Court Decision Doesn’t Affect Corporate Transparency Act Requirements for Most Companies and Real Estate Investors

As the joke goes, when asked how to get to Carnegie Hall, a musician answered “practice.” Although diligent practice is the means to become an expert in most endeavors, musicians are particularly obsessed with practice.

From the start, musicians are told how many hours they should practice per day – but they are also told it’s the quality, not the quantity, of practice that matters. Vocalists and wind instrument players generally recognize there is a physical limitation to how much they can play in a day.

But for pianists and string players, the limitations aren’t as obvious. And the most passionate and driven musicians constantly seek to improve their art – no matter how much work it takes. In conservatories, it can become a badge of honor to practice four, five, or even six hours a day -- top of three or four additional hours of ensemble or chamber group rehearsals.

However, there are physical and sometimes, mental, limitations on how much any person can practice. Over time, playing an instrument eight to ten hours a day can take its toll on a musician. Over practicing taxes both the body and the mind. Eventually, over practicing results in diminished returns and can cause injuries, such as tendonitis, carpal tunnel syndrome, and other repetitive use injuries or focal dystonia.

Sometimes, that injury can be reversed with treatment, rest, and technical changes. But some injuries are permanent. A musician facing a chronic injury may become depressed or decide to leave music altogether to protect both their physical and mental health.

Like athletes musicians are encouraged to challenge limits.  Over practice happens when the musician misjudges precisely where their limit is and breaches the boundary between working to their limit and breaching that limit. Over practice shows us that there can be too much of a good thing.

On March 1, 2024 an United States District Court in Alabama held in National Small Business United dba National Small Business Association v. Yellen (NSBA Case) that the Corporate Transparency Act (CTA) is unconstitutional.  In ruling that stating that CTA breaches constitutional limits, the Court noted “the wisdom of a policy is no guarantee of its constitutionality.”  This article discusses that Court decision and why despite that decision, most companies and real estate investors must comply with the CTA.

What Is the Corporate Transparency Act?

In December 2020, Congress adopted the Corporation Transparency Act (CTA), which requires certain entities, called “reporting companies,” to report the names of the “company application” who formed the entity and the names of individual owners. The CTA exempts entities with more than 20 employees or $5 Million in annual gross receipts, businesses already subject to close federal regulation, and certain non-profit and political organizations. The CTA also exempts “dormant” entities formed before January 1, 2020 with no assets, significant revenue, foreign ownership, or recent ownership changes.

However, most small businesses, real estate investors, and even newly-formed companies with no assets or employees because they aren’t conducting business to report ownership information to the Financial Crimes Enforcement Network (FinCEN).

FinCEN has targeted real estate for scrutiny out of concerns that real estate investments might be used for money laundering. Mortgage lenders require real estate investors to form special purpose entities (SPEs) to own the property being financed. Mortgage lenders also prohibit the real estate SPE from having employees. So although real estate SPEs may have more than $5 million in gross receipts, most still will be reporting companies under the CTA.  

A particular challenge in reporting under the CTA is that  companies that have no owners and have never conducted business or had assets are reporting companies. This requirement is particularly challenging for attorneys and others who may form an entity in anticipation of a client needing it for their real estate acquisition or a new business. When formed, the entity has no assets, receipts, employees, or owners, but still must file a CTA report.

If an attorney formed the entity, they are the company applicant. Technically the entity initially has no employees. And the client’s identity or anticipated use of the entity may be subject to the attorney-client privilege – particularly if the entity owns no assets and is not conducting business. Further, contracts for business or real estate acquisition often require confidentiality until the closing, so even if the entity has owners, it may breach the purchase agreement to disclose that information.  

Reporting companies must report the following information to FinCEN:

• Company Name and DBAs

• Principal Office Address

•  Formation Jurisdiction

• Tax Identification Number

• Information about “beneficial owners,” defined as “any individual who, directly or indirectly, either exercises substantial control over such reporting company or owns or controls at least 25 percent of the ownership interests of such reporting company.” 

• Information about “company applicants,” who are individuals who formed or directed formation of the company

Each beneficial owners and company applicant must report their date of birth, address, and a unique identifying number (e.g., driver’s license or passport), along with a photo of the document containing that number.

