Corporate Transparency Act May Require Small Businesses and Real Estate Investments to Report Beneficial Owners
Early 20th-century Italian composer Ottorino Respighi’s best-known compositions are three tone Roman tone poems (musical composition written to “illustrate” a non-musical source) written in the 1920s. The most often performed of these tone poems, Pines of Rome, has four movements, each creating an impression of the pines in a different part of Rome.
Pines of Rome’s instrumentation is as unique as the images Respighi attempts to create with his music. The composition calls for a recording of a nightingale and six buccina of various sizes. A buccina was a brass instrument from ancient Rome.
Since there are few buccina or professional bucinne players nowadays, orchestras substitute other almost equally obscure brass instruments for the buccina. Frequently mellophones, a marching band substitute for the French horn, or flugelhorns, a valved bugle which resembles (and sounds like) a fat trumpet, play the buccina parts.
To add to the drama, the buccina parts typically aren’t performed on stage in the orchestra. Instead, they perform in three groups throughout the concert hall or even hidden backstage. Since the nightingale sound is a recording, its source in the concert hall can be even more obscure. A first-time Pines of Rome audience member can find themselves looking around to find the hidden source of these unusual instrument sounds.
Like Pines of Rome audience members, people trying to learn who owns a private corporation or limited liability company (I’ll use the term Company to describe both) can be equally frustrated. Because most states don’t require the owners to be disclosed, frequently, sometimes, only the owners or Company management know who owns the business.
On December 11, 2020, as part of the National Defense Authorization Act (NDAA), Congress passed the Corporate Transparency Act (CTA). The CTA will require US Companies to disclose their ownership. The NDAA passed with a sufficient margin to make it veto-proof, so it eventually will become law even if the president vetoes it.
The CTA is likely to have a significant impact on real estate investments and may affect small businesses. Due to lender requirements, most of those are held through special purpose entities, which could be considered shell companies under the CTA.
What Companies Will Be Subject to the CTA?
The CTA applies to so-called “shell companies” or companies without significant operations. The CTA defines “reporting company” as any corporation, limited liability company (LLC) or “similar entity” that is created by a filing with a federal, state, or triable government or which is authored to do business in the United States except for entities that:
have more than 20 full-time employees in the United States
report more than $5 million in gross receipts or sales to the Internal Revenue Service (IRS)
have an operating presence at a physical office in the United States
entities, such as banks that are already subject to close federal regulation
entities considered “dormant”
Information the CTA Requires to be Reported
Under the CTA, reporting companies will need to provide FinCEN with the following information for beneficial owners:
full legal name
date of birth
business or residential street address
unique identification number (e.g., non-expired driver’s license, state identification, or passport number)
Reporting companies must report to FinCEN upon formation and when there is a change in beneficial ownership.
Beneficial owners whose information must be reported include any individual who directly or indirectly:
exercises substantial control over the entity
owns or control 25% or more of the ownership of the entity
These individuals aren’t considered beneficial owners under the CTA:
individuals acting as intermediaries, custodians, or agents for someone else
minors, provided their parent’s or guardian’s information is reported
individuals acting solely as employees of an entity whose control and economic benefits come only from their employment status
individuals whose only right in the reporting company are through inheritance rights
most creditors
What the Proponents Claim the CTA Will Do
The CTA says that “malign actors seek to conceal their ownership or corporations, limited liability companies, or similar entities in the United States to facilitate illicit activity.” The CTA describes these the “shell companies” as Russian nesting ‘Matryoshka’ dolls, across various secretive jurisdictions.” The CTA concludes, there needs to be a “clear, Federal standard for incorporation practices.”
Who Opposed the CTA and Why?
Despite proponents’ claims that the CTA is necessary to prevent illegal activity, dozens of reputable organizations, including the American Bar Association, the American Civil Liberties Union, National Federation of Independent Business, National Grocers Association, National Retail Foundation, National Association for the Self-Employed, National Apartment Association, and National the Restaurant Association opposed the CTA when it was first proposed in 2019. The concerns focused around “burdensome, duplicative reporting,” the impact on small business, and erosion of the “privacy of law-abiding citizens.”
How the CTA May Affect Real Estate Investments
Mortgage lenders nearly always require real estate investments to be held in special purpose entities (SPE). Unless they own a large property, real estate SPEs usually won’t fall under any exemptions. These SPEs typically have no employees and rarely have 20 employees. Smaller real estate investments don’t generate the $5 million in gross revenues required to qualify for the exemption. Whether they have a physical office or business location will depend upon whether the regulations, when promulgated, consider the real estate as a business location.
Many real estate SPEs have only one or a handful of owners. So, if the SPE is a reporting company, some or all of the owners’ information likely will have to be reported.
Real estate funds also may be reporting companies under the CTA. Real estate funds rarely have employees. Real estate development funds won’t have $5 million in gross revenues–at least not at the beginning. Real estate investment funds will have no revenues until they invest in properties and depending upon their size may never reach the $5 million threshold to be excluded from reporting requirements.
Another challenge is that as the real estate fund is marketed, it’s beneficial ownership will constantly be changing. Until regulations are promulgated, there is no way to know whether every new sale of units requires a new FinCEN report or whether only changes that add 25% owners must be reported.
Consequences Not Reporting
There are steep penalties–up to $500 per day for civil penalties–for not making required CTA reports. Criminal penalties for willfully providing false information include up to two years of jail time and a $10,000 fine. And penalties for nonreporting apply to both beneficial owners and the reporting company. Unless regulations exempt passive beneficial owners, this could negatively affect equity investment in small business or small real estate investments.
Privacy Concerns
Information reported under the CTA won’t be publicly available. But it will be available to law enforcement and to the IRS. And financial institutions will be able to access the information for some purposes.
Much of the mystique in Pines of Rome comes from antiphonal buccina parts and music performed by musicians offstage. Much would be lost if the performers were required to play on stage.
Increased ownership transparency and reporting burdens may well deter use of shell companies to hide illegal behavior as CTA proponents expect. Time (and regulations) will tell whether the increased transparency also has a chilling effect on small business and real estate as opponents fear.
© 2020 by Elizabeth A. Whitman
Any references clients and their legal situations have been modified to protect client confidentiality.
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