What is the Corporate Transparency Act, and how does it affect beneficial owners' businesses?

The Corporate Transparency Act is legislation that changes the reporting requirements for beneficial ownership information of business owners operating in the United States. It requires businesses to identify and document any person who holds a 25% or greater ownership interest or who exercises substantial control over the company.

Under the Corporate Transparency Act, most reporting companies must file information on each beneficial owner with the U.S. Treasury's Financial Crimes Enforcement Network (FinCEN). FinCEN has developed a database that holds information about each beneficial owner documented by a reporting company.

 

According to FinCEN estimates, this rule will classify over 32 million small businesses as reporting companies in its first year of implementation. This number is so high because FinCEN requires all currently active entities (regardless of their formation date) to report. All small business owners with substantial control or sufficient ownership interests in a company will be designated as beneficial owners. The law will affect many new business owners—between 5 and 6 million—each year. The law will apply to both new and existing businesses.

Why we need the Corporate Transparency Act

The Corporate Transparency Act is an attempt to drive down the use of the financial network for crime and terrorist financing. Its main goal is to target the use of anonymous shell companies. These companies, often located in a foreign country, have been a popular way for criminals and terrorists to distance themselves from their operations while still collecting the proceeds through their anonymous ownership interests.

While many shell companies are legitimate, criminals may use this corporate structure for money laundering. They do this by using business entities to process money through the financial system and reap their economic benefits.

FinCEN fact sheets describing the rationale for the Corporate Transparency Act refer to geopolitical events, specifically the invasion of Ukraine. It accuses Russian elites, state-owned enterprises, and Russian government proxies of attempting to use their ownership interests in shell companies to evade economic sanctions. It also notes that foreign entities anonymously exerting substantial control over an entity represent a national security issue. The new reporting requirements will help law enforcement conduct criminal or civil investigations into money laundering and other financial malfeasance.

Until the establishment of the Corporate Transparency Act, the onus for collecting beneficial ownership information centered on financial institutions. This responsibility came in the form of due diligence requirements under the Bank Secrecy Act.

FinCEN's Customer Due Diligence (CDD) requirements mandate the collection and storage of identity information for each beneficial owner of a business by financial institutions, including banks, security brokers, and mutual funds. It gathered information on those with ownership interests in businesses registering accounts. These rules were passed in 2016 and became effective on May 11, 2018.

FinCEN also began requiring title insurance companies to collect beneficial ownership information for companies buying residential property ownership without external financing in certain U.S. areas. Other mechanisms for detecting criminal financial activity came in the form of currency transaction records and suspicious activity reports.

The final rule creating Customer Due Diligence represented a significant regulatory burden for banks. While banks' customers were required to submit information on each beneficial owner, they did so to the banks, who had to collect and document data on beneficial owners. The banks responded by supporting legislation that would transfer at least some of the reporting requirements for beneficial ownership and ownership interest information onto the business entities themselves.

Pressure to reform the reporting requirements for beneficial ownership information also came from other quarters, notably the inter-governmental Financial Action Task Force (FATF). This organization had long pushed for countries to collect information on beneficial owners, in particular urging the U.S. to tighten its regulations on documenting ownership interest information.

The introduction of the Corporate Transparency Act

The Corporate Transparency Act became law on Jan. 1, 2021, and took effect Jan. 1, 2024. It is the culmination of years of work by lawmakers at both national and international levels. It prompted the creation of three rules by FinCEN.

The first rule dealt with the mechanics of providing information on each beneficial owner and their ownership interest in the reporting company.

The second, for which FinCEN issued a notice of proposed rulemaking in December 2022, defines who may access information provided by a reporting company on its beneficial owners from the Beneficial Ownership Secure System. It also defines how they may use information on the beneficial owner and their ownership interests.

Finally, the third rule will revise FinCEN's CDD to acknowledge and accommodate the new reporting requirements now that the onus is on each reporting company to document its beneficial owners. The agency must produce this rule no later than a year after the effective date of the rule for reporting beneficial ownership information on Jan. 1, 2024.

Defining a reporting company

Under the Corporate Transparency Act, a limited liability company, a corporation, or any other entity that is created by filing paperwork with a state Secretary of State can be designated as a reporting company. There are two main types of reporting companies: domestic and foreign reporting companies.

