Introduction

On December 11, 2020, the National Defense Authorization Act for Fiscal Year 2021 (“Defense Act”) was presented to the President, who then vetoed the legislation on December 23. The House voted to override the veto on December 28, and the Senate soon followed on January 1, 2021. Accordingly, the Defense Act became law.

The Defense Act is often viewed as a piece of “must-pass” legislation, so it is a convenient vehicle for other bills to hitch a ride on and, as a result, make it to the legislative finish line. That’s why the Defense Act included a section on anti–money laundering, which includes Title LXIV–Establishing Beneficial Ownership Information Reporting Requirements, referred to as the Corporate Transparency Act (CTA).

The CTA is an overlay on state and other entity formation rules that brings the United States more closely aligned with ownership disclosure requirements of the Organisation for Economic Co-operation and Development. It does not require states to alter the process and procedure for which entities are formed. Although navigating these rules may feel like a heavy lift, the CTA is a relatively “light touch” compared with reporting requirements of other countries.

In this article, we summarize the CTA’s provisions that will be of interest to professional advisors, business owners and others. We also summarize some of the final rules and regulations issued on September 29, 2022 by the Department of the Treasury’s Financial Crimes Enforcement Network (FinCEN), to implement the CTA’s beneficial ownership reporting requirements (proposed rules were issued on December 8, 2021). FinCEN issued additional proposed regulations on December 16, 2022 (https://public-inspection.federalregister.gov/2022-27031.pdf) governing protocols for accessing and disclosing beneficial ownership information.  An additional set of proposed regulations updating and revising certain customer due diligence rules is expected in about a year or so.

Overview

Reporting under the CTA depending on whether the entity is a new or existing company. Any reporting company formed or registered before January 1, 2024 (effective date of the final rules) must submit its initial report no later than January 1, 2025. Any reporting company formed or registered on or after January 1, 2024, must submit its initial report within 30 calendar days after formation. The CTA can generally be summarized in two simple sentences:  First, CTA requires certain types of domestic and foreign entities, called ‘‘reporting companies,’’ to submit specified beneficial ownership information (BOI) to FinCEN. Second, FinCEN is then authorized to share this BOI with certain government agencies, financial institutions, and regulators, subject to appropriate protocols. These two simple sentences result in numerous questions:   

Which types of entities must report?                   When to report BOI to FinCEN?

Are there exemptions?                                           What happens if not submitted?

Why is this required?                                              Where is the information submitted?

Who is a Beneficial Owner?                                      Who has access to the information?

What specified information is reported?            Who is responsible for periodic reports?

What if information changes?                               How is it filed with FinCEN?

Before addressing these questions, it is helpful to understand the background determined by Congress, which serves as the context for the beneficial ownership reporting provisions. The background or “sense of Congress” recognizes that:

• More than 2 million corporations, limited liability companies (LLCs) or other similar entities are formed under state law each year;
• Most states do not require information about the beneficial owners of these entities;
• Malign actors try to conceal their ownership to facilitate illicit activity, including money laundering, terrorist financing, drug trafficking, and securities fraud; and,
• Money launderers and others intentionally use corporate structures in order to evade detection.
  

As a result, federal legislation providing for the collection of beneficial ownership information is needed to:

• set a clear, federal standard for incorporation practices;
• protect U.S. national security interests and interstate commerce; and,
• better enable efforts to counter money laundering and terrorist financing.
  

Which types of entities must report beneficial ownership information? 

Only certain types of entities known as a “reporting company” must report beneficial ownership information. A reporting company is a corporation, LLC or other similar entity (e.g., limited partnership) that is (i) created by filing a document with a state’s secretary of state or (ii) formed under a foreign country’s law and is registered in the United States by filing a document with a state’s secretary of state. The CTA does not specifically include a trust as a reporting entity, and the final rules do not expand the definition to trusts generally, but would include business trusts (statutory and Massachusetts trusts), which are entities that are created by filing a document with the secretary of state. However, further study will be given to determine if trusts should be included within the definition of “reporting company.”[1] It is noted that the European Union requires beneficial ownership reporting for trusts in accordance with its 5th Directive on Anti–Money Laundering.

Are any entities exempt from reporting? 

Reporting companies do not include approximately two dozen categories of companies, many of which are in highly regulated industries, including certain: public companies; banks; registered brokers or dealers; investment companies or investment advisors under the Investment Company Act of 1940; registered entities under the Commodity Exchange Act;  public accounting firms; organizations under section 501(c) of the Internal Revenue Code; entities that employ more than 20 full-time employees in the United States with more than $5 million in gross receipts (as reported on the previous year’s federal income tax return) and have an operating presence at a physical office within the United States; and (dormant) entities in existence for more than one year and not engaged in active business and not owned by a foreign person (and several other enumerated entities). Although FinCEN has the authority to exempt certain other entities pursuant to rules, it has declined to do so in its proposed and final rules despite requests to do so in various comment letters.

