06/20/2024

Corporate Transparency Act: Considerations For Trusts And Trustees

The Corporate Transparency Act (the “Act”) was enacted in 2021 as part of the National Defense Authorization Act to create transparency in business entity ownership and prevent illegal business activity. The Act was passed on January 1, 2021, and final rules were promulgated on September 30, 2022. The reporting requirements are effective January 1, 2024.

Under the Act, domestic and foreign “reporting companies,” are required to submit identifying information about their “beneficial owners” and “company applicants” to FinCEN. A “reporting company” is any domestic or foreign entity that is formed by filing with a government agency.^[1] For domestic entities, this generally means corporations, LLCs, and any other entity that is formed by filing with a federal or state office.^[2] The “beneficial owner” of a reporting company is “any individual who, directly or indirectly, either exercises substantial control over the reporting company or owns or controls at least 25% of the ownership interests of the reporting company,”^[3] and the “company applicant” is the individual who directly files the reporting company’s organizational documents with the government agency, such as the Secretary of State.^[4] 

Penalties for noncompliance under the Act are severe. Willful failure to report complete or updated beneficial ownership information to FinCEN in compliance with the Act may result in civil penalties of up to $500 for each day that the violation continues, or criminal penalties including imprisonment for up to two years and/or a fine of up to $10,000.

For clients with closely held businesses, compliance requires special attention to FinCEN’s regulations regarding beneficial owners, which can be especially complicated when ownership of a reporting company is held in one or more trusts for estate planning purposes.

Trusts as Reporting Companies

A trust may be a reporting company if it was created by filing a document with a secretary of state or similar office, such as for a statutory trust or business trust.^[5] Filing a trust registration statement with a court of law for the purpose of establishing the court’s jurisdiction over the trust does not make the trust a reporting company for these purposes.^[6] Thus, a trust established for estate planning purposes will generally not be considered a reporting company for purposes of the Act, although this should be determined on a case by case basis.

If a trust was created or registered by filing with the secretary of state, it may nevertheless be exempted from reporting if it meets one of the twenty-three (23) exemptions in the regulations.^[7] Notable exemptions from the definition of “reporting company” for these purposes include banks, tax-exempt entities, subsidiaries of certain exempt entities, and inactive entities.

Beneficial Ownership Through Trusts

Closely held business owners may be subject to reporting under the Act if their company qualifies as a “reporting company,” even if they own their business through one or more trusts and not in an individual capacity. Under the final regulations to the Act, reporting companies are required to identify all “beneficial owners,” defined as individuals who either: (a) exercise substantial control over the company; or (b) own 25% or more of the company.

Substantial Control

An individual exercises substantial control over a reporting company if the individual meets any of the following criteria: (1) the individual is a senior officer; (2) the individual has authority to appoint or remove certain officers or a majority of directors of the reporting company; (3) the individual is an important decision-maker; or (4) the individual has any other form of substantial control over the reporting company.^[8]         

Furthermore, an individual may have substantial control over a company directly or indirectly through: (1) board representation; (2) ownership or control of a majority of the voting power or voting rights of the reporting company; (3) rights associated with any financing arrangement or interest in a company; (4) control over one or more intermediary entities that separately or collectively exercise substantial control over a reporting company; (5) arrangements or financial business relationships, whether formal or informal, with other individuals or entities acting as nominees; or (6) “any other contract, arrangement, understanding, relationship, or otherwise.”^[9] The regulations specifically identify that an individual may have substantial control over a company by serving as a trustee of a trust “or similar arrangement” which enjoys these powers.^[10]

Thus, the regulations contemplate that an individual may have substantial control over a reporting company, and therefore be subject to the Act’s reporting requirements, if the individual serves as a trustee of a trust “or similar arrangement” which directly or indirectly exercises substantial control over the company. A “similar arrangement” likely includes arrangements which delegate a trustee’s powers such as trust protectors and business management committees. 

When a trust has substantial control over a reporting company, such as through control of the voting power of the company, the individuals empowered to exercise such control on behalf of the trust are considered beneficial owners and required to report under the Act. 