A domestic reporting company is a corporation, a limited liability company, or an entity registered in the U.S. This registration happens through the filing of a document with a state or similar office in that state. A foreign reporting company can have other business structures beyond LLCs and corporations. It is formed in a foreign country but registers to do business in the U.S. through the filing of a document as a foreign entity with a state or similar office.

Exempt entities

FinCEN lists 23 types of exempt entities that do not qualify as reporting companies under the reporting requirement:

• Securities reporting issuer
• Governmental authority
• Bank
• Credit union
• Depository institution holding company
• Money services business
• Broker or dealer in securities
• Securities exchange or clearing agency
• Other Exchange Act registered entity
• Investment company or investment adviser
• Venture capital fund adviser
• Insurance company
• State-licensed insurance producer
• Commodity Exchange Act registered entity
• Accounting firm
• Public utility
• Financial market utility
• Pooled investment vehicle
• Tax-exempt entity
• Entity assisting a tax-exempt entity
• Large operating company
• Subsidiary of certain exempt entities
• Inactive entity

Companies qualify as tax-exempt entities if they meet any of the following criteria:

• The IRS considers them exempt entities under section 501C of the Internal Revenue Code (this will include many entities with nonprofit organization status).
• They lost tax-exempt status under the code less than 180 days prior.
• They are political organizations as defined under section 527a of the code.
• They are trusts as defined under section 4947a of the code.

The agency defines a large reporting company as meeting all of the following criteria:

• It is otherwise subject to a Federal regulatory regime.
• It has over 20 people with full-time employment status in the U.S.
• It has more than $5 million in gross receipts or sales on a prior year's tax return filed with the IRS, excluding foreign receipts.
• It has a physical operating presence in the U.S.
• It is owned by an entity already exempt under the Corporate Transparency Act.
• It is otherwise designated as exempt by the Secretary of the Treasury and the U.S. Attorney General.

A reporting company must be an active business. FinCEN defines an inactive entity as meeting all of the following criteria:

• It was created before Jan. 1, 2020.
• It is not engaged in active business.
• It is not owned by a foreign person, resident, domestic partnership, corporation, or other estate or trust.
• It has not sent or received over $1,000 while transacting business in the last year.
• It has no assets, including ownership of other companies, in the U.S. or elsewhere.

Defining beneficial owners

When defining an individual as a beneficial owner, the Corporate Transparency Act targets those who have sufficient ownership interests (either current or future interests) in the reporting company. An individual who exercises substantial control over a company also qualifies.

The reporting requirements for beneficial ownership focus on ownership percentages when evaluating ownership interests in a reporting company. An individual with 25% or more in a reporting company's ownership interests is considered a beneficial owner. Ownership interests include equity, stock, or voting rights but also include capital or profit interest. FinCEN views any assets or profits of a limited liability company, often referred to as a "unit," as similar to stock in a reporting company and therefore considers these to be ownership interests.

Convertible instruments also count as ownership interests. These are instruments that can be converted into equity, stock, or voting rights, or into capital or profit interest, and therefore confer economic benefits on the owner. This category also includes a future interest in convertible instruments or rights to purchase other ownership interests.

Under this future interest definition, anyone known by the reporting company to hold an option or privilege of buying or selling other ownership interests is considered a beneficial owner who can collect economic benefits, according to FinCEN. The agency also includes a catch-all rule that covers "any other instrument, contract, arrangement, understanding, relationship, or mechanism used to establish ownership."

Senior officers typically exercise substantial control over a reporting company. Alternatively, a beneficial owner might have substantial control over the senior officers (including the ability to appoint and remove senior officers) or otherwise have substantial control over the reporting company's decisions.

FinCEN defines the following roles as senior officers:

• President
• Chief financial officer (CFO)
• General counsel
• Chief executive officer (CEO)
• Chief operating officer (COO)

While a director often exercises substantial control over a reporting company, meaning these individuals could often qualify as beneficial owners, this might not always be the case. FinCEN has said that it will consider each director on a per-case basis when determining whether they exercise substantial control over a reporting company.

FinCEN has also attempted to clarify what substantial control means in the context of influential decisions. It gives several examples covering business, financial, and structural decisions.

An individual exercises substantial control over a reporting company if they make business decisions such as hiring staff, signing and terminating major contracts, or deciding on areas of geographical focus.

On the financial side, someone who approves major expenditures or investments is responsible for taking on debt or who approves the operating budget exercises substantial control over the reporting company.

