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Editorial 9 MIN READ

The Corporate Transparency Act is law, and formation practice is about to change

A beneficial-ownership filing regime arrived on New Year's Day over a presidential veto, with FinCEN now on the clock to write the rule

The Editors
Staff, Incorporator.org
9 min read Updated
Contents 7 sections
  1. How the law got here
  2. What the statute actually requires
  3. The 23 exemptions, and who they actually help
  4. Penalties and the confidentiality posture
  5. What to expect from FinCEN
  6. The open questions
  7. Sources

n January 1, the Senate voted 81 to 13 to override President Trump's veto of the William M. (Mac) Thornberry National Defense Authorization Act for Fiscal Year 2021, and with that override the Corporate Transparency Act became federal law. Buried in Division F, Title LXIV of a defense bill nobody will read all the way through are the provisions that will, within about a year, require nearly every small LLC and corporation in the United States to file its beneficial owners with the Treasury Department.

This is the most consequential change to American entity-formation practice since the rise of the LLC. It is also still half-built, because the statute delegates the operative details to FinCEN, and FinCEN has not yet issued a proposed rule.

How the law got here

The Corporate Transparency Act had been circulating on the Hill in one form or another for roughly a decade. It moved this time as sections 6001 through 6502 of the NDAA, with the substantive beneficial-ownership reporting regime concentrated at sections 6402 and 6403 of Pub. L. 116-283. Section 6403 drops a new section 5336 into Title 31 of the United States Code, slotting the reporting obligation into the Bank Secrecy Act alongside the existing anti-money-laundering architecture.

The path through Congress was unusual. Both chambers had passed the conference report with veto-proof majorities in early December. The President vetoed the bill on December 23, citing grievances unrelated to the beneficial-ownership provisions (Confederate base names, Section 230, troop levels in Germany). The House overrode on December 28 by 322 to 87. The Senate followed on January 1 by 81 to 13. It was the first successful veto override of the Trump presidency, and it delivered, among many other things, a federal beneficial-ownership registry that opponents in the small-business bar had spent years trying to stop.

The effective date of the reporting requirement is not January 1, 2021. Section 6403(b) directs the Treasury Secretary to issue implementing regulations no later than one year from enactment, and the reporting obligation attaches on the effective date of those final regulations. Existing entities will then have two years to file their initial report; entities formed after the regulations take effect must file at formation. The practical calendar, in other words, is: proposed rule sometime in 2021, final rule by January 1, 2022 at the latest, reporting begins whenever the final rule says it begins, with existing entities backfilling over the following two years.

What the statute actually requires

The core mechanic is short. A "reporting company" must file a report with FinCEN identifying each of its beneficial owners and each "applicant" (the person who forms it). The report must include, for each such individual, the full legal name, date of birth, current residential or business street address, and a unique identifying number from a non-expired passport, state driver's license, or other acceptable identification document, along with an image of the document. A "FinCEN identifier" mechanism lets a frequent filer register once and then reference the ID on later reports rather than re-submitting the underlying data.

The statutory definition of "reporting company" sweeps broadly. It covers any corporation, limited liability company, or "other similar entity" that is created by the filing of a document with a secretary of state or equivalent office, or that is formed under foreign law and registered to do business in the United States. The drafting choice matters: the regime is triggered by the act of filing to create the entity, which is why sole proprietorships and general partnerships sit outside it, and why LPs, LLPs, LLLPs, and statutory trusts sit inside.

A "beneficial owner" is defined in 31 USC § 5336(a)(3) as 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. The statute excludes minor children (whose parent or guardian's information is reported instead), nominees and custodians acting on behalf of another, employees whose control or economic benefit derives solely from employment, heirs with a future inheritance interest, and creditors unless the creditor otherwise meets the control or ownership threshold. What counts as "substantial control" is left to the rulemaking. Practitioners should expect that term to do a lot of work, and to be one of the most contested parts of the proposed rule.

The 23 exemptions, and who they actually help

Section 5336(a)(11)(B) lists twenty-three categories of entities that are not "reporting companies" and therefore owe nothing to FinCEN. The list reads like a tour of the already-regulated parts of the economy: SEC-registered issuers, banks and credit unions, bank and savings-and-loan holding companies, registered money-services businesses, broker-dealers, Exchange Act-registered securities exchanges and clearing agencies, registered investment advisers and investment companies, insurance companies, state-licensed insurance producers, CFTC-registered commodity entities, public accounting firms registered under Sarbanes-Oxley, public utilities, financial market utilities, pooled investment vehicles, 501(c) and 527 tax-exempt organizations, entities that assist such tax-exempts, and subsidiaries wholly owned by exempt entities.

Two of the exemptions deserve separate attention, because they are the ones most often misread.

The "large operating company" exemption at section 5336(a)(11)(B)(xxi) applies to an entity that employs more than 20 full-time employees in the United States, has an operating presence at a physical office in the United States, and has filed a federal tax return demonstrating more than $5 million in gross receipts or sales in the previous year. All three conditions are required, not any one. A small LLC with large gross receipts but fewer than 21 employees still files.

