Navigating The Corporate Transparency Act

Christine Green of Steptoe & Johnson PLLC discusses the Corporate Transparency Act and the recent litigation regarding its constitutionality.

This transcript has been edited for length and clarity.

David D. Stewart: Welcome to the podcast. I’m David Stewart, editor in chief of Tax Notes Today International. This week: the transparency act’s unclear future.

After only being in effect for two months, the Corporate Transparency Act ran into a roadblock. The Alabama U.S. District Court ruled in National Small Business United v. Yellen that the law was unconstitutional. So what effect will this ruling have, and what should businesses do as future deadlines approach?

To discuss more about the Corporate Transparency Act and the latest updates, I’m joined by Christine Green, a member at Steptoe & Johnson. Chrissy, welcome to the podcast.

Christine Green: Thanks for having me.

David D. Stewart: So why don’t we start off by giving listeners an idea of what this Corporate Transparency Act is?

Christine Green: Sure. This is a new federal disclosure law, and the important thing to remember is that it’s aimed really at the small guys out there, and this is the first time that we’ve had a law like this in our country. So a lot of companies, they’re subject to maybe SEC disclosures or things of that nature, or banks that have to make public and federal disclosures. This law, though, really affects a lot of small businesses, virtually all of them.

Really what it is is any entity, so a corporation, a limited liability company, limited partnerships, that’s formed, and even entities that are registered to do business in states, so that would be like a non-U.S. company that’s registered to do business here, has to disclose information about itself and its beneficial owners to the federal government, to FinCEN, which is the Financial Crimes Enforcement Network. Really this law gets to the individuals who control an entity or who have an ownership stake in it, and really the purpose is to try to prevent illicit criminal behaviors, like money laundering, tax fraud, terrorism.

David D. Stewart: Why did this come up? Why did the government suddenly decide that it needed this information?

Christine Green: This has been in the works for several years now. It initially came up in actual legislation in the Anti-Money Laundering Act of 2020, which was then later amended, and we’ve had this Corporate Transparency Act that made its debut in the National Defense Authorization Act, which was put in place in 2021. So this has been in the works for several years and even before then, members of Congress, members of the government were really pushing for the United States to adopt a disclosure law like this.

A lot of other countries have them, where you do have to report your beneficial owners to a government, and the U.S. has really never had anything like that. The fear is that foreign actors are forming entities in the United States and using entities to engage in criminal behaviors and that the federal government in the U.S. really has no way to identify or see where that is.

So the goal of the law is to really identify where that’s taking place and identify what companies, what individuals.

David D. Stewart: Now, this involves reporting to the federal government. Have the states been collecting this information or is this entirely new?

Christine Green: States would have some of this information just by virtue of when you incorporate an entity or when you register a business in a state, but not all of this information, so this is a little bit new. But the United States is different than other countries where this acts of incorporating or registering to do business are really on a state-by-state basis. We don’t have federal corporations. You can’t choose to incorporate just plainly in the United States. You have to choose, “OK, I’m going to have a Delaware corporation. I’m going to have a West Virginia limited liability company.” So it’s a little bit different than other countries.

So states have some of this information, but this is really the first time that the federal government is saying, “Hey, we would like to have all this information aggregated and on file in a database.” I should note that the database that this is housed in with FinCEN, it’s not open to the general public. You can’t go on and search it, but a lot of folks have doubts about how secure this governmental database is and whether there will be security breaches.

David D. Stewart: Well, I guess that raises the other question of what is the government planning on doing with this information?

Christine Green: So far, the database is going to be allowed to be accessed on request by federal and state law enforcement agencies, and also the IRS, if they’re in the midst of an investigation, and they want to find out more about a certain company, certain beneficial owners, they’ll be able to request to use the information. The law, this new Corporate Transparency Act here, the effective date of it was January 1, 2024, so we’re just at the start of it. So we haven’t yet seen exactly how the federal government plans on using the information.

David D. Stewart: What have businesses been doing in the run-up to this? Has there been some preparation for this year’s new filing requirements?

Christine Green: Yeah, so there’s been a lot going on. I’ll talk about a couple aspects of that.

One is from the adviser side. Law firms certainly have been dealing with internal policies on how they will form entities, what their engagement letters will look like, what kind of communications do they need to give to clients on this law. Accounting firms have been doing a lot of the same thing.

But then on the other side of it, this law, again, it goes to the small guys, it impacts the small guys. So you have a lot of small business owners out there who are still completely unaware that this law exists. So that creates kind of the system where folks that are more sophisticated, they’ve been getting ready for this, they’ve been maybe working with their advisers and legal counsel and collecting information about their beneficial owners, figuring out, “Hey, do we have to disclose anything?”

On the other hand, then you have folks that are totally unaware of this. And when they do see something in the media about this new federal disclosure law, there’s this panic. They’re panicking, saying, “Oh my, this is another cost of doing business, administration I have. What do you mean I have to report my information to the federal government? I’m just a small mom-and-pop kind of shop.”