Structural decisions such as reorganizations, mergers, or amendments of important governance documents will identify someone as having substantial control over a reporting company.

Note that this list of decisions is not extensive. FinCEN seems eager not to let any beneficial owners slip through the net. It includes a catch-all rule that captures substantial control "exercised in new and unique ways."

The definition also includes anyone who exercises substantial control over a reporting company via intermediaries. This could be the grantor or settler of a trust if the reporting company is owned by the trust (that is, someone who can revoke the trust or withdraw assets). It could also include beneficiaries of that trust who receive income from it, or who can demand distribution of the assets.

Exemptions to beneficial ownership

The Corporate Transparency Act exempts several people from the beneficial owner definition. These include:

• Minors
• Individuals acting as nominees, intermediaries, custodians, or agents on someone else's behalf
• Employees who are not senior officers and whose only interest or control is derived solely from their employment status
• Individuals whose only interest in a reporting company is derived solely from the right of inheritance
• Contingent trust beneficiaries
• Creditors whose only interest is to recover business debts

Beneficial ownership and limited liability company business structure

Owners of a limited liability company, called members, might also be considered beneficial owners based on their ownership percentage and level of substantial control under the LLC laws. Multiple members in a limited liability company could be considered beneficial owners, as could an LLC with only one member. Limited liability partnerships could be designated reporting companies. A sole proprietorship that does not use a single-member LLC is not considered a reporting company.

Company applicants

An applicant is the person who "files" the paperwork to form the business. Applicants also must be listed in the FinCen report. If a company hires a business or a professional to form their business, then that business or professional will also need to be listed. There is a limit of two company applicants per entity.

Requirements for reporting companies

A reporting company must provide information about itself, its beneficial owners, and each company applicant in its report to FinCEN under the Corporate Transparency Act.

Reporting requirements for a reporting company

A reporting company must provide several pieces of information about itself:

• Its full legal name
• Any trading or DBA names
• Its address
• Its federal tax ID number
• The jurisdiction where it was created

Note the reporting company must provide this information itself. It cannot rely on a parent company to provide this information for it.

Reporting requirements about beneficial owners

The Corporate Transparency Act requires the following information from a reporting company about its beneficial owners:

• Their full legal name
• Their birth date
• Their home address
• An image of an acceptable identification document, such as a passport or driver's license, along with the issuing jurisdiction and the document's ID number.

There are some differences in beneficial owner reporting under the Corporate Transparency Act when compared to FinCEN's Customer Due Diligence (CDD) rules. CDD rules restrict ownership status at a beneficial level to five individuals. Under the Corporate Transparency Act, there is no limit to the number of beneficial owners exercising substantial control or holding sufficient ownership interests in a reporting company.

Existing entities are exempted from reporting information about people filling the company applicant role. Reporting companies created after Jan. 1, 2024, need to collect company applicant information. Older entities do not.

If a beneficial owner's control, ownership interests, or future interest in a reporting company is derived solely through multiple exempt entities, then the company can file the names of those exempt entities on its initial report in lieu of the individual beneficial owner's personal details. This rule does not apply to beneficial owners with ownership interests in a reporting company or control of that reporting company through both exempt and non-exempt entities.

Reporting requirements about company applicants

A company applicant must provide the following information:

• Their full legal name
• Their birth date
• Their address
• An image of an acceptable identification document, such as a passport or driver's license, along with the issuing jurisdiction and the document's ID number.

Note that "address" above does not stipulate the home or business address. This is because the type of address to be provided depends on the exact role of the company applicant. If they work in company formation as a profession, such as an attorney or corporate formation agent, then company applicants must provide their business address. Otherwise, the Corporate Transparency Act requires the home address of the company applicant.

How to file a report

The initial report containing beneficial ownership information needs to be filed only once rather than each year. However, changes to information about a beneficial owner will require an updated report, as will corrections to erroneous information. If a reporting company changes its status to become exempt, then it must also file a report alerting FinCEN to this change.

FinCEN has explained that a reporting company will be able to file its initial report electronically. A corporation or LLC pays nothing to file an initial report, although FinCEN estimates that the filing of a document will cost $85 on average in administrative time for a reporting company with a simple business structure.

FinCEN has said that when the submission form is published, it will be available on the Beneficial Ownership Information Reporting website. Both a limited liability company and a corporation will be able to use this form.

A limited liability company or corporation that qualifies as a reporting company may use the FinCEN website to file its initial report. LegalZoom plans to offer filing assistance as well.

