The Corporate Transparency Act (CTA), which came into effect on January 1, 2024, has significant implications for government contractors and commercial businesses. This client alert summarizes recent developments in the CTA—including constitutionality, physical office requirements, unpopulated joint ventures, and substantial control—to help businesses comply with and avoid harsh enforcement penalties. If you formed an entity on or after January 1, 2024, and are not subject to one of the exemptions, then you must file your initial BOI report within 90 days from the effective date of creation or registration of the entity. This is especially important for any joint ventures formed on or after January 1, 2024.
Background
As reported by PilieroMazza, the CTA is legislation enacted by Congress in 2021 that requires privately held U.S. businesses to report certain identifying information for all “beneficial owners” of such businesses to the Department of Treasury’s Financial Crimes Enforcement Network (FinCEN); the result of the reporting will be a central registry of beneficial owners that can be searched by various governmental entities.
Importantly, FinCEN has a powerful enforcement mechanism: the willful failure to report, complete, or update beneficial ownership information to FinCEN—or the willful provision of or attempt to provide false or fraudulent beneficial ownership information—may result in civil or criminal penalties. Civil penalties include 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. Senior officers of any entity that fails to file a required BOI report may be held accountable for that failure.
Ruling from Alabama District Court
On March 1, 2024, an Alabama federal court ruled in National Small Business United v. Yellen that the beneficial ownership information (BOI) reporting requirements established by the CTA are unconstitutional (linked here). However, it’s essential to note that this ruling only applies to the plaintiffs in the case. Additionally, the government has already appealed the decision, resulting in a protracted timeline of uncertainty. For now, the CTA remains in effect for other covered reporting companies.
For new entities that are formed in 2024 and are not exempted from reporting, we advise filing the BOI report within the 90-day deadline. For entities formed before 2024, the deadline to file a report is not until January 1, 2025; for these existing entities, we recommend preparing to provide the BOI report and allow time to monitor updates and guidance as the situation evolves.
In any event, the enforcement penalties for failure to file a BOI report are quite harsh, and the safest option is to timely file a BOI report.
To be clear, the CTA remains in effect notwithstanding the Alabama federal court decision and you should comply with the reporting requirements.
Qualifying for the Large Operating Business Exemption
The CTA mandates that most entities, including LLCs and corporations, report beneficial ownership information. However, there are a number of exceptions, including an exemption for large operating businesses. To qualify, a company must satisfy six criteria, with the three primary elements discussed below.
- Employees: The company must have more than 20 full-time employees. However, this total must be independent of any affiliates (a company cannot aggregate total employees across affiliated entities). Additionally, each of the employees must work for the company for a minimum of 30 hours a week. Finally, the individual must actually be a statutory employee; leased employees (or independent contractors (1099s)) do not count as employees.
- Revenue: The entity must have reported more than $5 Million in U.S.-based gross sales or receipts. Unlike the employee metric above, this number can be the aggregate of all U.S. revenues across affiliates in cases where there is a consolidated tax return or all taxable income flows through to a parent. For example, for a limited liability company (LLC) parent with multiple wholly-owned LLC subsidiaries that elected pass-through taxation, the total sales are aggregated to the parent. Importantly, this metric is based on the most recent tax return; thus, new entities will not qualify for this exemption, no matter the sales. Also, if a large operating company is sold and the tax status is changed as a result, the company may lose its exemption.
- Physical Office: The company must have a “physical operating location.” While many of our clients satisfy the numbers-based metrics discussed above, we are finding this third element is causing headaches. This element requires the company maintain a physical office in the U.S. that: (i) the entity owns or leases; (ii) is where it regularly conducts its business; AND (iii) is physically distinct from the place of business of any other unaffiliated entity. Since many businesses abandoned their physical office space during COVID, we are seeing companies with clearly large operating businesses, no longer have a physical space that qualifies. It is not clear yet whether arrangements like subleased office space or dedicated space at a workshare site satisfy these requirements. However, it is clear that if the company does not have a physical operating location the entity owns or leases, then this exemption does not apply.
