Last month’s post explained how setting up a dummy company can help seal a deal. Unfortunately, dummy companies can be used for far more nefarious purposes, including money laundering, terrorism financing, and tax fraud. For example, the New York Times and 60 Minutes revealed how high-end real estate has been snatched up by dummy companies linked to foreigners with ties to organized crime, despotic regimes, or both.
They were able to use dummy companies to anonymously move money into the United States, because most States do not require organizers of corporations or LLCs to disclose their true owners. That’s the case in Texas. The certificate of formation for a Texas corporation must identify its initial directors but not its shareholders. And the organizer of a Texas LLC can conceal its members by setting the company up as a manager-managed LLC and then appointing a non-member as the manager. While the ability to conceal the company’s owners is good for a buyer seeking to obtain a lower price or discourage competitive bidding, it presents a significant challenge for law enforcement and intelligence agencies.
To combat the illicit use of dummy companies, Congress enacted the Corporate Transparency Act. It was tucked away in the National Defense Authorization Act, which became law on January 1, 2021, when Congress overrode President Trump’s veto.
The Corporate Transparency Act generally requires corporations, LLCs and other similar entities to file reports on their beneficial ownership with the Financial Crimes Enforcement Network (FinCEN) of the Department of the Treasury beginning next year. While the Corporate Transparency Act was aimed at malign actors using dummy companies, its obligations, like the rain, fall on the just and unjust alike. Millions of companies will have to file new reports on their beneficial ownership with the federal government, regardless of whether they are dummy companies or engaged in any illegal activity. While the scope of those reporting obligations are not clear yet, here’s what your company needs to know now:
Is My Company Required to Report?
The Corporate Transparency Act has an expansive reach. With some exceptions, the Corporate Transparency Act’s reporting requirements apply to “a corporation, limited liability company or other similar entity that is
- Created by the filing of a document with a secretary of state or a similar office under the law of a State or Indian Tribe; or
- Formed under the law of foreign country and registered to do business in the United States by the filing of a document with a secretary of state or a similar office under the law of a State or Indian Tribe.”
FinCEN’s regulations will likely flesh out what “other similar entity” means, but it likely includes limited partnerships, limited liability partnerships, professional associations and professional corporations formed under Texas law. On the other hand, sole proprietorships, general partnerships and trusts are probably not “other similar entities” because their formation does not require the filing of a document with the Texas Secretary of State.
The Corporate Transparency Act has multiple exceptions. Publicly held companies are exempted, as are those operating in heavily regulated industries (such as insurance companies, exchanges or clearing agencies, public accounting firms, 501(c) non-profit organizations, banks and credit unions). Another exemption covers larger companies that reported $5 million or more in gross sales or receipts on their previously filed income tax returns and have both a physical presence in the United States and 20 or more full-time employees. Conversely, certain stagnant companies without assets or financial activities in the preceding year are also exempt.
What Information Does My Company Have to Report?
The Corporate Transparency Act requires reporting companies to identify each “beneficial owner” by full legal name, date of birth, current address and unique identifying number from an acceptable identification document, such as a passport or driver’s license.
The Corporate Transparency Act defines “beneficial owner” as “an individual who directly or indirectly, through contract, arrangement, understanding, relationship or otherwise—
- Exercises substantial control over the [company]; or
- Owns or controls not less than 25 percent of the ownership interest of the [company].”
Excluded from the definition of “beneficial owners” are: minors; creditors; nominees, intermediaries, custodians, or agents acting on behalf of another individual; individuals whose only interest is through a right of inheritance; and individuals “whose control over or economic benefits from such [company] is derived solely from the employment status of the person.”
The Corporate Transparency Act, however, does not explain when a person exercises “substantial control” over a company. An individual is typically considered to “control” a company when he directly or indirectly owns more than half of its ownership interest. But giving “substantial control” that meaning would create a redundancy, so the Corporate Transparency Act likely means something different. Companies will have to wait until FinCEN promulgates its regulations for more guidance.
When Does My Company Have to Report?
The Corporate Transparency Act’s reporting requirements do not become effective until FinCEN promulgates its regulations, which are mandated by January 1, 2022. Companies formed after that date must report when they are formed. Companies formed before the regulations are promulgated must report in a “timely manner” but not later than two years after the regulations’ effective date.
Additionally, companies must report any changes to their beneficial ownership in a “timely manner” but not later than one year after the change occurs.
Who Has Access to My Company’s Information?
The Corporate Transparency Act states that companies’ beneficial ownership is “sensitive information and will be directly available only to authorized government authorities.” It directs FinCEN to “maintain the information . . . in a secure, nonpublic database.” FinCEN may release the information only to national-security, intelligence or law-enforcement agencies who are conducing authorized investigations and to financial institutions (with customer consent) who have legally mandated anti-money-laundering or customer-due-diligence obligations. The Corporate Transparency Act also permits the IRS to access the beneficial ownership information for tax-administration purposes.
Unauthorized disclosure or use of a company’s beneficial ownership information is a crime punishable by up to five years’ incarceration and a $250,000 fine. So no need to worry. It’s not like the federal government has had several massive cybersecurity breaches.
What Are the Consequences for Failing to Report?
There are severe consequences for failing to accurately report the company’s beneficial ownership information, even if the company is not engaged in money laundering or any other illegal activities. Willful failure to report complete or updated information can result in a civil penalty of $500 per day. It is also a crime punishable by up to two years’ incarceration and a $10,000 fine.
The Corporate Transparency Act also contains a “safe harbor” provision. Persons are not subject to civil or criminal penalties if they voluntarily submit a report containing complete and correct information within 90 days of discovering that a prior report contains inaccurate information.
Tilting the Scales in Your Favor
Achieving the laudable goals of cracking down on money laundering and terrorist financing comes at a considerable cost. The Corporate Transparency Act creates significant privacy risks and imposes a substantial administrative burden on companies. Its reporting requirements apply to the vast majority of companies operating in this country. Each of those companies will have to update their reports every time one of their beneficial owners changes his or her address or face being charged with a federal crime. The Congressional Budget Office estimates that the Corporate Transparency Act will generate approximately 25 to 30 million filings per year and that compliance costs will be substantial. Ironically, most of that burden will fall on small businesses. After all, large companies can take advantage of exceptions to the reporting requirements because they are publicly traded or have $5 million or more in gross sales or receipts.
As discussed above, companies are not required to report until FinCEN promulgates its regulations, which will hopefully clarify some of the Corporate Transparency Act’s more ambiguous provisions. In the meantime, begin planning for compliance by reviewing your companies’ organizational documents and documenting its owners and officers. If there is any change in the company’s ownership, be sure to collect the information will eventually be reported to FinCEN.