The Court Decision

In the NSBA Case, the Department of Justice (DOJ) argued that Congress had authority to adopt the CTA under three of its constitutional grants of authority:

• National security and foreign affairs authority

• Commerce Clause

• Necessary and Proper  Clause (taxing authority)

 DOJ claimed that CTA falls under Congress' foreign affairs powers The DOJ posited that collecting beneficial ownership information, therefore, is crucial to enhancing national security, intelligence, and law enforcement efforts to stop money laundering and other illegal activities.

DOJ also claimed CTA falls under Congress' Commerce Clause authority because Congress may regulate businesses that affect interstate commerce. The Court rejected this argument, noting that the CTA doesn’t mention interstate commerce or use the word “commerce” anywhere in its language.  

The CTA regulates “reporting companies,” defined as companies “created by the filing of a document with a secretary of state or a similar office under the law of a State or Indian Tribe; or formed under the law of a foreign country and registered to do business in the United States by the filing of a document with a secretary of state or a similar office under the laws of a State or Indian Tribe.” Therefore, the Court concluded, the CTA regulates legal entities formed under state law, which is purely intrastate matter – not businesses engaged in interstate commerce. That some of those entities might be engaged in interstate commerce doesn’t change the CTA’s purpose – to regulate noncommercial, intrastate entities.

Finally, DOJ claimed that the CTA is a necessary and proper exercise of Congress’ authority to impose taxes, reasoning that knowing who owns entities might aid the Internal Revenue Service (IRS)in collecting income taxes. However, as the Court noted, penalties for CTA noncompliance aren’t a tax and aren’t paid to the IRS. Further, unlike taxes, CTA penalties are punitive in nature.

What’s Next for the Corporate Transparency Act?

The Court decision is over 50 pages long, so this article is only an outline of DOJ’s main arguments and the Court’s holding. What’s most important to businesses and real estate investors is the limited scope of the Court decision.

The decision in the NSBA Case only applies to the plaintiffs in that case. On March 4, 2024, FinCEN issued an official notice stating that it will not enforce the CTA against plaintiffs in the NSBA Case, so NSBA members need not file CTA reports. However, the court decision doesn’t’ apply to non-NSBA members, and FinCEN’s notice implies those non-members still must file their CTA reports.

DOJ and FinCEN have appealed the court decision to the United States Court of Appeals. It could take years for the Court of Appeals to render a final decision. In the meanwhile, others may file copycat litigation in other federal courts, which regardless of the decisions in those cases likely will be appealed to the Court of Appeals. It seems likely that this issue eventually will go before the United States Supreme Court.

It's also possible that Congress will amend the CTA to address the constitutional concerns in the NSBA Case. The court decision clearly describes changes would bring the CTA under the constitutional umbrella.  Given that 2024 is an election year, it’s unclear whether Congress will rush to amend the CTA or whether any amendment will depend on the composition of Congress after the election, and possibly who wins the presidential election. After that, there could be a new round of litigation about constitutionality of the amended CTA.

What’s Next for Small Businesses and Real Estate Investors?

Congress may have passed the CTA with the good intentions of curtailing money-laundrying (particularly by foreign nationals) and identifying tax evasion. However, like musicians who practice to the point of injury, the CTA appears to have gone beyond the limits of Congress’ authority.  And just as it can take months of rest and medical treatment for a musician to recover from an overuse injury, change will not come quickly for the CTA.

For the time being small businesses that were NSBA members on March 1, 2024 need not make CTA reports.  But the Court decision doesn’t affect companies that weren’t NSBA members on March 1, 2024; those companies still must comply with the CTA.

Newly-formed companies (which could not have been NSBA members on March 1, 2024) should continue to make CTA reports within 90 days of formation. Companies formed before January 1, 2024 aren’t required to make CTA reports until December 31, 2024. So those companies can wait until year-end to file their reports.  However, all companies should collect the necessary information and documents so they are prepared to file CTA reports – even if they need not file them now.

© 2024 by Elizabeth A. Whitman

Any references clients and their legal situations have been modified to protect client confidentiality

DISCLAIMER: The content of this blog is for informational purposes only and does not provide legal advice. No one should take any action regarding the information in this blog without first seeking the advice of an attorney. Neither reading this blog nor communication with Whitman Legal Solutions, LLC or Elizabeth A. Whitman creates an attorney-client relationship. No attorney-client relationship will exist with Whitman Legal Solutions, LLC, or any attorney affiliated with it unless a written contract is signed by all parties.