If an entity satisfies all three of these elements (in addition to the three factors not discussed herein), then the company is exempt from the CTA and does not need to file a BOI report. In other words, the company does not have to take any action related to CTA. However, if at any point in the future the company no longer qualifies for this or any other exemption, then a BOI report must be filed within 30 days of the change in status.
Exemption for Subsidiaries: What About Unpopulated Joint Ventures?
The CTA also provides an exemption for subsidiaries whose ownership interests are controlled or wholly (i.e., 100%) owned, directly or indirectly, by one or more “certain” exempt entities (only 18 of the 23 exemptions are on the list of “certain” exemptions). Importantly, subsidiaries of a large operating company are among the listed types of certain exempted parents. In a typical umbrella enterprise where the ultimate parent is a qualified large operating business under the CTA, any subsidiary that the parent wholly owns should qualify as an exempt subsidiary. However, any ownership stake in the subsidiary by a reporting entity triggers reporting obligations for the subsidiary. Stated another way, if the parent is a reporting entity, then the subsidiary has reporting obligations as well.
A common question in the government contracting world is the unpopulated joint venture (JV). Typically, the JV is a new LLC owned by two unaffiliated entities. One of the JV partners might qualify for the large operating company exemption (see above for the requirements), while the other JV partner might not qualify for any exemptions to reporting. In this example, (1) the “large” JV partner qualifies for an exemption and does not need to file a BOI report, (2) the “small” JV partner must file a BOI report for its entity, and (3) a BOI report needs to be filed for the JV LLC, because the JV entity is partially owned by a non-exempt entity. As FinCEN explained, “[i]f an exempt entity controls some but not all of the ownership interests of the subsidiary, the subsidiary does not qualify.”[i]
Further, on the JV entity’s BOI report, the exempt entity’s name is all that is reported for the “large” JV partner, but all of the beneficial owners of the non-exempt JV partner are reported on the JV entity’s BOI report. Any future changes to the information in the BOI report must be reported to FinCEN within 30 days of the change, on both the JV entity’s report and the non-exempt JV partner’s BOI report.
An important reminder is that the CTA only requires reports for entities that file organizational paperwork with a state or tribal agency (e.g., corporations, LLCs, limited liability partnerships). If the JV is formed without filing organizational documents, like in a common-law partnership arrangement, then the JV entity is not a reporting company under the CTA and is not required to file a BOI report.
SBA Control vs. CTA Substantial Control
Under the CTA, reporting companies are required to report information on individuals exercising “substantial control,” which is a confusing element and was more fully detailed in a prior client alert linked here. However, businesses that operate under Small Business Administration (SBA) regulations are familiar with SBA’s “control” requirements and additional confusion is arising as a result.
Let’s compare SBA’s control requirements with the CTA’s substantial control provisions in the context of a typical Chief Financial Officer (CFO):
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SBA Control
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CTA Substantial Control
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So, SBA’s control guidelines are similar to CTA’s, but in comparison, CTA’s definition of control is much broader in scope, at least when it comes to individuals directly involved in the company. In other words, the goal of SBA’s analysis is to drill down to confirm the qualifying individual exercises actual control, whereas the CTA’s goal is to cast a wide net to require reporting of all individuals who might exercise control over the company.
It is worth noting that there are exceptions for certain employees of a company that exercise substantial control only in their role as an employee of the company, but senior officers are expressly excluded from this exception. Therefore, a typical CFO would need to be reported as a beneficial owner, notwithstanding they only exercise control in their capacity as an employee of the company.
PilieroMazza attorneys are here to assist you. If you need guidance concerning compliance with the CTA, please contact Meghan Leemon, Paul Tracy, or another member of the Firm’s Government Contracts or Business & Transactions practice groups.
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