More Trouble than it’s Worth – Potential Issues with the Corporate Transparency Act
- Background on the Corporate Transparency Act
On January 1st, 2024, the Corporate Transparency Act (“CTA”) became effective, requiring many business entities to report to the Financial Crimes Enforcement Network (“FinCEN”) the entities’ owner(s) full legal name(s), date of birth(s), current address, and identification number from a driver’s license, ID card, or passport. 31 U.S.C. § 5366(a)(1), (b)(2)(A). The goal of the CTA regulations is to help prevent tax evasion and money laundering through shell corporations, which simply put are legal entities with no (or minimal) employees, customers, business, or assets. (Nat’l Small Bus. United v. Yellen). The CTA has a specifically large effect on small businesses, as they are most likely to fall outside of one of the 24 listed exceptions. Banks, insurance companies, tax-exempt organizations, publicly traded companies, and large operating companies are all exempt from filing this ownership information, as well as any subsidiary companies of a company that falls under any exemption. The CTA provides that entities created before January 1, 2024, have until January 1, 2025, to report their beneficial ownership to FinCEN, while all newly formed entities that do not meet an exception must report its ownership information to FinCEN within 90 days of formation.
II. Potential Issues with the CTA
While the goal of stopping financial crimes is certainly noble, some worry that the CTA was very poorly drafted and may have far more negative consequences than beneficial results. First off, the CTA’s overly broad terms may not pass constitutional muster, as was the case in a recently decided district court matter Nat’l Small Bus. United v. Yellen. Second, even if the Yellen ruling is overturned, or Congress refines the CTA to meet constitutional standards, unduly burdensome demands on small business owners, excessive punishments to those that violate the CTA, and ineffectiveness of the Act’s intended purpose may eventually doom the CTA.
A. Is the CTA constitutional?
The CTA’s overly broad terms potentially expand beyond the constitutional limits of Government regulation. In a recently ruled on District Court case in Alabama, the court found that the CTA does not satisfy Congress’s enumerated powers and is therefore unconstitutional. See Generally Yellen.
The National Small Business Association (“NSBA”) and several other plaintiffs recently challenged the constitutionality of the CTA in an Alabama District Court. In that case, the NSBA filed a motion for summary judgment against FinCEN and the United States Department of the Treasury (collectively the “Government”). The Government argued that the CTA is constitutional and that Congress had authority to enact the CTA under any of these three theories: 1) its foreign affairs powers, 2) its Commerce Clause authority, or 3) its necessary and proper exercise of taxing power.
Looking at the first argument, the Government argued that collecting the reporting information is “needed to protect vital United State’s National Security Interests” and that updated regulation on government entities is needed to align the United States laws more closely with other Countries. The court rejected this argument, holding that 1) even if other governments used domestic entities for illegal activity in the U.S., that is not enough to allow the federal government to regulate state incorporation issues, and 2) the Government’s argument of compliance with international standards is far too broad as it would give the federal government the right to do essentially anything in the name of bringing the U.S. into compliance with international standards.
Second, the Government argued that the Commerce Clause in the Constitution gives Congress the power to regulate these companies’ ownership in this manner. The Government argued that the Commerce Clause gives Congress the power to enact the CTA under 1) the channels of interstate and foreign commerce, 2) the instrumentalities of things and persons in interstate and foreign commerce, and 3) activities that have a substantial effect on interstate and foreign commerce. The Court found that it is clear by the plain language of the CTA that it does not govern the channels or instrumentalities of interstate commerce. The Court specifically focused on how the CTA requires regulation for all entities that are formed including those that are not in commerce, and that if the language in the CTA limited regulation to businesses in commerce, this act may be constitutional. Looking to whether the CTA governs activities that have a “substantial effect” on interstate commerce, the Court stated that Congress can regulate pure intrastate, non-economic activity that “(1) has a substantial effect on interstate commerce in the aggregate, when (2) the regulation is in the service of a comprehensive statute that regulates commercial activity on its face, and (3) regulation of the non-economic, non-commercial activity is necessary to make the broader regulation effective.” The court held that Commerce Clause does not give the CTA constitutional authority because “the plain text of the CTA does not regulate the quintessentially economic activities the Government asserts or require entities to engage in those activities to be regulated.”
Third and finally, as mentioned previously, the Government tried to argue that Taxing Power & the Necessary and Proper Cause gives the CTA constitutional authority. The Court held that while Congress does have power to levy taxes, it would be a “substantial expansion of Federal authority” to allow Congress to regulate business information in this manner. In conclusion, the court found that none of the Government’s three main arguments defending the CTA as constitutional were compelling and therefore granted the NSBA’s motion for summary judgment.
B. Unduly Burdensome on Small Business Owners
There are other potential issues beyond the CTA’s constitutional authority to regulate business. Unduly burdensome requirements for small businesses, excessive punishment for trivial offenses, and the ineffectiveness of the CTA may doom the Act as well.
Small businesses will bear a huge weight with the enactment of the CTA. FinCEN currently estimates that the CTA will apply to 32.6 currently existing entities and 5 million new entities each year. The main type of businesses subject to the CTA are businesses that have less than $5 million a year in gross revenue and have less than 20 full-time employees. Congress’ reason for targeting small businesses as mentioned earlier is because business entities with less activity and employees are more likely to be used for illegal activity such as tax evasion and money laundering; however, the unintended consequence is now arguably the least equipped businesses from a resource perspective, are now taxed with the CTA regulations.
According to a survey done by the National Small Business Association (“NSBA”), the average small business is looking at compliance costs of approximately $8,000 in the first year alone. Some small businesses may be able to afford this increase in regulation costs, but many will be financially strained to meet these demands. Additionally, small business owners are on average less sophisticated, and more likely to be unaware of the proper regulations. According to a survey done by the NSBA, the majority of small business owners are not even aware of these regulations, let alone have any idea how to comply with them.
Additionally, the consequences of failing to comply with CTA regulations are extremely punitive. Failure to report CTA regulations properly is punishable by $500 per day civil penalty up to $10,000, and up to two years in prison. Failure to comply with what are essentially paperwork forms could lead to a person getting a felony and paying thousands of dollars in fines.
Finally, the CTA may end up being an ineffective measure to prevent financial crime. While higher regulation certainly will not help criminals, it seems highly unlikely that merely reporting and placing more entities under scrutiny will deter criminals from their criminal action altogether.
III. Conclusion
The CTA seeks a novel purpose of cracking down on financial crimes in America. However, the Yellen case greatly calls into question the constitutionality of the CTA. Beyond the questions of constitutionality, the heavy burden placed on small businesses, excessive punishment, and potential ineffectiveness are all issues that Courts and Congress will have to consider going forward.