The "inactive entity" exemption at (xxiii) applies to an entity incorporated before January 1, 2020, that is not engaged in active business, is not owned by a foreign person, has not had a change in ownership in the preceding 12 months, has not sent or received funds greater than $1,000 in the preceding 12 months, and holds no assets. It is a narrow carveout for shelf entities and dormant holders, not a general safe harbor for a quiet LLC.

Holding-company LLCs that sit above operating subsidiaries are inside the regime. A two-member LLC that owns rental property, a single-member LLC used to hold intellectual property, a Delaware holding company with a Wyoming subsidiary: all of them will file. This is the population for whom the CTA is a new burden. The large regulated companies it nominally targets were already reporting ownership information in one form or another.

Penalties and the confidentiality posture

The civil penalty for willfully failing to report, or willfully filing false information, is not more than $500 for each day the violation continues or has not been remedied. The criminal penalty is a fine of not more than $10,000, imprisonment for up to two years, or both. The $500 per-day figure is adjusted for inflation, which means in operational terms that a year-long compliance miss tops out around $180,000 to $200,000 before criminal exposure attaches.

The confidentiality regime is stricter than the reporting regime. The beneficial-ownership database is non-public; section 5336(c)(2) authorizes disclosure only to specified federal agencies in furtherance of national-security, intelligence, or law-enforcement activity, to state, local, or Tribal law enforcement with a court authorization, to federal agencies on behalf of foreign law enforcement under specified conditions, to financial institutions (with customer consent) for customer-due-diligence purposes, and to federal functional regulators overseeing those institutions. Unauthorized disclosure carries a civil penalty of $500 per day and a criminal fine of up to $250,000 and five years' imprisonment, rising to $500,000 and ten years for aggravated cases. Congress, in other words, treats a leak from the database as a more serious offense than a failure to report to it.

What to expect from FinCEN

FinCEN has the pen now. The statute gives the Secretary one year from enactment to issue implementing regulations, which puts the outside date at January 1, 2022. Realistically, expect an advance notice of proposed rulemaking in the spring or early summer of 2021, a proposed rule after the comment period closes, and a final rule sometime in late 2021 or the first weeks of 2022. The comment cycle is where the operative ambiguities get resolved: what "substantial control" means, how the "company applicant" definition handles commercial registered agents and formation services, what the image-upload workflow looks like, how corrections and updates get filed, whether there is a safe-harbor for inadvertent errors, and what the FinCEN-identifier mechanics look like in practice.

Formation service providers, registered agents, and corporate law firms will be the first to feel the operational weight. Every formation workflow will need a beneficial-ownership capture step. Every ownership change, name change, or address change in a reporting company will need a downstream FinCEN filing, because section 5336(b) requires updated reports within one year of the change (the rule may shorten this). The downstream effect on operating agreements is that any reasonably drafted agreement now needs to obligate each member to provide and promptly update the information the entity is required to report, and to indemnify the entity for the consequences of a failure.

The open questions

Two sets of questions will dominate the comment cycle.

The first is definitional. "Substantial control" is the lever on which a great deal of the regime turns. A narrow reading (senior officer, or a seat-holding director) leaves ordinary minority investors outside the reporting population. A broad reading (anyone with a veto over a major decision, for example a protective-provision holder) pulls in most preferred shareholders at a venture-backed company. FinCEN's choice here will shape how the rule intersects with standard startup financings. Similarly, "ownership interest" needs a definition that handles profits interests, phantom equity, warrants, convertible notes, and SAFEs in a way that is both administrable and honest about who actually owns the company.

The second set of questions is procedural. The statute contemplates a single federal filing, but state-level filings still create the reporting company in the first place. Whether FinCEN attempts to coordinate with state secretaries of state, and whether states will update their certificates of formation to collect beneficial-ownership information at the filing step, is an open institutional question. Most state SOS offices are not built for this, and their modernization budgets are, on a generous reading, mixed. Expect a patchwork first.

The deeper question, the one the comment letters will dance around, is whether the CTA can be enforced against the population it was written for. The regulated entities on the exemption list already file; everyone else has, until now, enjoyed the right to form an entity in Delaware or Wyoming or New Mexico without naming themselves. A rule that is written well but enforced weakly will produce a registry populated mostly by the honest, which is neither the regime's stated purpose nor a useful outcome. The next year of rulemaking is where that question gets answered, or not.

For anyone who forms entities for a living, the work for 2021 is to read the proposed rule when it drops, file a comment on the pieces that will break workflow, and start redrafting engagement letters and operating agreements to put the beneficial-ownership reporting burden in writing on the person whose data is actually being reported. The rest, including whether the regime ends up mattering the way its drafters hoped, will depend on how FinCEN writes the thing and how Treasury funds its enforcement.

Sources

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