affairs, particularly as to the identities of their owners. In less than a year, that will begin to change. Starting in 2024, a federal law will require many privately-owned companies to disclose to a federal agency certain basic information about their major owners and controlling persons. The information will not be made public, but it will be available to federal, state and local agencies for specific purposes. During the months before the law takes effect, private companies should begin preparing for the new reporting requirements, particularly since there will be civil and criminal penalties for failing to file such reports.
Overview
The new law is the Corporate Transparency Act (CTA), which Congress enacted in 2020 as part of major legislation to combat money laundering and terrorist financing. Under the CTA, privately-owned companies that are not exempt will have to report to the U.S. Department of the Treasury’s Financial Crimes Enforcement Network (FinCEN) certain “beneficial ownership information” (BOI) about each person who either owns 25% or more of the company’s ownership interests, or who exercises “substantial control” over the company. (In many cases, they will also have to report BOI for persons involved in forming the company.) The reporting requirements for newly-formed companies will become effective on January 1, 2024. Companies that were formed before that date will have until January 1, 2025 to file their reports. These requirements, and some other important aspects of the CTA, are summarized below. If you would like to discuss how they will affect your company, please contact Philip Kinkaid at 713.535.5542 or one of the other corporate attorneys listed at the end of this article.
Companies that must report
Basic rule
The CTA applies to corporations, limited liability companies (LLCs), and other types of companies that are created by a filing with a Secretary of State or equivalent official (SOS). In Texas, these include limited partnerships, professional associations, cooperatives, and real estate investment trusts (REITs). The CTA does not apply to the following types of companies and entities, because they are not formed by SOS filings:
- Trusts (except for REITS and, outside Texas, business trusts and other statutory trusts).
- General partnerships, including joint ventures structured as general partnerships. It is not clear if limited liability partnerships (LLPs) are included or excluded.
The CTA also applies to non-U.S. companies that register to do business in the U.S. through an SOS filing.
Exemptions
The CTA exempts 23 types of companies from the reporting requirements. The most important exemptions are these:
- “Large Operating Companies,” defined as any company that meets all of the following requirements:
- It employs more than 20 full-time employees in the U.S.
- In the previous year, it filed a U.S. federal income tax return demonstrating (on a consolidated basis) more than $5 million in gross receipts or sales from U.S. sources.
- It has an operating presence at a physical office in the U.S.
This exemption for Large Operating Companies may come as a surprise, because many important federal laws take the opposite approach: they apply to large companies and exempt small ones. By contrast, the CTA applies to small companies rather than large ones. This is because the CTA’s primary purpose is to combat money laundering and terrorism financing. Those criminal activities are typically conducted through small companies. (The vast majority of small companies in the U.S., of course, are not engaged in such illegal activities.)
- Publicly-traded companies.
- Other specified types of companies that are already subject to reporting requirements or regulatory oversight, such as banks, credit unions, insurance companies, public accounting firms, broker-dealers, investment advisors, investment companies, certain types of pooled investment vehicles, regulated public utilities, etc.
- Tax-exempt entities and certain related entities.
- Inactive entities that were formed before 2020, hold no assets, and meet certain other requirements.
- Wholly-owned subsidiaries of most types of exempt companies, including Large Operating Companies.
Companies that are subject to the CTA, and that are not exempt, are considered “Reporting Companies.”
Reporting requirements
Beneficial Owners
A Reporting Company must report to FinCEN the BOI for each of its “Beneficial Owners.” A Beneficial Owner is defined as someone who either owns or controls 25% or more of the “ownership interests” of the Reporting Company, or who directly or indirectly exercises “substantial control” over the Reporting Company.
25% ownership. In applying the 25%-ownership test, the term “ownership interest” is not limited to traditional equity, such as stock, membership interests, units, capital interests and profits interests. Instead, it also applies broadly to any instruments (including debt) that are convertible into equity, as well as options, warrants, futures, puts, calls and other rights to buy or sell equity. It also applies to both non-voting as well as voting interests.
Substantial control. A “Beneficial Owner” also includes anyone who exercises “substantial control” over the Reporting Company, regardless of what percentage of ownership interests they own. (Indeed, someone who exercises “substantial control” will be considered a Beneficial Owner even if they own no ownership interests – making the term “Beneficial Owner” something of a misnomer.) “Substantial control” exists if the person meets any of the following criteria:
- Serves as a senior officer of the Reporting Company, such as a President, CEO, COO, CFO or General Counsel.
- Has authority over the appointment or removal of any senior officer or a majority of the board of directors (or similar body).
- Directs, determines, or has substantial influence over important decisions made by the Reporting Company, including numerous specified types of decisions.
- Has “any other form of substantial control” over the Reporting Company – an undefined, “catch-all” criteria.
For each Beneficial Owner, the Reporting Company must report the following BOI to FinCEN:
- Full legal name.
- Date of birth.
- Residential address.
- Passport number, driver’s license number or other acceptable identification, together with a copy of the ID document.
