The Corporate Transparency Act: Navigating Reporting Requirements and Constitutional Challenges

by Avery Aston, Associate Member, University of Cincinnati Law Review Vol. 92

I. Introduction

By the end of 2024, many companies doing business within the United States are required to disclose beneficial ownership information to the Financial Crimes Enforcement Network (“FinCEN”).¹ Preexisting companies, with the exception of the few excused entities, will be required to report by the end of 2024 and newly incorporated entities are required to file within ninety days of incorporation.² The beneficial ownership disclosure includes identifying information such as name, date of birth, address, and identification documents such as passports and driver’s licenses.³ This disclosure requirement is called the Corporate Transparency Act (“CTA”), which aims at combating money laundering, terrorism, and tax evasion within the corporate system. The CTA is estimated to apply to 32.6 million existing entities and the estimated 5 million entities formed in the United States each year.⁴ While the CTA appears to be a relatively simple disclosure law, it is already facing opposition and questions of constitutionality—a federal district court in Alabama held the act to be unconstitutional in March of 2024.⁵

The purpose of this article is to identify the compliance requirements of the CTA and explain the constitutional questions involving the CTA. Part II of this article summarizes the reporting requirements of the CTA and discusses the recent Northern District of Alabama case ruling the CTA unconstitutional. Part III identifies the consequences of the Northern District of Alabama Ruling and alternatives to the CTA.

II. Background

The CTA is part of the National Defense Authorization Act for Fiscal Year 2021 (“NDAA”), which became effective law once Congress overridden former President Trump’s veto on January 1, 2021.⁶ The CTA became effective on January 1, 2024.⁷ The primary purpose of the CTA was to enhance transparency in entity and ownership structures to combat illicit activities such as tax fraud and money laundering.⁸ The target information the U.S. Department of Treasury is attempting to gather includes specific information on the business’s beneficial owners. The beneficial ownership reporting will be used by FinCEN to create a database of beneficial ownership to “crack down on anonymous shell companies, which have long been the vehicle of choice for money launderers, terrorists, and criminals.”⁹ Shell corporations are corporations that do not have assets or active business operations and make it easy to disguise the beneficial owner or the true purpose of the shell entity.¹⁰ While shell companies can be utilized for legitimate and legal purposes, funneling illicit money through a shell company allows people to create a chain of many transactions, making it difficult to find the source of the funds.¹¹ Additionally, the United States has been previously criticized by the Financial Action Task Force (“FATF”), an international task force with a mission of monitoring member countries’ progress in implementing anti-laundering, for not requiring the disclosure of beneficial owners of companies in 2016.¹²

A. Compliance with the Corporate Transparency Act

Under the CTA, starting January 1, 2024, existing companies have until the end of 2024, and new companies have 90 days (about 3 months) after receiving actual or public notice that the company’s registration is effective to comply with the reporting requirements.¹³ The reporting requirement requires businesses to report information of the beneficial owner and company applicant.¹⁴ A beneficial owner is an individual who controls at least 25 percent of the company or “has substantial control” of the company.¹⁵ The company applicant is the individual who files to form the corporation, but the reporting of the company applicant is only required to be reported to for companies created on or after January 1, 2024.¹⁶

All companies classified as a “reporting company” that otherwise do not qualify for an exemption, are required to report Beneficial Ownership Information. Beneficial Ownership Information “refers to identifying information about the individuals who directly or indirectly own or control a company.”¹⁷ Reporting companies consist of “domestic reporting companies” and “foreign reporting companies.”¹⁸ A “domestic reporting company” includes corporations, limited liability companies, and companies who filed with the secretary of state or a similar office under state law.¹⁹ Foreign companies registered to do business in a U.S. jurisdiction may be a “Foreign reporting Company.”²⁰ The small business guide provided by FinCEN lists the twenty-three specific entities not required to report.²¹

If companies fail to report the Beneficial Ownership Information, they will be subject to enforcement and penalties by FinCEN, both criminal and civil.²² If a company willfully fails to report beneficial ownership information or provides false or fraudulent information, the business can be subject to civil penalties for up to $500 each day the violation occurs and criminal penalties, including imprisonment for up to two years and fines of $10,0000.²³

B. Legislative History and Purpose of the Corporate Transparency Act

FATF criticized the United States for not complying with standards on collecting Beneficial Ownership Information from companies and encouraged the United States to comply before July 2008.²⁴ Between 2008 and the creation of the CTA, several pieces of legislation requiring the reporting of beneficial ownership information were introduced to Congress.²⁵ In 2019, the 2019 Transparency Proposal, also known as the Corporate Transparency Act of 2019, was proposed to congress.²⁶

