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Editorial 9 MIN READ

Holding companies in January 2021: a field report with the CTA four days old

The Corporate Transparency Act just passed over a veto override, and the structure most founders use is the structure Congress is now looking at

The Editors
Staff, Incorporator.org
9 min read Updated
Contents 6 sections
  1. What the statute actually does
  2. Who is exempt, and why it matters for holding structures
  3. The twenty-month view from May 2019
  4. What to do before the rules take effect
  5. What remains unclear
  6. Sources

n January 1, 2021 the Senate overrode a presidential veto of the National Defense Authorization Act for Fiscal Year 2021, which means Division F of that statute, the Corporate Transparency Act, is now law. A holding company structure designed in December still works in January. It just has a federal reporting obligation attached that it did not have last week.

This is the third time we have written about holding companies, and the first time the shape of the answer has changed for a reason that has nothing to do with state law. The original 2017 piece on holding company structure and the 2019 revisit both treated the question as a state choice: Delaware for the case law, Wyoming for the fees, Nevada if you had a specific reason. The federal layer was essentially empty. It is not empty anymore.

What the statute actually does

The Corporate Transparency Act is Title LXIV of the William M. (Mac) Thornberry National Defense Authorization Act for Fiscal Year 2021, Public Law 116-283, signed into law on January 1, 2021 when the Senate completed the override vote. The operative sections are 6401 through 6403. Section 6403 creates a new 31 U.S.C. § 5336, the beneficial-ownership reporting regime, and tasks the Financial Crimes Enforcement Network (FinCEN) at Treasury with running it.

Every "reporting company" will have to file a report with FinCEN identifying each beneficial owner. A reporting company is a corporation, LLC, or similar entity created by filing with a secretary of state or equivalent. Formed-abroad entities registered to do business in a U.S. state are also covered. The statute excludes 23 categories, and that exclusion list is what most of the operational planning will turn on.

A beneficial owner is, in the statute's language, an individual who directly or indirectly either "exercises substantial control" over the entity or "owns or controls not less than 25 percent of the ownership interests" of the entity. Both prongs are live. Someone who owns 30% is in; someone who owns 0% but signs off on major decisions is also in. The statute carves a short list of non-beneficial-owner categories: minor children (reported via a parent or guardian), nominees, employees whose control comes only from their employment, inheritors who have not yet taken, and creditors qua creditors.

Each reported individual must be listed by full legal name, date of birth, current residential or business address, and a unique identifying number from a non-expired government ID (driver's license, passport, or similar), with an image of that document. An applicant who files the formation documents reports the same.

The report is not public. FinCEN holds the database and may disclose entries to federal agencies engaged in national-security, intelligence, or law-enforcement activity; to state and local law enforcement with a court authorization; to foreign authorities via a treaty request routed through a U.S. agency; and to financial institutions conducting customer due diligence with the reporting company's consent. The Act requires FinCEN to issue implementing regulations within one year, which on the face of the statute means by January 1, 2022. Reports will not be due before those regulations take effect.

Willful failure to report or willful filing of false information carries civil penalties up to $500 per day and criminal penalties including a fine up to $10,000 and up to two years' imprisonment. The statute also punishes unauthorized disclosure of reported information with comparable teeth, which is the provision the privacy hawks have been asking for since the 2009 FATF mutual evaluation flagged U.S. entity opacity.

Who is exempt, and why it matters for holding structures

The 23 exemptions are a legislative map of who Congress thought already reports enough. The ones that matter for holding-company planning are:

Publicly traded companies registered under Section 12 of the Exchange Act or required to file under Section 15(d). Regulated banks, credit unions, depository holding companies, money transmitters, SEC-registered investment companies and investment advisers, broker-dealers, and insurance companies. Public utilities. Accounting firms registered under Sarbanes-Oxley. Tax-exempt 501(c) organizations. And, most importantly for the middle of the market, "large operating companies."

A large operating company is defined, in the statute, as an entity that (i) employs more than 20 full-time employees in the United States, (ii) has an operating presence at a physical office in the United States, and (iii) filed a federal income tax return for the previous year showing more than $5,000,000 in gross receipts or sales. All three prongs must be satisfied.

The large-operating-company test is why holding companies will carry the CTA weight more than operating businesses will. A typical two-tier structure has a parent LLC and one or more operating subsidiaries. The subsidiaries may clear the 20-employee, $5 million-receipts threshold on their own. The parent almost never will. The parent has no employees, no physical office (the registered agent's address does not count, and the statute is drawn to exclude that dodge), and no direct gross receipts; its income flows up as distributions from the subsidiaries. A bare holding LLC is, by design, outside the exemption, and Congress wrote the statute with that design in view.