Who Is a Beneficial Owner?

As noted above, a reporting company must first identify each beneficial owner and company applicant. Then the reporting company must provide certain specific information about those individuals to FinCEN.

A beneficial owner is an individual who (i) directly or indirectly exercises substantial control over the reporting entity, or (ii) owns (individually or jointly) or controls at least 25% of the entity.[2]

The final rules define the terms “substantial control” and “ownership interest” in a manner that substantially broadens the universe of individuals who would qualify as beneficial owners. Substantial control includes (1) serving as a senior officer of the reporting company (e.g., president, CFO, general counsel, CEO and COO), (2) having authority over the appointment or removal of a senior officer or a majority of the board and (3) the ability to direct or influence important decisions made by the reporting company. The first category identifies individuals with nominal authority, and the second and third categories identify individuals with functional or de facto authority. The first category would exclude roles such as corporate secretary and treasurer, according to the final rules. The third category, according to final rules, would include individuals who “direct, determine, or have substantial influence over important decisions made by the reporting company.”

In comments to the proposed rules, CPAs and other tax professionals questioned whether an agency relationship to a reporting company could cause them to exercise substantial influence when they perform services within the scope of their duties. For instance, some tax and legal professionals may be formally designated as agents under IRS Form 2848 (Power of Attorney/Representative). In commentary to its final rules, FinCEN stated that it “does not envision that the performance of ordinary, arm’s-length advisory or other third-party professional services to a reporting company would provide an individual with the power to direct or determine, or have substantial influence over, important decisions of a reporting company.” Moreover, if a tax or legal professional is designated as an agent of the reporting company, the exception to the “beneficial owner” definition with respect to nominees, intermediaries, custodians, and agents would apply and such professional would not need to be reported.

There are many other ways someone can exercise control over a reporting company, including as trustee of a trust. Because of the broad nature of “control,” more than one person could be a controlling person. As a result, a reporting company would report all persons in substantial control, rather than assessing only the most appropriate ones as is the case with the current customer due diligence (CDD) requirements of the Bank Secrecy Act rules.

Ownership interest, according to the final rules, includes equity and convertible (debt) instruments, such as warrants, rights and options. Debt instruments can also be considered an ownership interest if they enable the holder to exercise the same rights as an equity owner, including converting to an equity interest. The final rules adopt this understanding as a way of ensuring that the underlying reality of ownership, not the form it takes, drives the identification of beneficial owners. The approach also thwarts the use of complex ownership structures and ownership vehicles, other than direct equity ownership, to obscure a reporting company’s real owners. It is possible to have no individual with a 25% or greater ownership interest, but it is not possible to have no one with substantial control of a reporting company.

Trusts. Ownership (or control) can be by way of an individual’s position as a grantor or settlor, a beneficiary, a trustee or by authority to dispose of trust assets, according to final rules. Final FinCEN rules would consider an individual as owning or controlling ownership interests held in trust if the individual is the sole permissible recipient of both income and principal from the trust, or has the right to demand a distribution of, or withdraw substantially all of the assets from, the trust. Other individuals with authority to dispose of trust assets, such as trustees, would also be considered as controlling the ownership interests held in trust, as would grantors or settlors that have retained the right to revoke the trust, or to otherwise withdraw the assets of the trust. Extensive comments were submitted to FinCEN on this topic; FinCEN considered these comments but adopted the proposed rules on trusts without change. One consequence of this broad rule is that, depending on the specifics of the trust, the ownership interests held in trust could be considered simultaneously as owned or controlled by multiple parties in the trust arrangement. This approach departs from current CDD rules, which generally requires only trustee information because assets held in a trust are deemed to be owned by the trustee (or, in some instances, by someone who can direct a trustee or add or remove a trustee). It is noted that FinCEN is required to update the CDD rules by January 1, 2025, to bring them into conformance with CTA rules. 

A reporting company must also report information on certain applicant(s). Proposed rules included as an applicant any individual who directs or controls the filing of such document by another person. This could have resulted in a cascading series of individuals considered as applicants. For instance, if a client’s CPA instructs an attorney to form an LLC, both might have been considered applicants (along with the associate attorney and paralegal who form the LLC and file the papers with the state). The final rules avoids this potential headache. Under final rules, the company applicant is the individual who directly files the document to (i) create or form a domestic corporation, LLC or similar entity or (ii) first register a foreign entity to do business in the United States. In either case, the final rules also include as an applicant the individual who is primarily responsible for directing or controlling the filing of such document if more than one individual is involved in such filing (thus, a maximum of only two company applicants).  

