Incorporator The Journal of U.S. Formation
Start Free Quiz
Editorial 7 MIN READ

NSBA v. Yellen: the constitutional challenge to the CTA, pending

A federal suit in Alabama argues Congress had no power to pass the Corporate Transparency Act, and the January 1, 2024 effective date is not moving

The Editors
Staff, Incorporator.org
7 min read Updated
Contents 6 sections
  1. What the statute actually does
  2. The plaintiffs' theory, in plain English
  3. Why the case is not yet the main event
  4. Second-order effects to watch
  5. What to do between now and January 1, 2024
  6. Sources

he National Small Business Association and an Alabama business owner named Isaac Winkles filed suit in November 2022 to strike down the Corporate Transparency Act. The case is pending in the Northern District of Alabama, the CTA's beneficial-ownership rule still takes effect January 1, 2024, and founders forming this year should plan as if the statute survives.

The complaint is National Small Business United (d/b/a National Small Business Association) v. Yellen, Case No. 5:22-cv-1448, filed November 15, 2022 in the U.S. District Court for the Northern District of Alabama, Northeastern Division. The defendants are Treasury Secretary Janet Yellen and FinCEN Acting Director Himamauli Das. The plaintiffs want a declaratory judgment that 31 U.S.C. § 5336 is unconstitutional and an injunction against enforcement.

What the statute actually does

The Corporate Transparency Act was enacted as Title LXIV of the William M. (Mac) Thornberry National Defense Authorization Act for Fiscal Year 2021, Public Law 116-283, over President Trump's veto on January 1, 2021. It added a new section 5336 to Title 31 of the U.S. Code, the anti-money laundering chapter that already housed the Bank Secrecy Act. Under § 5336(b), every "reporting company" has to file a beneficial ownership information report with FinCEN identifying each "beneficial owner" (any individual who, directly or indirectly, exercises substantial control or owns 25% or more of the entity) and, for entities formed after the rule's effective date, each "company applicant."

FinCEN's final reporting rule appeared at 87 Fed. Reg. 59498 (September 30, 2022) and sets the effective date as January 1, 2024. Entities in existence before that date get all of 2024 to file an initial report. Entities formed on or after January 1, 2024 must file within thirty days of formation. Penalties under § 5336(h) run up to $500 per day for continuing violations, and willful violations can reach $10,000 and two years in prison.

The statute exempts twenty-three categories of entities, most of them already regulated: SEC reporters, banks, credit unions, registered investment advisers, insurance companies, tax-exempt entities, and the "large operating company" exemption for firms with more than twenty full-time U.S. employees, a U.S. office, and more than $5 million in gross receipts on their last federal return. Single-member LLCs, closely held operating businesses, holding vehicles, and family LLCs are what's left; they are what the statute is aimed at.

The plaintiffs' theory, in plain English

The complaint is not subtle. It argues that Congress had no enumerated power to pass the CTA at all, and that the statute therefore violates the Tenth Amendment by invading a domain (the incidents of state-chartered entities) reserved to the states.

On the Commerce Clause: the plaintiffs note that § 5336 reaches every corporation, LLC, or similar entity created by filing a document with a state or tribal office, whether or not the entity has ever engaged in interstate commerce, whether or not it has any revenue, and whether or not it has any employees. A single-member LLC that holds a rental house in the same state as its owner is a reporting company. The complaint argues that regulating the mere act of existing under state law is not a regulation of commerce, and that NFIB v. Sebelius, 567 U.S. 519 (2012), forecloses the government's fallback argument that Congress can regulate economic inactivity.

On the Necessary and Proper Clause: the government will argue the CTA is a tool to enforce anti-money-laundering and tax laws. The plaintiffs reply that this theory would swallow the Tenth Amendment, because on that logic Congress could federalize any state-law incident of incorporation by labeling it an information-gathering predicate for some federal regime.

