Update on the Corporate Transparency Act: Navigating a Potpourri of Possible Pitfalls

Pursuant to the Corporate Transparency Act (CTA), certain domestic and foreign entities doing business in the United States are required to disclose information about their beneficial owners to the Financial Crimes Enforcement Network (FinCEN). Effective January 1, 2024, the CTA was designed to combat the use of anonymous shell entities and opaque ownership structures that could potentially be used to facilitate money laundering, terrorism financing, and other financial crimes.

Although FinCEN has developed guidance regarding CTA compliance, such as FinCEN’s Small Entity Compliance Guide and more than 100 Beneficial Ownership Information Frequently Asked Questions (FAQs), many ambiguities in the application of the CTA remain. The failure to comply with the CTA can be costly: Violations of CTA reporting obligations can result in criminal and civil penalties, including monetary fines and imprisonment. This Update highlights certain potential pitfalls we have observed during 2024 in the practical application of the CTA, particularly in light of certain areas of ambiguity in the final rule and additional guidance provided by FinCEN. See Sidley’s prior updates for more detailed discussion on the new regulatory landscape under the CTA.¹

A Federal District Court Ruled the CTA Unconstitutional — But Compliance Is Still Required for Most Reporting Companies

On March 1, 2024, the U.S. District Court for the Northern District of Alabama ruled that the CTA is unconstitutional on the grounds that it exceeds Congress’ enumerated powers, including its authority over foreign affairs, the Commerce Clause, the taxing power, and the Necessary and Proper Clause.² The court enjoined the government from enforcing the CTA against the specific plaintiffs in the case – the National Small Business Association (NSBA) and one of its individual members. The government filed an appeal with the Eleventh Circuit on March 11, 2024, and while there are other pending federal cases that challenge the constitutionality of the CTA, it will likely take time for the courts to resolve the issue nationwide. While NSBA members as of March 1, 2024, may currently enjoy a reprieve from CTA reporting obligations, FinCEN has affirmatively stated its view that all other reporting companies are still required to comply with the CTA.³

Single-Member LLCs That Are Disregarded Entities Can’t Rely on the Large Operating Company Exemption

The CTA includes 23 categories of exemptions from the definition of “reporting company,” generally for entities already subject to substantial federal or state regulation under which beneficial ownership may be known. To qualify for the “large operating company” exemption, an entity must satisfy the following criteria:

1. employ more than 20 full-time employees in the United States;
2. maintain an operating presence at a physical office in the United States; and
3. have filed a federal income tax or information return in the United States for the previous year demonstrating more than $5 million of gross receipts or sales, excluding gross receipts or sales from sources outside the United States.

Although the CTA does not permit entities to consolidate employees across affiliated entities for the employee headcount, entities that are part of an affiliated group filing a consolidated tax return may use the aggregate amount of gross receipts or sales reported on the consolidated return.

A single-member limited liability company (LLC) that has not elected to be taxed as a corporation is “disregarded” as an entity separate from its owner for U.S. income tax purposes, and the owner of the LLC reports the LLC’s income and deductions on the owner’s federal income tax return. As a result, because disregarded LLCs do not file their own income tax return, and because LLCs cannot be part of an affiliated group of corporations filing a consolidated tax filing return, disregarded LLCs do not meet the requirements for the large operating company exemption.

Disregarded Entities Do Not Need to Obtain a Separate EIN for CTA Reporting Purposes

Every reporting company is required to provide a tax identification number (TIN) on its beneficial ownership information (BOI) filing: an employer identification number (EIN), a Social Security number (SSN), or an individual taxpayer identification number (ITIN). Foreign reporting companies that do not have a U.S. TIN must provide a TIN issued by a foreign jurisdiction, as well as the name of that jurisdiction. On July 24, 2024, FinCEN released FAQ F.13,⁴ which provides additional guidance clarifying that disregarded entities are not required to obtain a unique EINs strictly to meet the CTA’s BOI reporting obligations. Harmonizing the CTA’s TIN requirements for disregarded entities with those of the Internal Revenue Service (IRS) regarding TIN usage, FinCEN clarified that disregarded entities may report different types of TINs in different circumstances:

1. If a disregarded entity has its own EIN, it should report that EIN as its TIN. There is no requirement for a disregarded entity to obtain its own EIN if it can provide another TIN for BOI reporting purposes per the below (or, if a foreign reporting company, a foreign tax identification number).
2. If a disregarded entity has a single individual owner with a SSN or ITIN, it may report the owner’s SSN or ITIN as its TIN.
3. If a disregarded entity is owned by a U.S. entity that has an EIN, it may report the owner’s EIN as its TIN.
4. If a disregarded entity is owned by another disregarded entity or a chain of disregarded entities, it may report the TIN of the first owner up the chain of disregarded entities that has a TIN as its TIN.