Ownership of 25% or More

As noted above, in addition to enjoying substantial control over a reporting company, an individual is a beneficial owner of a reporting company and subject to the reporting requirements under the Act if the individual owns or controls at least 25% of the ownership interests of the reporting company. The regulations provide that for purposes of identifying an individual who owns 25% or more of a reporting company’s ownership interests, an individual may own the interests directly or indirectly, through any contract, arrangement, understanding, relationship, or otherwise.^[11]

With respect to a trust or similar arrangement which owns or controls 25% or more of the ownership interests of a reporting company, an individual is attributed such ownership for these purposes if the individual serves as a trustee of the trust or otherwise enjoys the authority to dispose of trust assets, or is a beneficiary of the trust and: (i) is the sole permissible recipient of income and principal from the trust; (ii) has the right to demand a distribution of or withdraw substantially all of the assets from the trust; or (iii) is a grantor or settlor of the trust and has the right to revoke the trust or otherwise withdraw the assets of the trust.^[12] 

Thus, when a trust owns 25% or more of the ownership interests of a reporting company, the following individuals related to the trust are considered beneficial owners and required to comply with the Act’s reporting requirements: (a) the trustee (and in the case of a corporate trustee, the individuals at the corporate trustee responsible for the trust); (b) any individual with the power to dispose of trust assets; (c) any beneficiary who is the sole income and principal beneficiary; (d) any beneficiary with a right to demand a distribution of or withdraw substantially all of the assets from the trust; and (e) a grantor or settlor who retained either the power to revoke the trust or the power to withdraw the trust assets.

Many common strategies for flexibility in trust arrangements require special attention under these rules to determine if they implicate additional beneficial owners, including powers of appointment and retained grantor trust powers over irrevocable trusts. 

Certain Individuals Exempt

There are five exceptions to the definition of a beneficial owner. The following individuals are excepted from the definition of “beneficial owner” under the regulations to the Act: (i) a minor child; (ii) an individual acting as a nominee, intermediary, custodian, or agent on behalf of another individual; (iii) an employee of a reporting company, acting solely as an employee, provided they are not a senior officer; (iv) an individual whose only interest in a reporting company is a future interest through a right of inheritance; and (v) a creditor of a reporting company. These individuals, regardless of qualifying as a beneficial owner under the rules discussed above, are excepted from the definition of beneficial owner and are not required to report under the Act. In the case of a minor child, the parent or legal guardian of the minor child is required to report information. Finally, for purposes of the employee exception, a “senior officer” is any individual holding the position or exercising the authority of a president, chief financial officer, general counsel, chief executive officer, chief operating officer, or any other officer, regardless of official title, who performs a similar function.[13]

Special Note Regarding Corporate Trustees

On April 18, 2024, FinCEN published new guidance regarding reporting corporate trustees as beneficial owners. The guidance confirms that in the case of a corporate trustee, the individuals who are employed or engaged by the corporate trustee who exercise substantial control over a reporting company through the trust (as may be done by an individual or by committee, depending on the circumstances) should report as beneficial owners under the Act. 

Additionally, the guidance indicates that if a reporting company’s ownership interests are owned or controlled by a trust with a corporate trustee, the reporting company should determine whether any of the corporate trustee’s individual beneficial owners indirectly own or control at least 25 percent of the ownership interests of the reporting company through their ownership interests in the corporate trustee.

Thus, the new guidance indicates that when a corporate trustee serves as trustee of a trust which owns interests in a reporting company, both the individual employees at the corporate trustee who exercise substantial control over the company and the beneficial owners of the corporate trustee itself may be required to report under the Act.

Alabama’s Unconstitutional Ruling

On March 1, 2024, the U.S. District Court for the Northern District of Alabama ruled in National Small Business United v. Yellen that the Act was unconstitutional. However, this ruling applies only to the individual plaintiffs in the case and the National Small Business Association and its members. Therefore, this decision does not relieve other reporting companies from the reporting requirements under the Act. The decision is currently under appeal and McGrath North will provide further updates as they develop.

Timeline for Reporting

Entities formed before January 1, 2024 are required to file the beneficial ownership report by January 1, 2025. Entities formed in 2024 have 90 days from formation to file, and for companies formed January 1, 2025 and beyond, the filing is due within 30 days from formation.

Please contact a member of the McGrath North tax and estate planning group for questions regarding compliance under the Act, and for assistance in filing a beneficial ownership report.