I recently presented The Corporate Transparency Act: A Must-Do List for the Looming Deadline through ALI-CLE and received a number of questions from the attendees. Here are their questions and the answers I provided:
Question No. 1:
If an entity is dissolved before December 31, 2023, will it still be subject to the CTA? What exactly does "engaging in active business" mean in the inactive entity exemption?
If an entity does not exist on January 1, 2024 then it will not need to file a beneficial ownership report. The more difficult question arises if an entity starts the dissolution process in 2023 but the process is not yet completed until sometime in 2024. If the dissolution process is completed before the end of 2024, then, on the January 1, 2025 deadline (for entities formed prior to January 1, 2024) the entity will not exist and is also will not need to file.
An entity is exempt from filing if it satisfies the requirements of an “inactive entity” in 31 CFR 1010.380(c)(2)(xxiii) which exempt from filing any entity that:
(A) Was in existence on or before January 1, 2020;
(B) Is not engaged in active business;
(C) Is not owned by a foreign person, whether directly or indirectly, wholly or partially;
(D) Has not experienced any change in ownership in the preceding twelve month period;
(E) Has not sent or received any funds in an amount greater than $1,000, either directly or through any financial account in which the entity or any affiliate of the entity had an interest, in the preceding twelve month period; and
(F) Does not otherwise hold any kind or type of assets, whether in the United States or abroad, including any ownership interest in any corporation, limited liability company, or other similar entity.
Question No. 2:
Does the nominee exception to the beneficial owners include Receivers appointed over a company by the Court?
FinCEN’s regulations provide that a reporting company should not report the PII of an individual who would otherwise be a beneficial owner but is “an individual acting as a nominee, intermediary, custodian, or agent on behalf of another individual.” 31 CFR 1010.380(d)(3)(ii).
In its discussion, FinCEN noted that this exception was contained in the statutory language of the CTA (citing 31 USC 5336(a)(3)(B)(ii)). The balance of the discussion, however, focused on comments raised regarding the application of the rule to “retained professionals with an agency relationship, such as tax and legal professionals who have been designed as an agent under IRS Form 2868.” FinCEN did not discuss how the language might apply to court-appointed receivers. In fact, the word “receiver” does not appear once in FinCEN’s September 2022 release discussing its final rule on beneficial ownership reporting.
FinCEN’s guiding principle is to require reporting companies to “report real parties in interest who exercise control indirectly, but not those who merely act on another individual’s behalf.” 87 Fed. R. 59,498, 59,534. Accordingly, it would seem consistent with this principle for a court-appointed receiver to be excluded. Nevertheless, there is no specific language on point in FinCEN’s regulations, so a prudent approach would be to disclose the PII of a court-appointed received until FinCEN either clarifies its regulations or publishes a private letter ruling that provides better direction.
Question No. 3:
Will FinCEN be sending notice to entities of their obligations under the CTA?
No. File this one under, “ignorance of the law is no excuse.” Nevertheless, FinCEN has been criticized in some quarters for its efforts to educate the business public about their upcoming obligations. FinCEN’s recently published Small Entity Compliance Guide is part of FinCEN’s efforts to educate the public. Nevertheless, much of the business public remains unaware of its obligations.
Question No. 4:
If an LLC member has the right to vote on big decisions, but has only a small percentage, how does the member have "substantial control"?
Your question relates to our discussion about identifying beneficial owners. A beneficial owner is any individual that either (a) owns 25% or more of the equity interest in the reporting company, or (b) has substantial control. 31 CFR 1010.380(d).
The term “substantial control” is defined in subsection (d)(1) and, as we discussed, has two open-ended prongs. In the first prong, an individual has substantial control if that individual “has substantial influence over important decisions.” The second prong also includes as a beneficial owner any individual who “has any other form of substantial control over the reporting company.” These two prongs operate in concert to ensure that a person with any form of substantial control (even if that form of control is omitted from the enumerated examples) is swept into the definition of “beneficial owner.”
My view is that the prudent approach is to be over-inclusive and to ascribe substantial control to a member of an LLC if that member has a right to participate in a vote over important decisions (even if the individual’s voting power is less than 25%). Because there is no safe harbor for the exclusion of any individual with any form of substantial control, the prudent approach would be to include every individual who would participate in a vote on an important decision.
Question No. 5:
What if a large operating company with many subsidiaries employs its employees in a lower-tier payroll subsidiary? What if the large operating company leases employees from a PEO?
Your question relates to the exemption for large operating companies which are defined as reporting companies that (1) have 20 or more full time employees, (2) reported gross receipts of $5 million or more in the prior year’s tax return and (3) has an operating presence at a physical office within the United States. 31 CFR 1010.380(c)(xxi).
In your hypothetical, the reporting company would satisfy the income and operating presents elements of the test, but would rely on employees that were nominally employed in a subsidiary of the reporting company. The answer will depend on the definition of “full time employee in the United States” which refers to definitions provided in 26 CFR 54.4980H-1(a) and 54.4980H-3 (regulations implementing the Affordable Care Act), except that the term “United States” has the meaning provided in 31 CFR 1010.100(hhh).
Applying these definitions requires outside expertise that is beyond the scope of my practice. I note however, that the Affordable Care Act definition of “employee” refers to “an individual who is an employee under the common law standard” and the definition of “employer” also contains a discussion of rules in which entities related under common ownership are aggregated into a single “employer” for certain purposes.
Consequently, I cannot provide a definitive answer to your question at this time but would encourage you to engage counsel familiar with the rules governing these definitions under the Affordable Care Act regulations which should lead to a definitive answer depending on the facts involved.