Different reporting companies may report the same TIN in BOI filings. Disregarded entities should consider which TIN should be reported based on their ownership structure.

Submit BOI Reports as Soon as Reasonably Practicable — Even if the EIN Arrives After the Reporting Deadline

FinCEN noted in FAQ G.3,⁵ released on July 24, 2024, that although a reporting company may generally obtain an EIN immediately by filing an online application with the IRS, in certain circumstances a reporting company may need to submit an application to the IRS to obtain an EIN (i.e., a Form SS-4) by fax (which generally takes four business days) or mail (which may take four to five weeks). In certain circumstances, however, a reporting company may not receive an EIN for six to eight weeks. Because including a TIN is required to make a BOI filing, a reporting company facing that situation will not be able to submit its initial BOI filing within the reporting period (i.e., 90 days for entities formed or registered in 2024 and 30 days for entities formed or registered in 2025 and thereafter).

In those cases, FinCEN indicated that the reporting company should make all reasonable efforts to file its BOI report in a timely manner, including requesting the other required information as early as practicable, and filing its report as soon as it receives its EIN. The best practice is to retain all documentation associated with efforts to comply with the BOI reporting requirements in a timely manner.

Timing Is Everything: Include CTA Covenants in Governing Documents to Ensure Compliance

In addition to filing initial BOI reports, a reporting company must file an updated BOI report if there are changes concerning the reporting company or its beneficial owners within 30 calendar days after the date on which the change occurs. For example, a target that is a reporting company is obligated to file an updated BOI report following an M&A transaction in which the target’s ownership changes. Similarly, if a reporting company has filed inaccurate information in its BOI reports, a corrected BOI report must be filed within 30 calendar days after the owner or the reporting company becomes aware (or has reason to know) of any inaccuracy.

To ensure a reporting company’s compliance with the CTA’s reporting obligations, we recommend including covenants in governing documents that require relevant information to be updated. For example, officers, directors, or managers and other beneficial owners should provide or update information relating to any changes of information required to be reported under the CTA (e.g., a change in a beneficial owner’s legal name, address, or acceptable identification document) in a timely manner and to cooperate with the reporting company with respect to its CTA analysis and filings. Each officer, director, or manager and other beneficial owner should also consent to the disclosure of such information to FinCEN. We recommend including those provisions in governing documents even for entities that, at the time of drafting, may not be subject to the CTA’s reporting obligations in the event such entities ultimately become subject to CTA reporting obligations.

Understand the CTA “Subsidiary” Exemption: It Presents a Trap for the Unwary

The CTA “subsidiary” exemption is drafted differently than most other situations where control-based subsidiary concepts apply. The CTA definition is based on ownership or control “of the ownership interests” of a reporting company, not control of the entity itself, its voting securities, or management of the entity. The CTA final rule⁶ (as amended, BOI Rule) also omitted to clarify the meaning of control as used in the exemption and only clarified that the ownership requirement is interpreted to mean “wholly owned.” After protracted speculation by law firms as to interpretations around “control,” FinCEN clarified on January 12, 2024, in FAQ L.6 that “[i]f an exempt entity controls some but not all of the ownership interests of the subsidiary, the subsidiary does not qualify. To qualify for the exemption, a subsidiary’s ownership interests must be fully, 100 percent owned or controlled by an exempt entity. A subsidiary whose ownership interests are controlled or wholly owned, directly or indirectly, by certain exempt entities is exempt from the BOI reporting requirements. In this context, control of ownership interests means that the exempt entity entirely controls all of the ownership interests in the reporting company, in the same way that an exempt entity must wholly own all of a subsidiary’s ownership interests for the exemption to apply.”⁷ FinCEN still has not defined “control” for purposes of the CTA subsidiary exemption, and the resulting ambiguity creates an incentive for reporting companies to err on the side of making a CTA filing.

