The Federal Corporate Transparency Act

Issue May/June 2022 June 2022 By David A. Parke
Business Law Section Review
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David A. Parke

The Federal Corporate Transparency Act (the Act), codified at 31 USC 5336, was enacted Jan. 1, 2021. Once this Act becomes effective, it will create new reporting requirements for many small business entities and other companies covered by the Act. The Act is intended to address the use of shell companies for money laundering, terrorist financing and other crimes, by requiring corporations, limited liability companies and other entities subject to the Act to identify those individuals who are the significant beneficial owners of the entities.

The Act will become effective after final regulations are promulgated by the Financial Crimes Enforcement Network (FinCEN). On Dec. 7, 2021, FinCEN issued proposed regulations, with commentary, regarding the beneficial ownership reporting requirements. Comments on the proposed regulations were due by Feb. 7, 2022. According to the preamble to the proposed regulations, this was the first of three rulemakings under the Act. FinCEN will also issue proposed regulations concerning access to the beneficial ownership information, and the existing customer due diligence rule applicable to financial institutions. 

There are civil and criminal consequences for violation of the Act. Although reporting companies subject to the Act are required to file the reports under the Act, FinCEN commented that responsible individuals may also have liability.

When the Act goes into effect, a “reporting company,” as defined in the Act, must report to FinCEN information regarding its individual “beneficial owners,” and the individual “applicants” who formed the company, as well as changes to such information. The database of information maintained by FinCEN would be confidential and used for law enforcement and similar purposes.

According to its comments, FinCEN expects that tens of millions of entities may need to report under the new Act. The Act applies to newly formed and existing corporations, limited liability companies and other entities created by filing with a secretary of state, unless exempt under the Act. The Act lists 24 types of entities that are exempt from the reporting requirements. According to FinCEN’s comments, “reporting companies” would likely include Massachusetts limited partnerships, registered limited liability partnerships and Massachusetts business trusts, unless exempt.

The Act also pertains to entities created or registered under the laws of a Native American tribe as well as foreign entities registered in the United States. This article will focus on entities created by filing with the secretary of state. 

The 24 exemptions include public companies, governmental authorities, banks, credit unions, certain brokers and dealers in securities and investment companies and investment advisors, insurance companies, certain registered public accounting firms, public utilities and certain pooled investment vehicles. Also exempt are tax-exempt organizations described in IRC Sec. 501(c) and tax-exempt organizations under IRC Sec. 501(a). The Act also exempts an entity with an operating presence in the United States that employs more than 20 employees on a full-time basis in the United States, and that in the previous year filed federal tax returns showing more than $5 million in gross receipts or sales. The Act also exempts a dormant entity under certain conditions — the entity must have been in existence for more than one year, not be engaged in an active business, not have any assets, not be owned by a foreign person, not have had a change of ownership within the prior 12 months, and not have sent or received funds more than $1,000 within the prior 12 months.

The Act will require the reporting of information regarding both an “applicant,” who is an individual who files the application to form the entity, and any “beneficial owners” of the entity. The Act and proposed regulations recognize two alternative components as to who might be regarded as a beneficial owner. One is an individual who owns or controls 25% or more of the ownership interests. The other is any individual who exercises “substantial control” over the entity. 

The Act excludes certain individuals from its definition of “beneficial owner”: i) a minor child, if information regarding the parent or guardian is reported; ii) a nominee, intermediary, custodian or agent on behalf of another individual; iii) an individual acting solely as an employee of an entity whose control is derived solely from his or her employment status; iv) an individual whose only interest is through a right of inheritance; or v) a creditor who does not exercise substantial control or own 25% or more of the ownership interests.

Where beneficial ownership is determined by reference to an individual’s ownership interest, the proposed regulations recognize that ownership may include a variety of interests, including convertible interests, and that an individual may exercise control by various means, including through a trust.

Where beneficial ownership is determined based on “substantial control,” the Act and proposed regulations indicate that individuals in substantial control include: 

● senior officers (which the proposed regulations say include the president, treasurer, secretary, general counsel, CEO, CFO and COO)
● anyone who has authority over appointment or removal of a senior officer or majority or dominant minority of the board of directors (or similar body)
● anyone with substantial influence over important matters affecting the reporting company, like:

▪ the scope of business of the company, including the sale of its principal assets
▪ reorganization, dissolution or merger of the company
▪ major expenditures, issuance of equity, incurrence of significant debt, or approval of the operating budget
▪ selection or termination of business lines or geographic focus
▪ compensation schemes and incentive programs for senior officers
▪ entry or fulfillment of significant contracts
▪ amendment of substantial governance documents and significant policies and procedures.

FinCEN commented that based on the breadth of the “substantial control” requirement, FinCEN expects that there would be at least one individual who is a beneficial owner under the “substantial control” component of the definition.

The information to be reported concerning individuals who are applicants or beneficial owners must include: 

● name, date of birth, and residential or business address (the proposed regulations call for residential address, except in the case of company applicants who file the organizing documents in the course of their business)
● unique ID number from an identification document (such as a driver’s license or passport), and FinCEN identifier.

An individual may obtain a unique FinCEN identifier and a reporting company may use an individual FinCEN identifier in lieu of information otherwise required about the individual.

Under the proposed regulations, the deadlines for reporting are in some cases shorter than the periods that could have been allowed by the Act. Under the proposed regulations, newly formed reporting companies must report within 14 days after formation; a reporting company created before the effective date of the final rule must report within one year after the effective date; and a reporting company must update any information regarding beneficial owners within 30 days after a change in such information.

The actual reporting requirements and deadlines will depend on the final regulations. In any event, many entities will, in the near future, be subject to new and ongoing reporting requirements under this Act. 

David A. Parke is a partner with Bulkley, Richardson and Gelinas LLP in Springfield, and a member of the Business Law Section Council of the Massachusetts Bar Association. His practice is focused on general corporate and business matters.