Given that the Corporate Transparency Act affects so many businesses, many of whom will likely be unaware of the Act until late in the process, there are likely to be scam sites and illicit social media campaigns impersonating FinCEN and hoping to gather personal information or even money from a reporting company, its company applicants, and its beneficial owners. These scams will often use fake domains with legitimate-sounding addresses. Be on the lookout for fraudulent online solicitations.

FinCEN identifiers

A reporting company or individual can request a FinCEN identifier for a beneficial owner or a company applicant. This is an identifying number that a reporting company can use when filing a business ownership information report involving that person.

The FinCEN number, which is not mandatory, is a useful way of simplifying business ownership information reports involving individuals involved in multiple reporting companies. Individuals will be able to request these electronically from the Corporate Transparency Act's effective date of Jan. 1, 2024. They will need to provide the same information that would have otherwise been filed on a business ownership information report. Alternatively, a reporting company can request them by ticking a box when filing a business ownership information report.

Reporting companies can take advantage of third-party services for help in submitting their business ownership information reports to FinCEN. The third parties can file the reports, either manually through the e-filing system that FinCEN is developing or through an application programming interface (API) that will allow them to file the reports directly from compatible software.

Updating information

Over time, beneficial owners' circumstances might change, and the details that the reporting company has provided about them to FinCEN will become out of date. The Corporate Transparency Act requires reporting companies to update this information in a timely manner.

For example, if a beneficial owner dies, their ownership of an interest in the reporting company will pass to one or more other parties. A change of address or a change in senior management would also trigger this requirement.

The reporting company must file a new report with FinCEN containing the updated information within 30 days of a change.

Note that updates are only required for changes to a reporting company or to beneficial owner information. FinCEN has said that the reporting company need not file changes to previously reported information about company applicants.

Reporting timelines

The initial report on beneficial owners filed with FinCEN is known as a Beneficial Ownership Information Return. Reporting companies created before the Corporate Transparency Act's effective date on Jan. 1, 2024, must file that initial report by Jan 1, 2025. Reporting companies created on or after that date were originally given 30 days for the filing of a document from the date that they received their registration documents.

On Sept 27, 2023, FinCEN issued a Notice of Proposed Rulemaking (NPRM) that would extend this time window from 30 days to 90 days for some reporting companies.

The agency said that this would allow a reporting company meeting certain conditions more time to gather information and reach compliance with the reporting requirements under the Corporate Transparency Act.

While this extension would triple the length of the filing window, it would only apply to reporting companies formed in the first year after the effective date. This means a reporting company formed on Jan. 1, 2025, or later would still be required to file its business ownership information reports within 30 days of receiving its registration documents.

The NPRM allowed for a 30-day public comment period from its appearance in the Federal Register.

Access to information after filing

Eventually, FinCEN will store information submitted by a reporting company in an electronic system known as the Beneficial Ownership Secure System. While the agency is still developing this system at the time of writing, it has promised to secure reporting company data using "rigorous information security methods and controls typically used in the Federal government to protect non-classified yet sensitive information systems at the highest security level."

While the Beneficial Ownership Information Access rule has not yet been finalized at the time of writing, the proposed rule would make the content of information provided by a reporting company available to five different types of entities:

• U.S. federal, state, local, and tribal government agencies.
• Foreign law enforcement agencies, judges, prosecutors, central authorities, and competent authorities. These would have to make their request through an intermediary Federal agency, which would access the Beneficial Ownership Secure System for them to retrieve the information. If authorities from a foreign country are not from a trusted country, they would need to make the request under an international treaty.
• Financial institutions seeking compliance with FinCEN's Customer Due Diligence (CDD) rules. These institutions would need permission from a reporting company to access their business ownership information data. FinCEN envisions the financial institution submitting identifying information about a specific reporting company to FinCEN rather than running open-ended queries about reporting companies on the Beneficial Ownership Secure System itself.
• Federal regulators assessing financial institutions for CDD compliance. They could request business ownership information for a reporting company that had already been obtained by the financial institutions they are assessing. They would also be able to obtain business ownership information for law enforcement purposes. The proposed rule also says that "certain self-regulatory organizations (SROs)" would be able to obtain business ownership information related to a beneficial owner of a reporting company for CDD compliance reviews.
• The U.S. Department of the Treasury, of which the Financial Crimes Enforcement Network is a part. Any official with employment status at the Treasury could obtain business ownership information about a reporting company in connection with their official duties, according to the proposed rule.