This FinCEN interpretation regarding control of all of the ownership interests of a subsidiary presents issues for entities with management carried interests, options, or other forms of incentive interests in the form of equity (including interests convertible into equity) that may be issued to individuals, as well as joint ventures with non-exempt entities as minority investors. Those structures raise the issues, even in situations where there is clear control and majority economic ownership by an applicable exempt entity. By contrast, the CTA, the BOI Rule, and FAQ L.6 leave open the possibility for the subsidiary exemption to apply based on indirect control of 100% of the ownership interests of a reporting company by an applicable exempt entity, including indirect control by a registered investment adviser through a pooled investment vehicle.

The FinCEN FAQ subsidiary interpretation also appears to conclude that, absent other facts, subsidiaries of public companies listed on exhibits to Form 10-Ks that have other nonexempt owners are not exempt from CTA reporting, notwithstanding the public disclosure in SEC filings and oversight of such entities within exempt parent financial controls. In the public company context, this leads to an odd result that private pooled investment vehicles are CTA exempt (based in part on SEC filings by registered investment advisers), while public company subsidiaries listed on public SEC filings are not. To date, FinCEN has not approved any CTA exemptions beyond the statutory exemptions. However, we believe this should be an area for FinCEN consideration to expand CTA reporting exemptions.

Consider Pros and Cons of Indemnification Provisions

Reporting companies are responsible for ensuring they submit accurate information to FinCEN, and both individuals and corporate entities may be held liable for willful violations. A person who willfully violates the BOI reporting requirements may be subject to civil penalties of up to $500 per day (subject to annual adjustment for inflation) and criminal penalties of up to two years imprisonment and a fine of up to $10,000.⁸

Reporting companies should consider whether to include an indemnification provision in favor of the reporting company with respect to any inaccurate information provided by beneficial owners for CTA reporting purposes, as well as for the failure to provide the reporting company with accurate, complete, and timely information. Such an indemnification provision could be included in the reporting company’s governing documents or in a CTA compliance policy. The reporting company could also enter into an indemnification agreement with each officer, director, or manager and other beneficial owner who may not otherwise be bound by another agreement with the reporting company (such as upstream beneficial owners). In particular, reporting companies and beneficial owners (including senior officers) should consider whether such an indemnification provision would conflict with indemnification obligations and exculpation by the reporting company of officers, directors, or managers under the reporting company’s governing documents or separate indemnification agreements with individuals or equity owners who are also CTA beneficial owners. To address any potential conflicting provisions, any existing indemnification and exculpation arrangements should be carefully reviewed in connection with implementing any CTA-specific indemnification provisions.

Conclusion

Overall, the application of the CTA to a particular entity requires a fact-intensive analysis, and, as indicated by FinCEN’s continued release of new guidance via its FAQs, interpretation of the CTA remains in flux. Contact your Sidley team with any questions on the CTA.

¹ U.S. Corporate Transparency Act: Guide For Private Fund Sponsors (January 2, 2024); Updates on U.S. Corporate Transparency Act Beneficial Ownership Reporting Requirements (December 14, 2023); and FinCEN Finalizes Rule to Require Many Domestic and Foreign Entities to Report Beneficial Ownership Information to U.S. Government (October 4, 2022).
² National Small Business United et al. v. Yellen et al., No. 5:22-CV-1448-LCB, 2024 WL 899372 at 9-52 (N.D. Ala. Mar. 1, 2024).
³ FinCEN, UPDATED: Notice Regarding National Small Business United v. Yellen, No. 5:22-cv-01448 (N.D. Ala.) (“Other than the particular individuals and entities subject to the court’s injunction ... , reporting companies are still required to comply with the law and file beneficial ownership reports as provided in FinCEN’s regulations.”).
⁴ See FinCEN’s Beneficial Ownership Information FAQ F.13.
⁵ See FinCEN’s Beneficial Ownership Information FAQ G.3.
⁶ 87 Fed. Reg. 59,498 (Sept. 30, 2022), as amended, available at https://www.govinfo.gov/content/pkg/FR-2022-09-30/pdf/2022-21020.pdf; https://www.govinfo.gov/content/pkg/FR-2023-11-30/pdf/2023-26399.pdf; https://www.govinfo.gov/content/pkg/FR-2023-11-08/pdf/2023-24559.pdf.
⁷ See FinCEN’s Beneficial Ownership Information FAQ L.6.
⁸ See FinCEN’s Beneficial Ownership Information FAQ K.2, FinCEN’s Beneficial Ownership Information FAQ K.3, and Section 1.3 of FinCEN’s Small Entity Compliance Guide.

Thank you to Knowledge Management Lawyer Katherine E. Gause for her significant contributions to this Sidley Update.