Which “specified information” is required to be reported?

Each reporting company will be required to submit to FinCEN a report containing the following information for each beneficial owner (and in some cases the company applicant):

For each beneficial owner:

• Full name;
• Date of birth;
• Current residential address; and,
• Identifying number (such as a passport, state ID or driver’s license) and the jurisdiction that issued such number. An image of such document with the individual’s picture must also be submitted according to the final rules.
  

For each company applicant:  

• Same information as a beneficial owner, plus:
• If the company applicant creates or registers companies in the course of their business, a business address must be provided. For all other company applicants, a residential street address.   
  

There may be some individuals who are reluctant to provide this information to a reporting company.  In such case, upon request of an individual or an entity, FinCEN can issue a so-called FinCEN identifying number to such individual or entity. In such case, that number could be used instead of providing the foregoing information.

Information on the Reporting Company Itself

Although not specifically required under the statutory provisions of the CTA, the final rules would require the reporting company to provide information about itself. In accordance with final rules, each reporting company is required to submit to FinCEN a report containing the following information for the reporting company:

• Full legal name and any “doing business as” name;
• Street address of principal place of business;
• State or jurisdiction of formation; and,
• Taxpayer or employer identification number (or a foreign tax ID number for some foreign reporting companies).
  

When to Report BOI Information to FinCEN?

There are various reporting requirements imposed on reporting companies. Some are one-time requirements such as initial reporting for new or existing entities. Other reporting can be periodic, such as updating or correcting beneficial ownership information (BOI). 

Existing entities. Any reporting company that has been formed or registered before January 1, 2024 (effective date of the final rules) shall submit to FinCEN a report containing BOI—but without any requirement to submit company applicant information—no later than January 1, 2025 (one year after the effective date of the final rule). The elimination of the need to submit company applicant information for existing entities reflects the fact that many companies could have been formed decades ago and the challenge presented in collecting such information.

New entities. Any reporting company that is formed or registered on or after January 1, 2024, shall submit to FinCEN a report containing BOI information no later than 30 calendar days after the triggering date. The triggering date, according to the final rules, is the earlier of (i) the date the company receives actual notice that its creation (registration) has become effective or (ii) the secretary of state (or similar office) first provides public notice that the company has been created. The clarity provided in the final rule recognizes that the date of filing with the secretary of state is not necessarily a useful reference point for commencing the time period in which to file the initial report. This short time frame is designed to encourage “reporting” to become part of the formation process.

Updated reporting. If there is a change in any of BOI information (for instance, due to a sale or gift of an equity interest or an admission of a new member), the reporting company must submit to FinCEN a report that updates such information within 30 calendar days. Final rules make clear that changes in expiration dates (i.e., driver’s license expiration) do not trigger a need for an updated report. Likewise, a change in previously reported information about company applicants does not need to be reported (unless the initial information was incorrect, in which case a corrected report must be filed). A special rule applies for updating information due to the death of an individual who was a Beneficial Owner by virtue of property interests or other rights subject to transfer upon death, and not solely because the individual owned or controlled 25% or more of a reporting company. In this case, a change in information would be deemed to occur when the estate of the deceased owner is settled (i.e., through operation of intestacy laws or a testamentary distribution).  

Incorrect reporting. If incorrect information was previously reported (at the time of filing), a reporting company has 30 calendar days from the date it knew, or should have known, that the information was inaccurate, to file an updated report. If the corrected report is filed within 30 days and also filed within 90 days after the date on which the inaccurate report was filed, it will meet the statutory safe harbor rules, and no civil and criminal penalties would be imposed.

Terminating entities. The final rules clarify that the termination or dissolution of a reporting company does not require filing an updated report. FinCEN will consider appropriate guidance in FAQs on this topic.

Other reporting requirements. The CTA also contains other reporting requirements for certain exempt entities, pooled investment vehicles, exempt subsidiaries and exempt grandfathered entities. For instance, an entity that is no longer exempt is required to file with FinCEN within 30 calendar days of ceasing to be exempt. Likewise, if a reporting company meets the criteria for any exemption after filing an initial report, such a change will trigger a filing of an updated report.

Who is responsible for initial or periodic reports?   