Updates. If there are any changes in the identities of the Beneficial Owners, or to any of their BOI, the Reporting Company must file an updated report with FinCEN within 30 days of the change – regardless of when the Reporting Company learns of it.
A Reporting Company that is formed (or registered) on or after January 1, 2024 must also report BOI for each “Company Applicant” – defined as the person who files the SOS document that forms the Reporting Company (or registers a non-U.S. entity to do business in the U.S.), and also any person who is “primarily responsible for directing or controlling” the filing of such document. There is no requirement, however, to update this information.
Information about the Reporting Company
In its FinCEN report, the Reporting Company must also include certain limited information about itself: its legal name, all trade names or “DBAs,” state of formation, address of its principal place of business, and its taxpayer identification number.
FinCEN Identifiers
To make the reporting process more efficient, FinCEN will allow an individual to report his or her own BOI to FinCEN and obtain a numerical “FinCEN Identifier.” (He or she will also be responsible for any updates to the BOI.) If that person is, for example, a Beneficial Owner of several Reporting Companies, each of those companies will only have to report the person’s FinCEN Identifier. (Reporting Companies will also be able to obtain their own FinCEN Identifiers.)
Phase-in of reporting requirements
The CTA’s reporting requirements will be phased-in in two stages:
- January 1, 2024: All new Reporting Companies – those formed (or, in the case of non-U.S. companies, registered) on or after January 1, 2024 – must report BOI for both their Beneficial Owners and Company Applicants to FinCEN within 30 days after their formation or registration.
- January 1, 2025: All existing Reporting Companies – those formed or registered before January 1, 2024 – must report BOI for their Beneficial Owners (but not their Company Applicants) to FinCEN no later than January 1, 2025.
Penalties
Penalties for willfully violating the CTA’s reporting requirements include (1) civil penalties of $500 per day that a violation is not remedied, (2) a criminal fine of up to $10,000, and/or (3) imprisonment of up to two years.
Access to the reported BOI
BOI that is reported to FinCEN will not be public, and it will not be subject to disclosure under the Freedom of Information Act. FinCEN will be required to keep the BOI secure in a restricted-access database. Federal agencies will be able to access the database for certain purposes, including national security, intelligence, law enforcement, and tax administration, and to respond to inquiries from government authorities in certain foreign countries. State, local, and tribal law enforcement agencies can also obtain access, but only with a court order. Banks and other financial institutions can request specific BOI, but only with the Reporting Company’s consent.
Regulatory implementation
FinCEN is in the process of developing the regulatory framework to implement the CTA. It has already adopted a final rule governing the BOI reporting process and adding details to many of the concepts summarized above. More recently, it proposed a rule regarding access to the FinCEN BOI database, and has sought comments on proposed forms for reporting BOI and obtaining FinCEN Identifiers. It has also promised to post detailed answers to questions not addressed in those rulemakings.
How to prepare for the CTA
The first important CTA date (January 1, 2024, for newly-formed companies) is still several months away, and the reporting deadline for existing companies (January 1, 2025) is a year later still. But because the CTA introduces a completely-novel reporting regime, and because it intentionally focuses on small businesses, now is the time for privately-owned companies to begin considering a number of questions:
- Is my company subject to the CTA – or, on the other hand, does it qualify for any of the 23 exemptions? In many cases, this will turn on two important requirements to qualify for the “Large Operating Company” exemption: whether it has at least 20 full-time employees in the U.S., and at least $5 million in gross receipts or sales from U.S. sources, as shown on its previous year’s federal income tax return. If it does not satisfy both requirements, then it does not qualify for the “Large Operating Company” exemption.
If a company is not exempt, then the following questions should be considered:
- How do I calculate percentages of “ownership interests,” to determine if any owners meet the 25%-ownership threshold? In many companies with simple capital structures, the answer will be obvious. It may be much less obvious, however, in companies with complicated capital structures (given the expansive definition of “ownership interest”), or companies in which some ownership interests are held indirectly – for example, through upper-tier investment entities, holding companies, or trusts.
- How do I determine each person who exercises “substantial control” over the company? There may well be multiple people who qualify, given the expansiveness (and vagueness) of the “substantial control” definition.
- Who should be responsible for preparing the report, and who should verify it?
- What procedures should the company put in place to monitor future changes in its Beneficial Owners, or their BOI, that will require updated reports to FinCEN? A private company should also consider adding to its company agreement a requirement that it be promptly informed of any FinCEN-reportable changes. It may also want to encourage Beneficial Owners to obtain their own FinCEN Identifiers and thereby become personally responsible for reporting changes to their own BOI.
- As 2024 approaches, should the formation of new subsidiaries or affiliates be accelerated into 2023, to delay BOI reporting for them until the January 1, 2025 deadline for existing companies?
Attorneys in the Corporate Transactions practice group of Cokinos | Young are knowledgeable about the CTA and its final and proposed regulations, and will monitor future developments as FinCEN rolls out its implementation throughout 2023. To discuss how your company should prepare for the CTA, contact one of the following corporate attorneys at Cokinos | Young:
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