On Dec. 11, 2020, Congress passed the Corporate Transparency Act (CTA) with a veto-proof majority, in an apparent attempt to target shell companies commonly used in private equity transactions (including real estate transactions) in the United States. Supporters of the CTA argue that its new reporting rules, discussed in detail below, are essential to combating crimes that make use of anonymous shell companies, such as money laundering, human trafficking and illegal black-market operations. However, some detractors argue that, in addition to unreasonably intruding into the private affairs of law-abiding taxpayers, the CTA also stands to introduce significant reporting burdens, especially in the real estate industry, where multi-tier entity structures are common. The stakes are high: Failure to comply with the new requirements could even result in prison time and stiff monetary penalties.
The CTA will require certain entities (reporting companies), including a staggering number of existing limited liability companies and corporations, to disclose beneficial ownership information to the Treasury Department. A reporting company’s “beneficial owner” is the real, natural person that owns and controls the entity at the point of formation. Ownership and control are determined based on whether the individual either (1) exercises substantial control over the entity’s activity, (2) owns or controls at least 25 percent of the ownership interests in the entity, or (3) receives substantial economic benefits from the entity’s assets, as determined under forthcoming regulations from the Financial Crimes Enforcement Network (FinCEN), the Treasury Department bureau that will be in charge of administering the CTA reporting requirements.
Under the CTA, reporting companies will need to disclose the name, date of birth, current address and unique identifying number (e.g., a passport number or driver’s license number) of the beneficial owners. These disclosures will need to be updated on an annual basis if the reporting company’s beneficial ownership changes. However, it is important to note that these disclosures will not be publicly available; instead, FinCEN will maintain a private database available only to law enforcement officials and, with consent from the reporting company, financial institutions. Unlawful disclosure of beneficial ownership information can result in penalties.
Newly formed reporting companies must disclose beneficial ownership information at the time of formation. Existing reporting companies will need to report beneficial ownership information within two years after the effective date of the FinCEN regulations. As a result, many real estate ownership companies may become subject to significant reporting burdens on all or most existing entities through which they do business.
Knowing or willful failure to comply with the new requirements could result in criminal fines up to $10,000 and two years in prison. The CTA also provides for civil penalties of up to $500 per day that an entity is in violation of the reporting requirements imposed under the new regime.
Information about certain individuals who would otherwise be considered beneficial owners need not be disclosed under the CTA. Minors, nominees, intermediaries, custodians or agents, persons who control an entity solely because of their employment, or individuals whose only interest in a reporting company is through a right of inheritance are all excluded from the reporting requirements.
Additionally, certain types of entities are excluded from the definition of reporting company. In general, entities that are already subject to substantial reporting requirements will not be required to report beneficial ownership under the CTA. For instance, the CTA excludes: issuers of registered securities; governmental entities; most types of bank companies (including credit unions and bank holding companies); broker/dealers; registered investment advisers; registered investment companies; insurance companies; public accounting firms; certain dormant entities; certain 501(c) nonprofit organizations
Significantly, any U.S.-based entity that employs more than 20 full-time employees within the United States and has more than $5 million in aggregate gross receipts is not considered a reporting company under the CTA. This exception will be particularly important to non-publicly listed small and medium sized enterprises. A full list of the excluded entities will be codified upon enactment.
Still, it is likely that many of the entities commonly used in U.S.-based real estate transactions will not be exempt from the CTA.
For many years, the U.S. anti-money laundering apparatus has been significantly below par in comparison to other developed countries. With the enactment of the CTA, the United States will be compliant with international anti-money laundering standards and U.S. law enforcement agencies will have enhanced capability to coordinate with foreign law enforcement in this space.
However, this increased availability of beneficial ownership information to law enforcement comes at a cost. The smallest entities — those with fewer than 20 employees or less than $5 million in gross revenue — will need to comply with these new requirements, with potentially significant compliance burdens. Failure to comply will likely result in stiff civil or, in some cases, criminal penalties.
Because the CTA will likely apply to most real estate transactions, which typically use a multi-tier entity structure to achieve business objectives, there may be significant new reporting requirements for all new and existing real estate deals. These reporting requirements could be complex, depending on the specific circumstances of the transaction structure.
The implications of the CTA are evolving. Soon after the CTA is enacted, FinCEN will begin its regulatory rulemaking process, which should clarify and elaborate upon the CTA legislation. There is some uncertainty regarding how influential existing regulations will be in drafting the new FinCEN regulations; the existing regulations could give a clue as to the direction that FinCEN will take.
The new regulations will be especially important in determining the definition of “substantial benefit” under the CTA, as discussed above, and in determining who is actually responsible for paying fines imposed under the CTA or how to report changes in beneficial ownership.
Additionally, questions remain regarding how the new regulations will govern complex multi-jurisdictional structures involving trusts, given that some trustees could be exempt from reporting requirements. Furthermore, it is unclear how the regulations will address instances in which reporting companies are owned or controlled, directly or indirectly, by an exempt entity.
The 2021 National Defense Authorization Act, of which the CTA is a component, still awaits the President’s signature before it will be enacted as law. President Trump has signaled that he may veto the bill for reasons unrelated to the CTA; however, given the veto-proof majority by which the legislation was passed, it is likely that it will become law before the congressional term expires in January.
Zealous enforcement of already-burdensome FinCEN requirements in other contexts, especially within the banking industry, has made some practitioners nervous that this trend of creeping regulatory reporting requirements will continue in the future.
We recommend that owners of reporting companies and other entities, especially those not previously subject to beneficial ownership reporting requirements, contact legal counsel in order to carefully review the CTA disclosure requirements, which will take effect this year.
Matt Peurach is a partner in the corporate, investment funds, real estate capital markets and tax practices of law firm Morris, Manning & Martin.