A fundamental and practical issue is: Who will prepare and file CTA reports? Are law firms set up for this compliance requirement?  Will accounting firms have all the necessary details for filing a complete report?  Will attorneys or CPAs be concerned with punitive penalties for doing it wrong, as well as reputational issues?  Ultimately, the burden and requirement to file falls on the reporting company.  Regardless of who files or assembles the data, all reports are made under certification by the reporting company that the filing is “true, correct and complete.”[3] It is widely recognized that most of the information required to be reported may be provided to the reporting company by others, such as CPAs and attorneys, and beneficial owners themselves. Although that may be true, FinCEN deliberately places the responsibility for reporting correct information on the reporting company itself (and its senior officers). Therefore, even if advisors compile or prepare the reports on behalf of the entity, the reporting company should review the report for accuracy and completeness at it is ultimately responsible for the filing and certification. Advisors and others, however, can be subject to penalties as noted in the next section.

This begs the question: Which individuals can be held responsible for a reporting company’s failures? The final rules clarify the role of an individual in a reporting company’s failure to satisfy its obligations. The final rule states that a person is considered to have failed to report complete or updated BOI if “such person either causes the failure, or is a senior officer of the entity at the time of the failure.” This change is intended to provide clarity as to who may be liable for a reporting company’s failure to satisfy its reporting obligations.

Are there penalties for failing to report or providing incorrect beneficial ownership information? 

CTA rules contains both civil and criminal penalties for any person to who (1) willfully provides (directly or indirectly) false or fraudulent BOI, or (2) willfully fails to report, complete or update BOI. Any assessment as to whether false information was willfully filed would depend on all of the facts and circumstances surrounding the certification and reporting. Final rules state, as a general matter, FinCEN does not expect that an inadvertent mistake by a reporting company acting in good faith after diligent inquiry would constitute a willfully false or fraudulent violation.

It is important to note that penalties can be imposed on not just the reporting company but on a far broader group of individuals. Specifically, FinCEN rules provide that the term “person’’ includes any individual, reporting company, or other entity. Thus, the final rules make it clear that if a beneficial owner or company applicant, or even a company advisor, willfully provides false or fraudulent information to the reporting company, they can be liable for penalties.

For whoever is found to be in violation of these rules, civil penalties can cost up to $500 per day and criminal penalties can cost up to $10,000 per day and imprisonment for up to two years. Penalties may be avoided if the reporting company voluntarily files a corrected report within 90 days after submitting the original incorrect report.

Many of the reporting company obligations are triggered off the effective date of FinCEN regulations. Which is the effective date?

BOI reporting is triggered off the effective date of the final regulations, which is January 1, 2024. Although final rules were published in September 2022, several factors support the prospective effective date. Those factors include the development of standardized reporting forms (which according to FinCEN will be published well in advance of the upcoming reporting date), the build-out of new technology, time needed by the secretary of state to update websites and documents to notify reporting companies.

Who has access to BOI?

BOI is confidential and not available to the public, even upon specific request. FinCEN is, however, authorized to share BOI information with certain government agencies (including intelligence and law enforcement), financial institutions, and regulators, subject to appropriate protocols. There are rules regarding confidentiality and limited disclosure of BOI information. For instance, disclosure could be made upon a request from a financial institution to be used to satisfy mandatory customer due diligence requirements, but only with the consent of the reporting company. Disclosure could also be made to federal, state, local and foreign law enforcement authorities, upon request. BOI information will also be accessible for inspection or disclosure to officers and employees of the Treasury Department; such information could be used for tax administration purposes. FinCEN is expected to soon issue proposed regulations governing protocols and accesses to BOI information.

This information should not be construed as investment advice and is subject to change. It is provided for informational purposes only and is not intended to be either a specific offer by Bank of America, Merrill or any affiliate to sell or provide, or a specific invitation for a consumer to apply for, any particular retail financial product or service that may be available.

The Chief Investment Office (CIO) provides thought leadership on wealth management, investment strategy and global markets; portfolio management solutions; due diligence; and solutions oversight and data analytics. CIO viewpoints are developed for Bank of America Private Bank, a division of Bank of America, N.A., (“Bank of America”) and Merrill Lynch, Pierce, Fenner & Smith Incorporated (“MLPF&S” or “Merrill”), a registered broker-dealer, registered investment adviser and a wholly owned subsidiary of Bank of America Corporation (“BofA Corp.”).

Bank of America, Merrill, their affiliates, and advisors do not provide legal, tax, or accounting advice. Clients should consult their legal and/or tax advisors before making any financial decisions.

[1]  Not later than 2 years after the effective date of the regulations the CTA directs a study to be conducted (and a report submitted to Congress) evaluating whether (1) the lack of available beneficial ownership information for trusts raise concerns about the involvement of those entities in terrorism, money laundering, tax evasion, securities fraud, or other misconduct and (2) the failure of the United States to require beneficial ownership information for trusts formed or registered in the U.S. has elicited international criticism and what steps, if any, the U.S. has taken, is planning to take, or should take in response to such criticism.