The Corporate Transparency Act: Initial Observations and Considerations for Domestic and International Private Clients

It didn’t take very long for 2021 to bring about federal legislation that could significantly impact, or at least cause massive administrative headaches for, domestic and international private clients and their holding structures. The Corporate Transparency Act (the "Act") was enacted into federal law on January 1, 2021. With the close of the previous decade – a decade that brought the likes of FATCA, CRS, and other beneficial ownership and transparency laws around the world – it is not surprising that the United States is continuing to build on these global initiatives. This article first provides a brief overview of the Act and then raises some initial considerations and questions for private clients to start thinking about.

OVERVIEW

The purpose of the Act is to prevent the illicit use of so-called shell companies to conceal illegal activity or to facilitate money laundering and tax evasion, among other things. Accordingly, the Act requires information to be provided to the Financial Crimes Enforcement Network (FinCEN)¹  regarding the beneficial owners of certain companies, as well as information regarding the applicants who form these companies. What companies are subject to the Act, and what information must be reported?

Companies Subject to the Act: The Act applies to a "reporting company," which is defined as a corporation, limited liability company, or other similar entity that is: (i) created by the filing of a document with a secretary of state or a similar office under the law of a U.S. State (e.g., creating a Florida LLC by filing Articles of Organization on Sunbiz); or (ii) formed under the law of a non-U.S. country and registered to do business in the United States by the filing of a document with a secretary of state or a similar office under the laws of a U.S. State. At the outset, it is important to note that these rules generally apply to both U.S. and non-U.S. entities, but like any other law, there are exceptions.

Perhaps of most relevance to international private clients, the definition of a reporting company in the case of a non-U.S. entity excludes a non-U.S. company that is not registered to do business in the United States. Additionally, most traditional types of trusts that are used for estate planning purposes would not be considered reporting companies, as well as charitable entities that have qualified for special tax exempt status. Other exceptions of relevance to both domestic and international clients include, but are not limited to:

•companies that employ more than 20 full-time employees in the United States, that have filed a U.S. federal income tax return in the previous year showing more than $5,000,000 in gross receipts, and that have an operating presence at a U.S. physical office;

•companies that are already subject to certain oversight or regulations (e.g., banks, broker/dealers, certain SEC registered entities, and insurance companies, among others); and

•certain dormant companies.

Who and What Must Be Reported: A "beneficial owner" is any individual who, with respect to the reporting company, directly, indirectly, or otherwise: (i) exercises substantial control over the entity; or (ii) owns or controls 25% or more of the ownership interests of the entity. Of interest to private clients, however, a beneficial owner does not include an individual whose only interest in the relevant entity is through a right of inheritance. Other exceptions include minor children, as well as individuals acting purely as nominees or agents.

An "applicant" is any individual who files an application to form the relevant U.S. entity or who registers or files an application to register the relevant non-U.S. entity to do business in the U.S.

A reporting company must generally provide to FinCEN the following information for each beneficial owner and each applicant: such person's full legal name, birth date, a current home or work address, and a unique identification number, which is the number from an acceptable identification document, which includes a current U.S. passport, government-issued identification document, or U.S. driver's license (or in the case of a person not having one of the foregoing, a current passport issued by a non-U.S. government).

Reporting Due Dates and Penalties: Applicable due dates for filing the required information will depend on when final regulations implementing the Act are issued (but Treasury is required to issue such regulations within a year from the enactment of the Act, or January 1, 2022). For reporting companies that exist on the date those final regulations are issued, they will have two years to comply from the effective date of the final regulations. For reporting companies formed subsequent to the date of final regulations, they will be required to comply at the time of formation. Whether a reporting company is already in existence or newly formed, reporting will also be required to report certain changes in the beneficial ownership of the entity.

Failure to comply with the Act's reporting requirements can result in civil penalties of up to $10,000, as well as jail time in the case of criminal non-compliance.

CONSIDERATIONS AND QUESTIONS

The Act raises a number of questions and considerations that should be on the minds of individual private clients.

1. Use of Favorable Creditor Protection Jurisdictions
   The Act was clear in its attempt to have a uniform standard of reporting beneficial ownership information even though not every U.S. State requires companies formed under its laws to have a public registry for its beneficial owners. Delaware, Wyoming, and other U.S. States have become popular jurisdictions for providing some degree of privacy by not having a public registry of beneficial ownership. Many individuals seek privacy and confidentiality over their holdings for legitimate reasons, particularly if they are from jurisdictions with ongoing political turmoil or corruption. Selection of these types of jurisdictions could still be useful as many of these same U.S. States also have favorable creditor protection laws that may provide additional benefits for private client structures.

    

2. Trust Structures
   Private clients will often use trusts to facilitate legitimate tax and succession planning goals. Like many laws aimed at traditional business entities, the question is, how will trusts fit into the mix?
   