The only private sector organizations that will have access to the data are financial institutions, which may use it to prevent money laundering. The data will not be publicly available, even via Freedom of Information Act requests.

Developing a compliance plan

Organizations that qualify as reporting companies under the Corporate Transparency Act should prepare a plan for compliance as quickly as possible. A reporting company should involve all stakeholders in this process, including business owners, beneficial owners, and anyone filling a company applicant role. Consider taking the following steps to ensure that you meet your obligations under the legislation:

Consult with experts

The Corporate Transparency Act is a complex requirement with stiff penalties for beneficial owners of reporting companies who are not compliant. It is important to consult with your financial executives, along with legal experts, to ensure your filing is accurate and complete.

Third-party companies providing professional services will help you to build a compliance plan where appropriate and ensure you meet all requirements for a reporting company. They will advise you as the owner of a corporation or a limited liability company on how LLC laws vary and on your personal liability as a potential beneficial owner.

Determine whether you are a reporting company

Use the information in this document to decide whether you fall under the scope of the beneficial ownership information reporting rule as a reporting company under the Corporate Transparency Act. If you feel unable to do this alone, consult with your expert advisors to ascertain your status under the rule.

Determine which individuals are in scope

If you do qualify as a reporting company under the beneficial ownership reporting rule, you must identify the individuals who should provide information as beneficial owners. Use your date of incorporation to determine whether a registered agent or any other company applicants should also provide their information and, if so, who they are.

This would also be a good time to see whether beneficial owners or company applicants are involved with other reporting companies. If so, find out whether they plan to obtain a FinCEN identifier as part of their reporting duties for other entities.

Collect reporting information

A reporting company should not leave itself scrambling for the necessary information at the last minute. Instead, begin gathering this data immediately, checking its accuracy with beneficial owners and company applicants.

Create a change-tracking system

Given the 30-day deadline for updating inaccurate information, reporting companies should take a proactive approach to tracking changes in information on each beneficial owner. Develop an internal documentation and change tracking system that requires these stakeholders to update their information immediately—preferably in advance of such changes, where possible. For example, a beneficial owner who is planning to move house will be aware of their new address before the physical move and update their information accordingly.

This change tracking system should also acknowledge any alterations in corporate ownership interests and structure. For example, mergers and acquisition deals will now carry new liabilities if target companies are designated as reporting companies under the Corporate Transparency Act but are not compliant. The change tracking system should include steps to assess compliance when such changes take place and ensure that all the reporting information is completed.

Create a reporting workflow

Create a workflow that encompasses both change tracking of individual beneficial owner status and sending updated reports to FinCEN to ensure you stay in full compliance with the Corporate Transparency Act at all times as a reporting company. Document how and when this information was gathered, along with the other steps taken to ensure that the data was relayed to FinCEN.

Penalties and personal liability

A beneficial owner of a reporting company who does not follow the filing rules or who misleads FinCEN will face personal liability in the form of both civil and criminal penalties for failing to comply with the Corporate Transparency Act. FinCEN can impose civil fines of up to $500 for each day that a beneficial owner fails to report the correct information. Violators may also face criminal penalties of up to $10,000 or might even be incarcerated for a maximum of two years.

Conclusion

Lawmakers hope that the Corporate Transparency Act will enable the Financial Crimes Enforcement Network, in conjunction with law enforcement, to conduct criminal or civil investigations into domestic and foreign entities that help to bolster national security. The aim is to shine a light on every foreign reporting company or domestic reporting company with the hope of choking off money laundering sources for organized criminals who collectively exercise substantial control at arm's length. It will also target terrorist financing through money laundering and other means.

The reporting requirements will place an extra administrative burden on many business owners in the U.S., but FinCEN is doing its best to minimize the load on companies across the country while improving national security. The agency is working on creating assets to help reporting companies meet their requirements under the Corporate Transparency Act. These include videos, lists of frequently asked questions (FAQs), infographics, and compliance guides. The agency has promised to establish a contact center before the Jan. 1, 2024, effective date for the Corporate Transparency Act. This will field questions from reporting companies about procedures to follow when filing their business ownership information reports.

LegalZoom offers professional advice for small business owners to ensure that they meet all of the reporting requirements under the new FinCEN rules. Contact us today for guidance on how to file your initial report with minimal overhead.