Recently States have also began to require similar beneficial ownership disclosures. New York Governor, Kathy Houchul, signed Senate Bill 8059, which requires the filing of a beneficial ownership disclosure to the New York Department of State if the business is an LLC under New York Law or is registered to do business in New York.²⁷

C. National Small Business Ass’n, et al. v. Yellen et al.

On March 1, 2024, the U.S. District Court for the Northern District of Alabama, despite recognizing CTA as a “sensible and praiseworthy ends,” ruled the CTA as unconstitutional in National Small Business Ass’n, et al. v. Yellen et. Al.²⁸ In National Small Business Ass’n, an Ohio non-profit small businesses advocacy group, consisting of more than 65,000 small business members, sued the Treasury Department, the Treasury Secretary Janet Yellen, and the Director of FinCEN Himamauli Das, alleging the CTA exceeds “Congress’ authority under Article I of the Constitution and violate First, Fourth, Fifth, Ninth and Tenth Amendment.”²⁹

In the case, the government argued that Congress has the power to create the CTA under the “broad power to regulate commerce, oversee foreign affairs and national security and impose taxes and related regulations.”³⁰ Despite the government pointing to three powers that allow the establishment of CTA, the court ruled the CTA is unconstitutional because it “exceeds the Constitution’s limits on the legislative branch and lacks a sufficient nexus to any enumerated power to be a necessary or proper means of achieving Congress’ policy goals.”³¹ The court focused on the fact that the disclosure is triggered by incorporation, which is a state-regulated process.³² The court enjoined the government from applying the CTA to the parties, including the member businesses of the National Small Business Ass’n.

The court first analyzed Congress’s powers over foreign affairs and national security.³³ The government argued the enacting of CTA “‘is needed to… protect vital Unite[d] States national security interests; better enable critical national security, intelligence and law enforcement efforts to counter money laundering, the financing of terrorism, and other illicit activity’, and ‘bring the United States into compliance with international anti-money laundering and countering the financing of terrorism standards.”³⁴ The court found that Congress is limited by the enumerated powers because incorporation is an internal affair within a state, therefore national security interests are not a satisfactory justification for regulating state affairs.³⁵ Additionally, the court found that compliance with international anti-money laundering standards is a “good policy” but is not sufficient to make the CTA “necessary” or “proper” because foreign affairs does not extend to “purely internal affairs.”³⁶

The second government argument contends the power to establish CTA falls under the Commerce Clause. Congress has the power to regulate “those who use the channels of interstate commerce in order that those channels will not become the means of promoting or spreading evil, whether of a physical, moral or economic nature.”³⁷ Congress additionally has the power to “regulate and protect the instrumentalities of interstate commerce, or persons or things in interstate commerce.”³⁸ The government therefore argued entities incorporating under state law were almost certain to participate in Interstate Commerce.³⁹ The court held the government was incorrect when it argued that the Commerce Clause “allows Congress to regulate an entire class just because some members of the class use the channels and instrumentalities of commerce.”⁴⁰ Further, the court explains that incorporation is not an economic activity because the incorporation and the activities of the businesses are too attenuated, even if repeated elsewhere, to have a substantial effect on interstate commerce.⁴¹

The government’s final argument was that Congress has the power to enact the CTA under Congress’s taxing power.⁴² The government argues that “the collection of beneficial ownership information is necessary and proper to ensure taxable income is appropriately reported.”⁴³ The court determined it would be an inappropriate expansion of Congress’s authority to translate a power to tax into the power to collect “‘useful’” data and allowing tax-enforcement officials access to that data.”⁴⁴

The court ultimately found the CTA unconstitutional because it was not justified under Congress’s taxing powers, commerce clause, or foreign affairs powers. Therefore, the court did not decide on whether the CTA violates the First, Fourth, or Fifth Amendments.⁴⁵ The government has appealed against the decision, so it will be heard by the Eleventh District Court of Appeals.

III. Discussion

Following the National Small Business Ass’n, et al. v. Yellen et al. ruling, FinCEN released a statement that the government will not enforce the CTA against the plaintiffs in National Small Business Ass’n, but it will continue to enforce the CTA against all other businesses, as required by Congress.

