Compliance Virtual Diagram for regulations, law, standards, requirements
Seven years ago, the legal and financial worlds were rocked by the release of the Panama Papers—11.5 million confidential documents leaked from the former Panamian law firm, Mossack Fonseca. At the time, it was easy to be smug about the lack of well-known American names in the Papers—and conspiracy theories were flying. But despite the fabulous stories, there was likely an easy explanation: the U.S. is considered something of a tax haven.
It’s a controversial take in some circles, likely because of the connotations (I get angry emails every time I write about them). But, in the U.S., flexible entity structures, corporate tax breaks, and tax-favored capital gains can result in a relatively low tax burden, making it an attractive place to do business. In addition, states like Delaware and Nevada have tax structures and corporate laws considered favorable in many parts of the world.
And although Americans like to think of ourselves as open for business—suggesting transparency—other countries aren’t so sure. A 2014 Organization for Economic Cooperation and Development—or OECD—report noted that the Foreign Action Task Force, or FATF, scored the U.S. as “non-compliant” when focused on the “transparency of legal persons and arrangements.” And the Tax Justice Network ranks the U.S. first in their Financial Secrecy Index (first means the most secretive— the index is a ranking of jurisdictions the organization finds “most complicit in helping individuals to hide their finances from the rule of law”). According to global watchdogs, that matters because countries with higher transparency standards often tout lower rates of criminal activities like money laundering, tax fraud, and terrorism financing.
The global perception tends to be that, in the U.S., we demand a certain level of transparency when dealing with foreign banks and companies, but we don’t always have that same information to make available to other jurisdictions. That may be about to change.
Corporate Transparency Act
In 2021, Congress passed the Corporate Transparency Act—or CTA—as part of the National Defense Authorization Act for Fiscal Year 2021 (if you see references to 2020, it’s because the law was introduced in 2020 as part of the Anti-Money Laundering Act, but was eventually rolled into the CTA and passed in 2021). The law cites five key goals:
- set a clear, Federal standard for incorporation practices;
- protect vital United States national security interests;
- protect interstate and foreign commerce;
- better enable critical national security, intelligence, and law enforcement efforts to counter money laundering, the financing of terrorism, and other illicit activity; and
- bring the United States into compliance with international anti-money laundering and countering the financing of terrorism standards.
The center of the legislation is a mandate for reporting companies to file reports that identify a company’s beneficial owners with FinCEN, the Financial Crimes Enforcement Network. You may have had experience filing reports with FinCEN before—among other things, the Reports of Foreign Bank and Financial Accounts, sometimes called FBARs, are filed annually with the agency.
For purposes of the CTA, reporting companies can be domestic companies created under the laws of a state or Indian tribe, or entities formed under the law of a foreign country registered to do business in any state or tribal jurisdiction. This can include limited partnerships, limited liability partnerships (LLPs), business trusts, LLCs (including SMLLCs), and corporations—typically, any entity you would register with the state.
Notably, sole proprietors who are not SMLLCs are not considered a reporting company for this purpose—the same is true for general partnerships. And while trusts and estates professionals feared overreach, their fears were unfounded, as the regulations made clear that the law does not apply to revocable living trusts and irrevocable trusts.
Several other exceptions also apply, including issuers of securities, banks, and credit unions. Non-profit companies are also exempt.
Timing
So, why are we talking about this now? Reporting companies that are in existence on Jan. 1, 2024, have to file an initial report with FinCEN within one year. Those created after Jan. 1, 2024, have 30 days after receiving notice of their creation or registration to report. However, in September, FinCEN proposed extending the initial filing deadline to 90 days in 2024 (the 30-day rule would apply in 2025).
Reporting
Each report must identify the company, as well as four pieces of information about each of its beneficial owners: name, date of birth, address, and a unique identifying number and issuing jurisdiction from an acceptable identification document (and a scanned image of the document)—that could include a driver’s license or passport. This information is sometimes referred to as BOI.
No financial information or details about the business purpose or operation of the company are required.
A report must be updated within 30 days of a change to the beneficial ownership or upon becoming aware of or having reason to know of a change to information that was previously reported.
Beneficial Owner
A “beneficial owner” means those with substantial control or at least 25% ownership interest in the entity, whether indirect or direct (including joint ownership or ownership of a membership interest).
It also includes company applicants (meaning an entity that owns another entity). However, the CTA applies to people, so if a company is owned by another company, you’ll need to look through to find the human being.
What constitutes “substantial control” is facts and circumstances dependent. Generally, however, the test is whether the person can make important decisions on behalf of the entity—like an officer or director. If you can do those things, you will likely be treated as a beneficial owner for purposes of the CTA, even if you do not have an ownership interest.
Penalties
Penalties will apply for failing to provide the information or for providing false information (there is a good faith exception). The penalties are steep—$500 a day up to $10,000, and possible jail time of up to two years. The law also provides penalties for the misuse or unauthorized disclosure of this information.
Disclosures
One worry that many had about the law at its inception was the availability of the data. The information will not be publicly available and will typically only be disclosed only to law enforcement and certain financial institutions in connection with know-your-customer obligations.
Also, the CTA does not require you to file with the IRS, and you don’t have to share the report with federal or state tax agencies.
Next Steps
A quick warning: this is a new law, and more information, including updated rules and regulations, is to be expected.
And, of course, this is just a glimpse at the CTA. You can find more information in FINCen’s fact sheet.
Still not sure how or if you are subject to the provisions of the CTA? Tax, accounting, and legal professionals have been gearing up to assist clients with due diligence and risk assessment for some time. If you have questions, ask.
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