David D. Stewart: For the smaller businesses, what is the danger? What will happen to them if they don’t keep up to date on these filings?

Christine Green: The law imposes civil penalties for knowingly failing to file. I think the general view that a lot of practitioners have right now is that at least for the first couple of years, any financial and civil penalties associated with not following this rule, that FinCEN really isn’t going to be looking for people that just, “oops, I accidentally missed the deadline, or I didn’t realize this existed.” But one kind of wonders in the future, whether deadlines and failing to update information if FinCEN will take a more hard-line approach on it.

David D. Stewart: Well, let’s turn to the recent court challenge against this law. Could you tell me about the case that’s been going on in Alabama?

Christine Green: Yeah. Interestingly, a new case just came down, an opinion was issued, and the big headline, of course, is that the judge ruled that the Corporate Transparency Act is unconstitutional. This case was brought in a federal court in Alabama, and it was brought by the National Small Business Administration, which is a nonprofit organization focused on small business advocacy.

It’s got a lot of members — over 65,000 members from all states, all industries. And really the focus of this organization, it describes itself as nonpartisan, and it focuses on providing small businesses with access to capital programs like SBA funding and looking at laws and preventing implementation of what it views as unfair federal laws and regulations placed on small businesses.

The National Small Business Association, since the passage of the CTA in 2021, has been very vocal about this law and the burdens and harm that it places on small businesses and really has been trying to convince the government that you need to delay implementation of it. Our members are very concerned about it, and it’s such a broad law that it’s really not even serving the purpose that Congress intended it to.

So the National Small Business Association and one of its members, Isaac Winkles, were the plaintiffs in the case, and they sued the federal government on the grounds that, “Hey, this CTA law is unconstitutional.” That was back in November 2022 that this case was first filed. And so now here we are in March of 2024, and the judge issued a memorandum opinion siding with the plaintiffs and agreeing that the law was unconstitutional.

David D. Stewart: What argument did the court accept about this constitutional question?

Christine Green: The constitutional issues in this case, the court framed the question as, does the Constitution give Congress the power to regulate entities and their owners from the moment that they incorporate? Does the fact that you formed an entity mean that Congress has the power to then immediately regulate you? And the government said, “Yes, Congress does have that power. Congress has broad power to oversee foreign affairs and national security, broad power to regulate interstate commerce, and broad power to impose taxes and regulations.” Those were really the three constitutional issues at issue in the case.

In the case, I should mention, most following it are aware, but it was decided on summary judgment. So it was really just a case over the law itself. There was no dispute about the facts of the case, who the plaintiff was, whether or not his companies have to report under the Corporate Transparency Act. This was purely a, “We believe this law is unconstitutional, and we need you to decide this case.” So there was no fact-finding or anything. And the court agreed with the plaintiffs.

And just as a sort of broad summary, the court really focused on the fact that the Corporate Transparency Act requires entities upon their formation or their registration to be subject to this disclosure law. There’s nothing else that triggers having to make this disclosure to the federal government. And so, because incorporation in the United States is really an internal issue that each state governs, the court did not find that the government and Congress have the power to require this based on the broad power to oversee foreign affairs and national security, broad power to regulate commerce.

And on the taxing issue, the court didn’t really spend a lot of time discussing that, but just said, “Look, clearly this disclosure law and any penalties associated with not complying are simply not a tax.”

David D. Stewart: How has the government responded to this ruling?

Christine Green: FinCEN released a very brief notice saying that it will comply with the ruling. In that notice, it specifically states that the plaintiffs in the case, so that would be Isaac Winkles, his reporting companies, and the National Small Business Association, are not subject to disclosure. They don’t have to follow the CTA or report anything.

A couple of very important points about FinCEN’s notice. The first is that FinCEN has acknowledged that the injunction issued by the court applies to members of the National Small Business Association. And recall that that organization has over 65,000 members, so it’s very large. However, FinCEN has limited that to members as of March 1, 2024, which was the date that the case opinion was issued.

There’s been some commentary out there kind of speculating and wondering, could this ruling potentially apply to members of the National Small Business Association that become members after the ruling? Some folks out there say, “Yeah, it should apply,” which would of course create sort of a run on that organization and everyone trying to become a member. But so far FinCEN’s response has been, “No, you needed to be a member as of March 1, 2024.”

David D. Stewart: It seems that the sort of narrowness of this leaves a bit up in the air. How has the tax community reacted in general to this?

Christine Green: I think when the case first came out, there was this immediate panic of, “Oh goodness, what’s in this?” And then once everyone had 12 hours to sort of relax and read through the case and see what was there, now everyone’s recognizing that there’s going to be some uncertainty moving forward. It’s going to add another challenge when you’re advising clients on CTA issues. But everyone’s coalescing around this idea that, “OK, right now, this case in the injunction applies to the specific plaintiffs in the case and members of the organization as of March 1, 2024.”