Question No. 6 :
How do you interpret the 25% ownership requirement where there are intermediate holding companies? For example, ACME is owned by 4 holding companies 25% each, and each holding company is owned by 4 individuals (each owning 25%). Are the ultimate beneficial owners treated as each owning 25% of ACME or are they treated as owning approximately 6.25% of ACME because (i.e. 1/4th of the 25% of ACME owned by the holding company).
I dive into this question in Section 5.04 of my book. As I wrote there, FiNCEN’s regulation for calculating indirect ownership is “intentionally imprecise.” The regulation says that an individual is a beneficial owner if the individual owns 25% of the ownership interest in the reporting company “through ownership or control of one or more intermediary entities, that separately or collectively own or control ownership interests in the reporting company.” [Citing 31 CFR 1010.380(d)(ii)(D)].
The regulation does not contemplate the multiplication of ownership percentages at multiple levels (so that an individual who owns 50% of an intermediary that owns 40% of the reporting company would indirectly own 20% of the reporting company, for example). Consequently, in Section 5.04 of the book, I suggested that the best interpretation was that an individual would be an indirect beneficial owner in a reporting company if the individual was a beneficial owner (meaning >25%) of the intermediary and if the intermediary owned more than 25% of the reporting company. In reaching that conclusion, I acknowledged the possibility that it might be over-inclusive but that this would be a prudent interpretation.
In example four on page 27 of its Small Entity Compliance Guide, however, FinCEN clearly applies a “net percentage” method, so that an individual who owns 25% of an intermediary (which, in turn owns 25% of the reporting company) would indirectly own only 6.25% of the reporting company. While I remain convinced that FinCEN’s interpretation of its own regulation is not well-support by the regulatory text, until the question is addressed in a judicial decision, FinCEN’s interpretation will govern.
So, to answer your question, FinCEN’s interpretation of its regulations indicates that the four individuals in your hypothetical would not be beneficial owners by reason of ownership. Please note, however, that they could still be beneficial owners by reason of their “substantial control” of the reporting company, notwithstanding their sub-25% ownership.
Question No. 7:
Can you give an example of how to calculate an LLC that is being taxed as a corporation being analyzed under the Corporation calculation rule?
You can find a detailed explanation in Section 5.08 of my book, the Corporate Transparency Act Compliance Guide.
The logic, illustrated in the ‘decision tree’ graphic included in the slides, follows the following steps:
- First, calculate the voting power of each shareholder, calculated as a percentage of all the shareholders entitled to vote;
- Second, calculate the value that each shareholder would be entitled to receive in a hypothetical liquidation of the company;
- Third, count as a beneficial owner each individual who has 25% or more of the percentages you calculated in steps 1 and 2;
- Fourth, ask whether the outcome in step 3 can be determined with “reasonable certainty.” If you cannot determine the valuation of the company for purposes of the liquidation in step 2, you probably cannot conclude that the outcome in step 3 can be made with “reasonable certainty.”
- If the result in step 3 can be determined with “reasonable certainty” then the result in step 3 is final.
- If the result in step 3 is not final, then apply the “failsafe rule” described in 31 CFR 1010.380(d)(ii)(D) [Section 5.09 of the book]. The failsafe rule defines as a beneficial owner each individual who owns 25% or more of any “class or type of security” of the reporting company.
The terms “corporate capital rule” and “failsafe rule” are my own. You won’t find them labeled that way in the regulations, but I think those terms are easier to remember. You can see how FinCEN applies its regulations to this question on pages 19 – 24 of its Small Entity Compliance Guide.
Question No. 8:
Has FinCEN commented on corporations that file entity documents on behalf of attorneys, for example capital services? Would they be considered applicants?
Your question speaks to the “corporate service providers” like CT Corp, CSC, ComputerShare, Harvard Business Services, and others, who routinely file articles with state offices on behalf of attorneys and business owners. In many situations, an employee of a corporate service provider may be a “Company Applicant” whose PII will be required to be included in the reporting company’s BOI report.
The regulations [31 CFR 1010.380(e)] define “company applicant” as:
(1) For a domestic reporting company, the individual who directly files the document that creates the domestic reporting company as described in paragraph (c)(1)(i) of this section;
(2) For a foreign reporting company, the individual who directly files the document that first registers the foreign reporting company as described in paragraph (c)(1)(ii) of this section; and
(3) Whether for a domestic or a foreign reporting company, the individual who is primarily responsible for directing or controlling such filing if more than one individual is involved in the filing of the document.
In the Small Entity Compliance Guide, FinCEN clarified that it interprets this definition to mean that there may be as many as (but not more than) two persons who are the Company Applicant in any case: (1) the individual who directly files the document, and (2) the individual who is primarily responsible for directing or controlling such filing.
In a situation where a client requests an attorney to file articles of organization, and the attorney relays that request to a corporate service provider, the individual employee of the corporate service provider would likely be the individual “who directly files the document” and the attorney would likely be the individual who is “primarily responsible for directing or controlling such filing.” If so, the reporting company would need to identify both the individual employee and the attorney as the Company Applicant.
Question No. 9:
Is the attorney's job to actually upload to the federal database or just properly instruct clients so that they properly upload?
No, the CTA does not obligate an attorney to file a BOI report on behalf of the attorney’s client. The obligation to ensure that the reporting company files rests on the senior officers of the reporting company. 31 CFR 1010.380(g).
I think it is a fair interpretation of the Model Rules of Professional Responsibility that attorneys, in general, have an obligation to advise their clients on the law. To that end, I think it is prudent for attorneys who have formed entities and who provide general commercial and corporate advice to those entities, to advise their clients regarding the CTA and the need for reporting companies to file BOI reports.