17/11/23

US: Corporate Transparency Act Is Coming!

As published on: forbes.com, Friday 17 November, 2023.

Immediate Action Advisable

The Corporate Transparency Act (“CTA”) is a new federal law that may affect you in significant and unexpected ways. Since the law only becomes effective January 1, 2024 and entities created before 2024 only have to file January 1, 2025 it seems that most folks are just not taking any action now. That could be a significant mistake. There are really important actions that should be taken by many people now before the end of 2023 and few people realize that. This article will focus on actions you might want to take ASAP. Even if you think the CTA won’t affect you, read on as it may.

Quick CTA Background

There have been lots of articles discussing the CTA so the following is just a quick overview since the focus of this article is actions to take in 20234.

Congress enacted the CTA in 2021 as part of the National Defense Authorization Act for Fiscal Year 2021. The purpose of the CTA is aims to strip U.S. shell companies of anonymity that can hide illicit financial activity and for use in financing terrorist activities. The scope of the CTA is very broad to accomplish this.

The CTA will impact the owners, principles and other control persons involved in almost all limited liability companies (LLCs), corporations (both C and S corporations), limited partnerships (LPs), and other closely held entities. The reporting requirements are administered by FinCEN and they estimate that 32 million entities will have to report. Most of the entities created as part of an investment plan (e.g., a holding company for securities or a small business, or owning rental real estate), an estate plan (e.g., an LLC designed to hold various investments to facilitate trust funding or administration), or asset protection planning (any entity created to insulate the assets it holds, or to insulate those who own the entity for claims arising from the assets the entity holds) likely will be subjected to the new reporting rules. This is really broad and millions who have engaged in any type of planning will be entangled in these reporting requirements. Failure to file can trigger costly financial penalties and jail time. This is not to be ignored.

The CTA requires entities to report both beneficial owners and control persons, all broadly defined. Control people might include officers, directors, managers of an LLC, key employees, etc. Owners might include those holding options, warrants or other rights.

The reporting will include your name, home address (no P.O. boxes, and you cannot use c/o your attorney or CPA as an address). You will also have to file a copy of your driver’s license or passport. This is more personal data than many people have ever reported on an income tax return. But it is much worse, so read on.

Trusts, the foundation of many estate plans add incredible complexity and uncertainty as to these reporting requirements.

Why Should You Take Action Before the End of 2023?

There are three categories of actions that might be advisable to take before the end of 2023. These are discussed below. The purpose of all three categories of steps is to avoid or defer the invasive CTA reporting requirements. Read on as this is assuredly much worse, and more significant, that you probably realized.

Dissolve Unneeded Entities Before End of 2023

Consider dissolving entities you might no longer need before the end of 2023.

Example: Let’s say you have one or more entities that you created for business or real estate deals that didn’t happen. Many people keep those entities around so they don’t have to incur the cost or time delay to set up another entity. These are sometimes called “shelf-entities” because figuratively you leave them “on the shelf” in case you can use them later. Well with the CTA if you have shelf entities around you will have to have the CTA filings completed by January 1st, 2025. If you dissolve the unneeded entities before the end of 2023 you won’t ever have the CTA filings triggered. Is this really such a big deal? Maybe. If you have an entity that has even a $100 bank account or had any activity it won’t avoid filing under the CTA as an inactive entity. The bar of requirements for which entities must file is pretty low. And is it worth leaving an entity around you may not need and triggering filings that have such Draconian penalties if you commit even a foot fault on the requirements?

But it is much broader than just the shelf entity example above.

Example: You bought a fishing lodge with five college buddies. To avoid ancillary probate and to provide extra liability protection you had the cabin held in a limited liability company. That planning does make sense. But do all five of you want to file have the entity file detailed personal information with FinCEN and face the risk that if one of your friends changes his/her name or moves to a new home and forgets to inform the LLC so that an amendment can be filed you all may face penalties and potential jail time? Let’s say you hired a local real estate agent or CPA to be the “manager” of the LLC to provide a local address for bills, and to pay insurance, etc. That person would also have to be included in the filing. Now, what had been solid and standard advice to hold such a property in an LLC has to be weighed against the hassles of CTA filing and the specter of penalties and jail time for a miss on the requirements? If you terminate the LLC before the end of 2023 no filing will be required. If you wait until 2024 and realize that you would rather terminate the LLC then file, it is probably too late. It seems that a day into 2024 you may have to report under the CTA by January 1, 2025 even for only a few days of the entity’s existing in 2024. Consider that so much remains unclear in the CTA rules, and oh gee golly the Regs are only about 312 pages of joyful reading.