I think one thing in the tax community that’s been highlighted in the past couple of months, and this case is just a great example of it, is you have in the tax community, you have some that are lawyers, you have some that are CPAs and tax accountants, and they do tax return filing. A lot of small business owners with respect to the Corporate Transparency Act are going to their tax return preparer, their CPAs, and saying, “Hey, what do I do with this?”

And really it puts the CPAs in an unfair position to have to advise on a legal matter. And the fact that we now have litigation over it and is it constitutional, is it not, is just a perfect reason of why you really need legal counsel in this area to advise on “are you subject to reporting? What should you be doing? Could this case potentially apply to you, or maybe now you don’t have to report.” So it’s a good reason to make sure you’re getting legal counsel on these issues.

David D. Stewart: What’s next for this Alabama case?

Christine Green: Well, everyone, of course, is expecting that the government will appeal. They have 60 days to do that. One thing that everyone’s also expecting the government to do is to ask for a stay, meaning that the injunction would basically be lifted. We don’t really have a crystal ball. We don’t know whether that will be granted, but the CTA has a couple of deadlines in it. These deadlines are important because while we’re all waiting for this case on appeal, some of these deadlines may very well pass. And so that does create a lot of uncertainty for folks going, “Gee, where do we think this case is going to turn out? What happens on appeal?”

The deadlines are for companies that, I call them newly formed companies, if they were newly formed January 1, 2024, or later, so this year, they only have 90 days to comply with doing their initial disclosure report to FinCEN. But for companies that were already in existence prior to 2024, they have until January 1, 2025, to file their initial reports. But it’s very likely that the appeal of this could take longer than January 1, 2025. We might not know the outcome of the appeal to the Eleventh Circuit until after that deadline passes. So it is going to create some uncertainty when advising clients.

My own view of it is right now, you have to follow FinCEN’s view and their view of, “Hey, if you’re not one of the plaintiffs in this case, you’re not a member of the National Small Business Association, this law still applies to you.”

David D. Stewart: Is there any expectation for how this case might fare on appeal?

Christine Green: What I’m seeing and hearing right now is that it seems like the majority of the tax community and the legal community feel that the government will prevail. There are other similar laws out there in the tax world. When FATCA was introduced years ago, there was a lot of questions about that, kind of similar. This is a little bit different, but the feel out there that I’ve heard is people do think that the government will prevail.

In reading through the case, a couple of things that struck me about it that I found really interesting is that the case focused mainly on domestic entities, so U.S. entities that are formed in a state. So again, a corporation formed in Delaware, or a limited liability company formed in New York. The law, though, also applies to foreign entities that are registered to do business in the United States. The case really didn’t make any distinctions about that or get into the nuances, but it’s certainly, when discussing Congress’s power to oversee foreign affairs and national security, really focused on the fact that incorporation at the state level is an internal issue that’s regulated by the states, and the mere fact that you’re incorporating doesn’t really substantially impact foreign affairs and national security.

But one thing with the case that I kind of wonder is how would that analysis look when we’re looking at foreign entities that are registering to do business in a state? Still, registration is very much governed by state law and another state-regulated matter, but it might be a little bit different when we look at Congress’s power when we’re dealing with a foreign entity versus a domestic entity.

David D. Stewart: Now, given all the uncertainty around this, how should tax professionals be advising their clients as we’re waiting for an outcome of this case?

Christine Green: My view is that as we’re waiting for an outcome and there could be more litigation that pops up all over the country as we are awaiting the case, the injunction that was issued applies to the plaintiffs in that case, members of National Small Business Association. So other reporting companies, other small business owners, should be prepared that they’re going to have to comply and deal with these disclosure laws.

David D. Stewart: Is there any different advice that you would give for how to prepare depending on in the longer term however this case might turn out?

Christine Green: I think something that’s come up in my practice quite a bit is when you have sophisticated clients that are aware of the law, they’re on top of the law; a lot of times they want to get this done quickly, get this off their plate, get my filing done. And I’m all for that because again, if they have existing entities, they have until January 1, [2025], to make their initial filing comply, and I’m all for not being in my office on New Year’s Eve trying to submit a bunch of these online.

My advice is, “Hey, let’s look at your entity structure. Let’s start gathering the information. But let’s hold off. If your initial deadline isn’t until January 1, 2025, as much as you want to get this done and off your plate, we can start looking at what you need to file, helping you gather information, seeing whether any exemptions apply, but let’s hold off on actually filing anything. Let’s regroup. Let’s look at this once we get into the third quarter of this year, because chances are there’s going to be more guidance from FinCEN just on how to mechanically file or what might be required, and there might even be additional litigation that pops up between then and now.”

David D. Stewart: Well, Chrissy, this has been fantastic. Thank you so much for walking me through all that’s happened here.

Christine Green: Oh, thank you. You’re welcome. Thank you for having me.