   The definition of a reporting company does not specifically describe trusts; however, it does include an entity similar to a limited liability company or corporation that is created by the filing of a document with a U.S. State. Many types of trust arrangements exist, but not all trust arrangements are created equal. A common law trust established for estate planning purposes is likely not a reporting company pursuant to the Act because a common law trust is not an entity that is created by the filing of a document. On the other hand, certain trusts known as "statutory trusts" or "business trusts" exist under various U.S. State laws that do typically require the filing of a document in such U.S. State. It is these types of trusts that have the possibility of being treated as reporting companies under the Act.
   
   While a traditional estate planning type trust likely was not intended by the Act to be a reporting company, that does not mean that estate planning type trusts are not impacted by the Act. For example, it is very common for a trust to own an interest in one or more U.S. LLCs in order to facilitate the settlor's efficient transfer of his/her assets to family members. Often times, the trust is an irrevocable discretionary trust (whether U.S. or foreign). If the underlying companies of the trust are "reporting companies," the Act requires the beneficial owners of the companies to be disclosed. Who will be considered the beneficial owner for purposes of the Act? Are the beneficiaries considered exempt because their only interest in the U.S. LLC is through a right of inheritance? What if one of the beneficiaries serves as an Investment Advisor or Protector for the trust? Does this mean such person exercises "substantial control" over the U.S. LLC for purposes of the Act?
   
   On a similar note, will U.S. federal tax concepts play a role? For example, does the grantor vs. nongrantor trust distinction make a difference for purposes of the Act? Consider a U.S. individual who creates an intentionally defective grantor trust for estate tax planning purposes and funds it by making a completed gift of an interest in a Florida LLC. The individual is considered the owner of the trust assets for U.S. federal income tax purposes, but the individual is not a beneficiary of the trust and has successfully transferred the LLC interest out of the individual's gross estate for U.S. federal estate tax purposes. Will such an individual be viewed as a beneficial owner under the Act?
   
   What about a land trust? A land trust is a private arrangement whereby a trustee takes title to real estate with limited duties while the beneficial owners generally maintain full control over the land. Land trusts are not considered trusts at all in the common law sense. They are typically used to provide some degree of confidentiality as to ownership and/or provide a simple way for non-residents to own land in another jurisdiction without having to be subject to probate administration at death. At least in Florida, a land trust is not created by filing a form with the State of Florida. Thus, it is possible that a land trust could still be a viable way to provide some privacy for ownership of real estate.
   
   
3. U.S. Asset Ownership Structures
   Many foreign clients also utilize holding structures that implement one or more U.S. and/or non-U.S. entities to take title to assets located in the United States. Typically, such structures are designed to guard against U.S. federal estate tax exposures on the death of the non-U.S. beneficial owner. Consider, for example, a foreign client who forms a non-U.S. company to purchase a vacation apartment located in South Florida. The property is not rented out, and, therefore, the non-U.S. company does not register to do business in the State of Florida. Separate and apart from the potential U.S. tax risks that may present themselves with this type of structure, is this non-U.S. entity a reporting company for purposes of the Act? Outside of the real estate setting, the same question would apply to a non-U.S. entity formed to own a brokerage account or investment portfolio owning U.S. stock, a U.S. life insurance policy, or otherwise formed for purposes of owning U.S. financial assets (or even tangible personal property, like artwork, for example).
   
   
4. Family Limited Partnership Structures
   For domestic clients, family companies, such as limited partnerships, may be created and used for a variety of reasons. When designed and operated correctly, family companies can be used for the efficient transfer of wealth from a senior generation to a younger generation. A Florida limited partnership, for example, would be an entity similar to an LLC or corporation under the Act because a form is filed with the State for its creation. So while these types of family structures may have benign purposes, the Act will capture these types of structures as well.
   
   

CONCLUSION

These are only initial observations and questions. There may not be any immediate answers to the foregoing questions, at least not until final regulations are issued (and even then, chances are there will be new questions and observations that arise and plenty of ambiguity left to deal with). Until then, domestic and international private clients should start reviewing their existing holding structures to determine the relevant reporting implications brought on by the Act.

^{1. FinCEN is a bureau of the U.S. Treasury Department that collects and analyzes information about financial transactions in order to combat illicit activity, such as money laundering. Clients and their advisors may recall the FinCEN geographic targeting orders that have been issue in years past, requiring the reporting of certain all cash purchases of real estate located in certain counties. In addition, clients and their advisors are likely familiar with FinCEN Form 114, better known as the FBAR, which stands for the Report of Foreign Bank and Financial Accounts and requires a U.S. individual to report certain foreign bank accounts having an aggregate value in excess of $10,000.}