New Jersey Law Journal: What You Need to Know About the Corporate Transparency Act

Ultra-high net worth individuals are constantly seeking privacy within their estate planning. Prior to Jan. 1, 2024, they could preserve their anonymity by creating various domestic and foreign legal entities. Individuals would choose a name unrelated to their own for their entity, and the members of such an entity would remain anonymous. However, these practices have changed with the introduction of a new federal law called the Corporate Transparency Act (the Act). 31 U.S.C. Section 5336, 31 C.F.R. Section 1010.380.

Developed with the aim of preventing money laundering, the Act creates a database of information concerning individuals who own or control a substantial interest (Beneficial Owners) in certain types of domestic and foreign legal entities (Reporting Company or Reporting Companies). The Financial Crimes Enforcement Network (FinCEN) is in charge of creating and maintaining the database of the information the government collects pursuant to the Act. While not explicitly a tax or estate planning law, this anti-money laundering law still has a direct impact on individuals who own an interest in corporations, LLCs, limited partnerships, or similar entities, as well as individuals who serve in a fiduciary capacity of such entities. Many of the entities created as part of an individual’s estate plan are subject to the Act, although certain entities are exempt from the Act. Reporting Companies created prior to Jan. 1, 2024 will have until Jan. 1, 2025 to comply, Reporting Companies created prior to Jan. 1, 2025 will have 90 days after they are created to comply, and Reporting Companies created after Jan. 1, 2025 will have 30 days after they are created to comply.

Pursuant to the Act, a Beneficial Owner of a Reporting Company is defined as any individual who, directly or indirectly, (a) exercises “substantial control” over a Reporting Company, regardless of any actual “ownership” of the legal entity (henceforth referred to as the Substantial Control Test) or (b) owns or controls 25% or more of the ownership interests in the Reporting Company (henceforth referred to as the Ownership Test).

To comply with the Act, the senior officers of each nonexempt Reporting Company must disclose the Reporting Company’s name, trade name, principal U.S. physical address, state of formation and taxpayer identification number. The Reporting Company must provide the following information for each of the Beneficial Owners: (i) full legal name and date of birth, (ii) residential address and (iii) a copy of a non-expired U.S. passport, driver’s license issued by a state, or identification card issued by a state or local government.

There are civil and criminal penalties for willfully failing to report, providing false information or failing to update the personal information of a Reporting Company or Beneficial Owner. The civil penalty is up to $500 for each day the violation continues or is not remedied, and the criminal penalty includes a fine of up to $10,000, up to two years in prison, or both. While the senior officers of a Reporting Company that fails to file may be held accountable for the failure, a person may be subject to civil and/or criminal penalties for willfully causing a Reporting Company not to file or to report incomplete or false beneficial ownership information to FinCEN.

For estate planning attorneys with clients whose highest priority is privacy, this has created an administrative nightmare. General partnerships, sole proprietorships and trusts are typically not considered Reporting Companies. However, trusts which retain interests in Reporting Companies are not exempt from such compliance and are often considered Beneficial Owners. For various estate planning purposes, trusts are often members of various Reporting Companies. Thus, the Act creates many questions regarding a trust’s compliance.

When a trust holds or owns an interest in at least 25% of a Reporting Company, multiple individuals may be deemed to own or control the same ownership interest. For example, when a trust holds or owns the interest, the following individuals are considered Beneficial Owners as they meet the Ownership Test: (i) an individual trustee of the trust; (ii) an individual with “authority to dispose of trust assets”; (iii) a beneficiary who is the “sole permissible recipient of income and principal from the trust”; (iv) a beneficiary who “has the right to demand a distribution of or withdraw substantially all of the assets from the trust”; (v) a grantor of the trust “who has the right to revoke the trust”; and (vi) a grantor of the trust who has the right to “withdraw the assets of the trust.” Id. Minor children are not considered Beneficial Owners. Reporting Companies shall instead report information pertaining to such minor beneficiary’s parent or legal guardian. Residuary beneficiaries with a future interest in a trust are not considered Beneficial Owners.

Additionally, regardless of a trust’s ownership percentage in the Reporting Company, the following individuals are Beneficial Owners as they meet the Substantial Control Test: (i) a trustee that “owns a majority of the voting power or rights in the Reporting Company”; (ii) a trustee, trust protector, grantor, beneficiary or other individual “who controls a majority of the voting power or voting rights of the Reporting Company”; (iii) a trustee, trust protector, grantor, beneficiary or other individual “who directs important company decisions”; (iv) a trustee, trust protector, grantor, beneficiary or other individual who “holds the right to remove and replace a majority of the board of directors”; and (v) a trustee, trust protector, grantor, beneficiary or other individual “who holds the right to remove and replace the senior officers” of a Reporting Company. (Henderson, N.G., Borowsky, J.M. and Park, B.Y. “It’s Time to Get Our [CT]Act Together: Trusts, Family Offices, Private Trust Companies and the Corporate Transparency Act.”)

It is important to recognize that the aggregate value of an individual’s various ownership interests within a single Reporting Company is used to evaluate the Ownership Test. This means that if an individual owns 20% of a Reporting Company outright and free of trust, but the same individual is a beneficiary of a trust that owns 5% of the same Reporting Company, the 25% Ownership Test is met. Further, if three separate trusts each own 15% of a Reporting Company and all three of the trusts have the same trustee, the trustee would own 45% of the Reporting Company and would therefore be considered a Beneficial Owner under the Ownership Test.

Additionally, a Reporting Company held in a trust may be required to update its report multiple times per year. When a Reporting Company is held in a trust, the following events may trigger a reporting requirement: (a) a change of trust situs resulting in a change of address for the trustee; (b) “the resignation, removal or appointment of a trustee, advisor or protector; (c) a beneficiary reaching an age at which such beneficiary holds the power to control or dispose of trust assets”; (d) a minor beneficiary reaching the age of majority; (e) the “death of a beneficiary or grantor who was a beneficial owner; and (f) any other event that would trigger a change in the reporting information, including the change of address for a beneficiary, advisor or grantor who is a Beneficial Owner.” Id. These triggers, which previously only required simple changes within an entity, can now trigger additional reporting requirements. It is imperative that a Reporting Company be advised of these types of changes regarding a trust, since these changes must be reported within 30 days after the date on which such changed occurred. To ensure compliance with the Act, a Reporting Company may wish to include in its governing documents transfer restrictions which clearly outline that any transferee must provide such information as a condition of a permitted transfer.

While the goal of the Corporate Transparency Act is an important one, the Act introduces major hurdles from an estate planning perspective. Although a federal district court in the Northern District of Alabama has recently concluded that the Act is unconstitutional, this decision is expected to be appealed. National Small Business United v. Yellen, No. 5:22-cv-01448 (N.D. Ala.). Additionally, FinCEN has issued an announcement that they will not enforce the Act against the plaintiffs in that action only. Attorneys must therefore closely monitor any updates and continue to counsel their clients to ensure that they are in compliance with the Act. Clients will likely be surprised by the new obstacle to their privacy directly resulting from the Act, and the effects of the Act, whether intended or unintended, will be considerable for years to come.

Reprinted with permission from the March 19, 2024 issue of the New Jersey Law Journal. © 2024. ALM Media Properties, LLC. Further duplication without permission is prohibited. All rights reserved.

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