On the First Amendment: the plaintiffs argue compelled disclosure of associational and ownership information, without a narrowly tailored state interest, chills the right to associate and to speak through corporate form. They lean on NAACP v. Alabama ex rel. Patterson, 357 U.S. 449 (1958), and on Americans for Prosperity Foundation v. Bonta, 594 U.S. 595 (2021), which struck down California's donor-disclosure rule for charities on exacting-scrutiny grounds.

On the Fourth Amendment: the argument is that compelled surrender of private ownership information to a federal database, without a warrant or individualized suspicion, is a constructive search of the reporting company and its owners.

On the Ninth and Tenth Amendments: the familiar structural argument. The creation of corporate entities has been a state function since the founding. Federal regulation of the terms on which a state's entity exists, rather than of the entity's conduct in interstate commerce, is not within the powers given to Congress.

The government has moved to dismiss. Briefing continues.

Why the case is not yet the main event

Two features of the procedural posture matter.

First, the case is in district court. Whatever Judge Liles Burke rules, the losing side will appeal to the Eleventh Circuit, and whichever side loses there will petition for certiorari. Even on an expedited schedule, a circuit-level ruling is unlikely before mid-2024, and a Supreme Court answer, if there is one, is a 2025 or 2026 event. Founders forming in 2023 cannot wait.

Second, FinCEN has not paused the rule. 87 Fed. Reg. 59498 fixes the effective date at January 1, 2024, and nothing in the district-court docket has produced a preliminary injunction that would move it. FinCEN is, as of this week, publishing implementation materials and sample reports; the BOI E-Filing System is in development. Acting as if the statute will be enjoined before it takes effect is the most expensive bet on the board.

Second-order effects to watch

The exemption list is the real political battleground. The "large operating company" carveout takes the big trade associations out of the fight; the plaintiffs here are the small-business coalition that was not carveout-eligible. Any negotiated narrowing of the statute, if it happens, will come through the exemption definitions, not the core reporting requirement. Watch for FinCEN guidance interpreting "substantial control" and for the inevitable set of technical corrections in whichever must-pass vehicle moves this winter.

The company-applicant rule has already generated pressure on the formation industry. Under 31 C.F.R. § 1010.380(e), the individuals who directly file the formation document, and those who direct the filing, must be identified by name, birth date, address, and ID number. Registered-agent and formation providers are building intake workflows around that requirement now. Founders who use a service to form after January 1, 2024 should expect to supply ID scans at formation.

What to do between now and January 1, 2024

Form the entity you need. If you've been postponing a formation because of the CTA, stop; the delta between forming before and after January 1 is one thirty-day filing requirement and the name of whoever submits the certificate, not a reason to leave a business unincorporated.

Inventory the entities you already have. Holding LLCs, family LLCs, and dormant entities are all reporting companies unless they fit an exemption, and dormant entities are where missed filings happen. Anything you are not using should be dissolved this year rather than carried into a reporting regime that punishes inattention at $500 per day.

Decide who the beneficial owners are, on paper, now. The "substantial control" test sweeps in senior officers, board members with veto rights, and some profits-interest holders. Cap tables that were fine for securities purposes often do not answer the CTA question cleanly. Getting the answer wrong at the first filing is cheaper than getting it wrong on an update two years in.

Watch the docket, but plan as though the statute will take effect on schedule. That is the posture FinCEN is planning from, and it is the posture the regulated community should match. See our prior pieces on the CTA's enactment and the runway to January 1, 2024 for the operational picture.

The interesting thing about NSBA v. Yellen is not whether the plaintiffs are right about the Commerce Clause. It is that the statute is aimed at exactly the kind of entity the plaintiffs represent, and that the exemptions lifted everyone else out of the fight. A law whose political opposition has already been carved out of its coverage is unusually durable; the plaintiffs have the cleaner constitutional argument and the weaker political base. Which of those dominates is what the next two years of docket entries will show.

Sources

Keep reading

More from the journal.