On Jan. 1, 2021, Congress enacted the 2021 National Defense Authorization Act with an override of President Trump’s veto. With that legislation comes the Corporate Transparency Act (CTA), which will soon require small businesses to begin filing new forms to report the identity of their owners on every occasion that such information changes. Although the reach of this onerous disclosure requirement is limited to “small businesses,” it will still affect a great many businesses. And while tax advisors can assist with the preparation of these new forms, business entities must constantly (and quickly) inform tax advisors about ownership changes every time they occur.

Background

The CTA was enacted to help thwart money laundering, terrorist financing, corruption, tax fraud, and other illicit activity, with an ultimate goal to combat “the proliferation of anonymous shell companies that facilitate the flow and sheltering of illicit money in the United States.” FinCEN, the United States Department of the Treasury’s Financial Crimes Enforcement Network, issued proposed regulations last December that would implement the new “beneficial owner” disclosure requirements of the CTA. Some may be familiar with other reporting requirements imposed by FinCEN, such as the requirement to submit an annual Foreign Bank Account Report (FBAR) on Form 114.

Who Is Subject to the New Filing Requirements?

The proposed regulations will place a substantial reporting and compliance burden on small businesses. Specifically, the reporting requirement applies to any domestic company that was created by the filing of a document with a secretary of state or similar office (or any foreign company registered to do business in any state or tribal jurisdiction), and that meets any one of the following conditions:

• Employs 20 or fewer full-time employees in the United States;
• Reports no more than $5 million in annual gross receipts on its U.S. Federal income tax return for the previous year (including the receipts of subsidiaries and some related entities); or
• Operates wholly outside the United States (does not have an operating presence at a physical office within the United States).

This encompasses S corporations, C corporations, Limited Liability Companies, and any type of state-law partnership that is required to file with a secretary of state or similar office. The proposed regulations indicate that nearly 4 million businesses could be subjected to the reporting requirement each year, joining perhaps 30 million existing businesses that will be required to report less frequently.

The proposed regulations clarify that general partnerships, sole proprietorships, and common law trusts are not subject to the new filing requirements because these companies are not created by the filing of a document with a secretary of state or similar office. Furthermore, 23 other types of entities are exempted from the new filing requirements, including banks, insurance companies, tax-exempt organizations, publicly traded companies, and certain inactive entities.

When Do the New Filing Requirements First Apply?

The new beneficial owner disclosure requirements under the CTA will take effect on the effective date of final regulations. The proposed regulations have not been finalized, but that step is expected as early as this summer.

What Kind of Owner Information Must Be Reported?

If an entity is subject to the new reporting requirements, then it must identify all of its beneficial owners on the new form. A beneficial owner is any individual who either:

• Exercises substantial control over the entity; or
• Owns or controls at least 25% of the entity.

The proposed regulations generally provide that an individual exercises substantial control when the individual (directly or indirectly) provides services as a senior officer, has authority to appoint or remove any senior officer or a majority or dominant minority of the board of directors, or has authority to exert substantial influence over important matters affecting the entity. The proposed regulations also provide that ownership is determined with regard to “the underlying reality of ownership,” taking into account both direct and indirect ownership.

Notwithstanding the above definitions, a beneficial owner does not include a minor child (if the guardian is properly reported), an individual acting as a nominee, agent, or custodian (if the beneficial owners are properly reported), an employee whose control is derived solely from their employment status, an heir, or most creditors.

The reporting requirement applies to all US citizen and resident alien beneficial owners. When reporting a beneficial owner, the entity must include the full legal name of the owner, their residential or business street address, and a unique identifying number such as the individual’s driver’s license (including an image of the identification document), and the owner’s date of birth.

When Does the Report for Beneficial Owners Have to Be Filed?

The proposed regulations also set forth a timeline for reporting. For the initial report of existing businesses, the proposed regulations provide a filing deadline of one year from the effective date of the final regulations. For a new business created after the effective date of the final regulations, the initial report is required within 14 days of formation or registration.

All businesses are required to file an updated report 30 days after each date when there is a change to the beneficial owner information. It is notable that the CTA indicated there could be up to a one year timeline for filing this updated report, so the proposed regulations substantially shortened this recurring due date. More time to file would substantially decrease the compliance burden, and would also make it easier for advisors such as lawyers and accountants to notify clients about their filing obligations. This is an area to monitor closely when the final regulations are published.

Penalties for Failure to File

If a business willfully fails to file within the applicable timeframe, it could face a civil fine of up to $500 per day that the report remains unfiled or uncorrected. This penalty also applies to anyone who willfully provides false or fraudulent beneficial ownership information. Additionally, a willful violation can result in a criminal fine of $10,000 and up to 2 years in prison. A willful violation is one done voluntarily and intentionally and with specific intent. Willfulness generally is not indicated by entities that are unaware of a reporting obligation, or by entities that are aware but mistakenly believe that they are exempt.

The penalty is not just applicable to the business entity itself but to the individual beneficial owners or anyone else responsible for the entity’s filing. Thus, if an individual intentionally chooses not to file, the individual could be subject to these penalties even if the entity has limited liability under state law.

Final Thoughts

The new beneficial owner reporting requirements under the CTA and the proposed regulations presents a substantial reporting challenge for small businesses. The timelines proposed mean that these businesses may have a filing obligation before they are aware that one exists, and even before an advisor or attorney can notify them that the filing obligation exists. This is particularly true in the case of a change in ownership, as an accountant or an attorney may not be involved in the process.

Given the substantial penalties at stake, businesses and their owners will need to take time to familiarize themselves with the new filing requirements. While there can be no guarantee, the final regulations may ease some of these burdens by lengthening the time entities have to submit the new reports. Should you have questions about whether your business may be subject to these new reporting requirements, please contact us.  

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