The Coming FinCEN Reporting Requirements

On December 7, 2021, Treasury’s Financial Crimes Enforcement Network (FinCEN) issued a Notice of Proposed Rulemaking which promulgated proposed regulations (Proposed Regulations) interpreting the Corporate Transparency Act (CTA).[1]  The CTA, which will go into effect when final regulations are issued, imposes a significant new reporting requirement on companies required to report.

The goal of the CTA is to combat tax fraud, corruption, money laundering, and other illicit activity, by establishing a federal database, operated by FinCEN, to which corporations, LLCs, and other companies report information about the company’s beneficial owners. According to the preamble to the Proposed Regulations, perhaps as many as 30 million companies will be subject to FinCEN reporting. Law firms and accounting firms will directly assist the reporting companies, and will face reporting obligations of their own. This blog post summarizes the CTA reporting requirement and the proposed regulations.

Reporting Companies

The CTA imposes beneficial ownership reporting requirements on “reporting companies,” the definition of which includes domestic and foreign corporations, LLCs and other similar entities, subject to certain statutory exemptions. The Proposed Regulations describe a “domestic reporting company” as any entity that is created by the filing of a document with a secretary of state or similar office of a jurisdiction within the United States, and a “foreign reporting company” as any entity formed under the law of a foreign jurisdiction that is registered to do business within the United States.

The CTA specifically exempts 23 distinct categories of entities from its definition of reporting companies, and as a 24th exception it allows for the Treasury to provide for further exceptions if specified standards are met.  The Proposed Regulations do not add any exemptions, and quote the CTA exemption categories verbatim.

Many of the exempted entities already report information regarding beneficial owners to other credible sources.  Exempted entities include, among others: domestic banks, bank holding companies, savings and loan holding companies, and federal or state credit unions, certain issuers of securities registered with the Securities and Exchange Commission, certain entities registered with the Commodities Futures Trading Commission, certain pooled investment vehicles and tax-exempt 501(c)(3) organizations, investment advisers and insurance companies, registered public accounting firms, and certain public utilities.

Also exempted are companies that: (1) employ more than 20 employees on a full-time basis in the U.S.; (2) have filed U.S. federal income tax returns in the previous year showing more than $5 million in aggregate gross receipts or sales; and (3) maintain an operating presence at a physical office within the United States. As a result of this exemption and those mentioned above, the focus of the CTA is on small businesses and companies which are more likely to have opaque ownership structures susceptible to illicit activity.

Reportable Beneficial Owners

The CTA defines a “beneficial owner” as any individual who, directly or indirectly, either exercises “substantial control” over the entity, or owns or controls 25% or more of the “ownership interests” of the entity.  “Substantial control” and “ownership interests” are not defined in the CTA.  They are given broad definitions in the Proposed Regulations.

The ‘Substantial Control’ Prong

Under the Proposed Regulations, “substantial control” includes: (1) service as a senior officer of the reporting company; (2) authority over the appointment or removal of any senior officer or a majority or dominant minority of the board of directors (or similar body); (3) direction, determination or decision of, or substantial influence over, important matters affecting the reporting company; or (4) any other form of substantial control over the reporting company.

The first category is intended to cover individuals with nominal legal authority, and the second and third categories are designed to capture individuals with actual authority.  The fourth, catch-all category, appears to leave the door open to an ad hoc assessment of “substantial control.”  Since every person who exercises “substantial control” under any of the four categories is considered a “beneficial owner,” reporting companies could be required to provide information for a large number of individuals.  The Proposed Regulations also discuss “direct and indirect exercise of substantial control,” giving examples of a variety of ways in which control may be exerted.

The ‘Ownership Interests’ Prong

The term “ownership interests” under the Proposed Regulations is broadly defined, and includes traditional equity interests, as well as other interests such as capital or profit interests, convertible instruments, warrants or rights, or other options or privileges to acquire equity, capital or other interests in a reporting company.  Ownership interests may be owned directly or indirectly, and the Proposed Regulations give a nonexclusive list of examples of indirect ownership.

Exceptions to the Definition of Beneficial Owners

The Proposed Regulations describe five exceptions to the definition of beneficial owners outlined in the CTA: (1) a minor child; (2) an individual acting as a nominee, intermediary, custodian or agent on behalf of another individual; (3) an employee of a reporting company, acting solely as an employee and not as senior officer, whose substantial control over or economic benefits from such entity are derived solely from the employment status of the employee; (4) an individual whose only interest in the reporting company is a future interest through a right of inheritance; and (5) a creditor of a reporting company.

Required Identifying Information

The Proposed Regulations require a reporting company to submit to FinCEN certain information with respect to: (1) the reporting company; (2) each beneficial owner; and (3) the company’s applicant(s).  “Company applicant” is defined as an individual who files the company’s formation document for a domestic company, or the company’s registration document for a foreign company.

The reporting company must report its full name, any alternative names through which the company engages in business, its business street address, its jurisdiction of formation or registration, and its Taxpayer Identification Number (TIN), or, where a reporting company has not yet been issued a TIN, a Dun & Bradstreet Data Universal Numbering System Number or a Legal Entity Identifier.

For each beneficial owner and company applicant, reporting companies must disclose the individual’s full legal name, date of birth, current residential or business street address, and a unique identifying number from an acceptable identification document (e.g., a valid passport or driver’s license).  A reporting company is also required to provide a scanned copy of the identification document from which the unique identifying number of the beneficial owner or company applicant is obtained.  In lieu of specific information about an individual, the reporting company may provide the individual’s FinCEN identifier: a unique identifying number assigned by FinCEN to a person by submitting to FinCEN an application containing the information about that person which would be required in a report filed by a reporting company.

Timing for Reporting

Under the Proposed Regulations, reporting companies created or registered to do business in the United States before the effective date of the final regulations would have one year from the effective date of the final regulations to file their initial report with FinCEN.  Reporting companies created or registered to do business in the U.S. for the first time, on or after the effective date of the final regulations, would be required to file their initial report with FinCEN within 14 calendar days of the date on which they are created or registered.  If there is a change in the information previously reported to FinCEN, reporting companies would have 30 calendar days to file an updated report.  If a reporting company filed information that was inaccurate at the time of filing, the reporting company would need to file a corrected report within 14 calendar days of the date it knew, or should have known, that the information was inaccurate.

Penalties for Failure to Report

Willfully failing to report complete or updated beneficial ownership information to FinCEN in accordance with the regulations is a reporting violation.  A civil penalty of $500 per day may be imposed for as long as the willful failure continues without being remedied.  Further, the CTA provides for a fine of up to $10,000 and imprisonment for up to two years for a willful failure. “Willfulness” means a voluntary, intentional violation of a known legal duty.

The Bottom Line

The comment period for the Proposed Regulations ended on February 7, 2022.  Once the final regulations are promulgated, the CTA and those regulations will create a significant new reporting requirement for companies required to report.  Law firms and accounting firms will be the primary advisors assisting with compliance, and small law and accounting firms[2] (those with less than 20 employees and $5 million in gross receipts) will also need to comply as reporting companies.

[1] 31 U.S.C. Section 5336.

[2] For accounting firms, an exception from the reporting requirements is found in Section 5336(a)(11)(B)(xv), which provides that a reporting company does not include “a public accounting firm registered in accordance with section 102 of the Sarbanes-Oxley Act of 2002.” However, few accounting firms are so registered.