A. Immediate Implications

After National Small Business Ass’n, there are no immediate implications to the majority of businesses’ compliance with the CTA Beneficial Ownership Information reporting requirements because the court did not issue a nationwide injunction. The court only enjoined the government from not applying the CTA to the parties, which restricts the government from enforcing the CTA requirements on plaintiffs and the over 65,000 members of the National Small Business Ass’n. FinCEN released a statement stating they would not enforce the CTA against the plaintiffs of the National Small Business Ass’n.⁴⁶ Further, the ruling does not implicate required compliance with state reporting requirements such as the New York Beneficial Ownership Reporting requirements.⁴⁷ While there are no immediate effects with vast impacts on the enforcement of CTA this case may encourage more aggrieved businesses and advocacy groups to sue FinCEN, to seek injunctions, even national injunctions against the enforcement of CTA. A national injunction would possibly hinder the enforcement of the CTA against all businesses on a nationwide basis. As of now, it is too early to predict the future of the CTA, which will become clearer if other parties continue to file suit in federal courts and the results of the governments appeal of National Small Business Ass’n to the Eleventh Circuit Court of Appeals.

If the Eleventh Circuit Court of Appeals were to affirm the judgment in National Small Business Ass’n, this would create a binding precedent in the Eleventh Circuit, making CTA unconstitutional in Alabama, Florida, and Georgia.⁴⁸ While an affirmative ruling on appeal could create more certainty for the Eleventh Circuit, an actual determination on the constitutionality of CTA would not be determined without a decision of the Supreme Court, which would take years to resolve.⁴⁹

B. Future Effects if the CTA continues to be Deemed Unconstitutional by Courts

The CTA was found unconstitutional because required disclosure is triggered by incorporation, a state-regulated process. An argument against this ruling is even though the incorporation process is considered a power delegated to the states, the CTA’s disclosure of owners of the entities being incorporated is an act that does not intrude upon the State’s powers to incorporate businesses.⁵⁰ An additional argument against ruling of the CTA unconstitutional is regulating federal anti-money laundering, is clearly a regulation of economic activity, making it within the scope of Congress’s powers.⁵¹

As pointed out in the National Small Business Ass’n opinion, even if the CTA is found to be unconstitutional, there are likely other ways the law could be structured to fall within Congress’s powers. Congress could structure the act to require the disclosure requirement as soon as a business engaged in interstate commerce.⁵² This would be in Congress’s purview as this would prevent the channels and instrumentalities of interstate commerce from being utilized for purposes such as evading taxes, wire fraud, and hiding illicit wealth.⁵³ While this would be deemed to fall within Congress’s legislative powers, this would lead to non-disclosure from state-registered entities that do not participate in interstate commerce. Eliminating this category from required disclosure would more than likely lead to non-disclosure from the exact shell companies the CTA was created to target. So, while there may be ways for Congress to better craft the legislation to fall within its purview, it may not be as effective at preventing money laundering, preventing terrorism, and detecting shell companies as the current CTA.

IV. Conclusion

In light of the Corporate Transparency Act, small businesses, and other entities alike, will need to be prepared to disclose Beneficial Ownership Information or else face civil and criminal penalties. Entities existing prior to 2024 must have the information to report to FinCEN by the end of 2024, and the entities formed in 2024 must return the information within ninety days of approval of incorporation. While National Small Business Ass’n has the potential to interfere with the enforcement of the CTA in the Eleventh District, making the future of CTA uncertain, currently there are no widespread effects of the ruling, other than the non-enforcement against the plaintiffs to the suit. Even if found unconstitutional down the line, as suggested by the National Small Business Ass’n opinion, there will be alternative legislation possibilities to gain beneficial ownership information from entities.

Cover Photo by Pictures of Money on Flickr

Avery Auton

A current 2L, Avery Auton earned her B.A. in Business Non-Profit Administration and Political Science from Franklin College. When not studying for law school Avery enjoys golfing, spending time with family, and hanging out with her cat Jojo.

References

1
U.S. Beneficial Ownership Information Registry Now Accepting Reports, Fin. Crimes Enf’t Network (FinCen) (Jan. 1, 2024), https://www.fincen.gov/news/news-releases/us-beneficial-ownership-information-registry-now-accepting-reports.
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Id. at *3.
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Robert W. Downes, et al., The Corporate Transparency Act- Preparing for the Federal Database of Beneficial Ownership, Am. Bar Ass’n (Apr. 16, 2021), https://www.americanbar.org/groups/business_law/resources/business-law-today/2021-may/the-corporate-transparency-act/.
7
31 C.F.R.§ 1010.380; Are You ready? The Corporate Transparency Act Becomes Effective Jan, 1, 2024, Thomson Reuters (Oct. 19, 2023), https://tax.thomsonreuters.com/blog/are-you-ready-the-corporate-transparency-act-becomes-effective-jan-1-2024/.
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Id. at *17.
34
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36
Id. at *24-25.
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38
Id. at *27 (quoting U.S. v. Lopez, 514 U.S. 549, 558 (1995)).
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48
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53
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