There is a dedicated exemption for subsidiaries of exempt entities, which means a regulated bank's holding structure does not have to report every sub. But a family-office holding LLC, a real estate holdco, or a small-business parent that owns two LLCs running local storefronts is a reporting company, and so are the operating subsidiaries unless each one independently clears the large-operating test.

The twenty-month view from May 2019

The 2019 revisit landed on three observations that still hold. Wyoming's privacy pitch was overstated once you factored in foreign qualification in the operating state. Delaware's case law still earned its premium for any structure that might see a real dispute. A single-tier LLC with an S-corp election was often a better answer than a parent-child structure for owners who were really running a consultancy out of their basement.

The CTA does not change any of those three conclusions individually, but it changes the marginal case. Specifically, the decision to add a second entity for asset segregation now carries a new cost: two BOI reports instead of one, two sets of updates when ownership changes, two sets of updates when control changes, and two sets of penalties if you miss a filing. For a structure with real assets to segregate, this is rounding error. For a structure whose only purpose was to hold a single rental property that a good umbrella policy would have handled, the cost-benefit just moved.

Congress did not intend to discourage holding structures. The cost is administrative, not substantive, and the middle-market law firm industry is already gearing up to automate it. But the direction is clear: if your holdco exists because someone told you in 2014 that every serious person has a holding company, 2021 is a good year to reexamine whether it is earning its keep.

What to do before the rules take effect

FinCEN has one year to issue regulations under § 5336(h). The rulemaking will cover, among other things, the precise mechanics of reporting, the format of the BOI database, the rules for updates when ownership or control changes, the treatment of trusts (the statute mentions them but does not fully resolve them), and the definition of "substantial control" beyond the short statutory text. Expect a Notice of Proposed Rulemaking in the Federal Register in 2021, a comment period, and a final rule by early 2022. Existing entities will have a grace period after the effective date of the final regulation to come into compliance. New entities formed after the effective date will have to report at formation.

Four moves make sense in the next ninety days, while implementation is still pending.

First, inventory what you have. List every entity you are a beneficial owner of, whether by ownership or by control. If you have a parent LLC with three sibling subsidiaries, that is four reports, not one. If a single individual controls all four, that individual will be listed on all four. Multi-entity founders routinely undercount when they try to do this from memory.

Second, clean up the ownership cap table now, not after the regulations come out. Old promised equity that was never papered, verbal promises to early contractors, founders who drifted away without formally transferring their interests: any of this complicates a BOI filing. FinCEN will want a definite answer to the 25% question, and ambiguity about who owns what is expensive to resolve under a reporting deadline. The fix is cheap in January and less cheap in November.

Third, reconsider whether entities you created for a reason that no longer applies are worth keeping. Delaware LLCs carry a $300 annual tax (see 8 Del. C. § 18-1107) and, starting in 2022 or 2023 depending on the final rule, a BOI filing. An entity that exists because you might one day do a thing you have not done in three years is more expensive than it was on December 31. Dissolutions filed in early 2021 avoid both the 2021 Delaware tax and the first BOI cycle.

Fourth, if you are contemplating a new structure, form it now rather than waiting. New entities formed before the effective date of the final rule get the existing-entity grace period, which under the statute is at least two years after the effective date. New entities formed after the effective date report at formation, which in practice means within a much shorter window. This is a modest advantage, but it is real.

What remains unclear

The statute leaves important questions for FinCEN to resolve. The definition of "substantial control" is the big one. The statute requires that someone who exercises substantial control be reported, but does not list the indicia. Board seats, officer roles, veto rights in an operating agreement, major-decision consents, and economic interests below 25% that come with special voting rights are all candidates. The rulemaking will draw a line, and where it draws it will determine whether a holding structure with a passive majority owner and an active minority manager lists one person or two.

The treatment of common holding-company features, tiered ownership with special-purpose vehicles at the top, revocable trusts that hold membership interests, family limited partnerships, is mostly left to the rules. 31 U.S.C. § 5336(a)(3)(A) says beneficial ownership can run through any contract, arrangement, understanding, or relationship, which is broad. The question is how FinCEN operationalizes it without making every trust grantor file.

The interplay with state transparency regimes is also open. California's SB 1195 and New York's LLC Transparency Act discussion have both been heading in this direction at the state level. FinCEN preemption, if any, will matter to multistate structures.

And the timing of the first filings for existing entities is, at this moment, an implementation detail. The statute allows up to two years from the effective date of the final rule, which pushes the real deadline plausibly into late 2023 or 2024. That is an eternity in structure-planning time. It is also close enough that the work should start now.

If you formed a holding LLC in 2018 because your lawyer said so and you have not thought about it since, the next twelve months are the cheapest time to either sharpen it or dissolve it. The structure that survives the CTA is the one that was earning its maintenance cost in the first place.

Sources

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