Example: You have a small home based business. Standard planning has been for ever so long to set up an entity, typically for years that entity has been an LLC, to hold the business. The purpose of having an entity operate the business was to provide protection if a business claimant ever sued. That should, if all entity formalities were adhered to, limit the ability of a claimant to get to your personal assets outside the business (e.g., your home). If you are the 100% owner of the LLC, and your business is pretty substantial or risky, perhaps the CTA filing is not much of a worry as you can just file and you might not be that uncomfortable giving your home address and a copy of your driver’s license to FinCEN. Maybe. So, in that instance you might keep the LLC intact and just do your CTA filings as required. But what if the home based business is not that big? Or what if you really don’t face any material liability exposure from the nature of the business you have? Then perhaps you might weigh the decision differently and decide that you’d rather get rid of the LLC in 2023 and avoid any CTA filings. What if you have a business in an LLC and gave a key employee an option to buy equity? Or perhaps you gave a salesperson a profits interest to motivate them to work hard for the business. You might have in the LLC operating agreement a successor manager or even a co-manager to help run the business. All these people may have to report information to your LLC under the CTA that you would then have to file with FinCEN. Perhaps at some level of hassle you might weigh the decision differently and prefer to get rid of the LLC in 2023.

So, identify every entity you have and consider whether you should liquidate them before the end of 2023. Be sure to speak to your CPA to identify any income tax implications. And while you might be able to liquidate the entity online on your own at a state website, ya probably should check with an attorney to see what ancillary considerations, steps and documents might be worthwhile.

Set Up New Entities in 2023

The caption for this discussion sounds to be the exact opposite, inconsistent with, the discussion in the previous section about getting rid of entities in 2023. Yep! Welcome to CTA World! So, depending on your circumstances different options might be appropriate for you to consider. Let’s say you are planning a new business startup early next year, 2024. If you set up the entity in 2024 you have to complete your CTA filings within 90 days (it was 30 but it seems to have been extended to 90) of forming the entity. Since so many of the CTA rules remain unclear, it might make sense to form the entity before the end of 2023. If you do that you won’t have to face a CTA filing until January 1, 2025. That will give you more time to file, and more time for advisers to figure out what the rules really are. Consider, for example, that as of today the FinCEN has not even released forms or made the web page for filing available for review.

Trusts May Need to be Modified or Decanted before 2024

This is a biggie and quite complicated. But it could be really important.

Example: In 2012 you and your spouse set up spousal lifetime access trusts (“SLATs”) before the exemption was to be reduced in 2013. SLATs are one of the most common estate planning tools in use for married couples. When you set up the trusts you named different powerholders and fiduciaries in each trust to help differentiate them for the reciprocal trust doctrine.

1. You named each other as investment trustee (or investment advisor) in each trust so that you could make decisions as to the entity interests each trust holds.

2. You named a corporate institutional trustee to get situs or jurisdiction in a trust friendly state, say Delaware.

3. You each named different persons to serve as trust protector. This is a person given rights such as to change the trustees, move the situs and governing law of the trust to another state, and potentially a wide array of steps depending on your preference and that of the drafting attorney.

4. In each trust a person was given the power to loan the settlor who created the trust money from the trust. That was done to help assure that for income tax purposes the trust is characterized as a grantor trust (disregarded) and to provide another means of access to the trust.

5. Your spouse was given a right to appoint trust assets structured in a manner not to cause inclusion in her estate of the trust assets. This is called a limited power of appointment. You, however, were not given such a power in the trust your spouse created for you. This was done to make the trusts different to endeavor to avoid the so-called reciprocal trust doctrine. That tax and legal doctrine could facilitate a creditor or the IRS unraveling the two trusts if they are too similar to each other.

6. In your trust, but not that of your spouse, an individual was given the power to add charitable beneficiaries. That makes the trust more flexible, is another characteristic that would support the trust being characterized as a grantor trust for income tax purposes, and because it is in only one but not the other trust, it might help further differentiate them for purposes of the reciprocal trust doctrine.

When you set up the trusts each trust owns a different percentage interest in a vacation home located in another state. If your trust was formed in DE and your spouse’s in Nevada you had to have the vacation home located in Massachusetts held in an entity as a trust should not own real estate in another jurisdiction directly. Also, the securities and investments transferred to each trust were first placed in a family limited partnership to provide more control, valuation discounts for estate planning purposes, and management functions. Each of the ten persons above, named in each trust, will have to provide confidential information to each of the two entities which will have to report all of that information to FinCEN under the CTA. Typical of many of these trusts, none of the people other than the institutional trustee and investment trustee signed the trust document. The people you named more than a decade ago to make loans, serve as trust protectors, never signed the trust and have no recollection of your having told them so long ago that they were given these appointments. That assumes you even told them. Many people never bothered. Now, you have to track down all these people, some of whom you no longer have a relationship with, and tell them that they need to give you their home address, a copy of their driver’s license, etc. and that they will be responsible to inform the entity if they ever change their home address or name. And oh, you might add when you make that call “You can face high financial penalties and jail time if you don’t comply.” In many, perhaps most, cases these people will have no idea what you are talking about, thought (if they were even aware) that they were doing you a favor, and now they have to disclose confidential information and face significant penalties. This is going to be a real party!

So, what does all the above have to do with actions you should consider before the end of 2023? If you realize that you have lost touch with the people named in all these positions, or that they would be upset (or worse) finding out what their CTA obligations are, consider modifying the trust to change those people to someone more appropriate. Depending on the positions involved, the terms of the trust, and state law, you might find it easier, or even necessary, to decant the trust into a new trust to make these changes. Decanting is the process of the trustee creating a new trust and then pouring the existing trust into the new trust. There may be other options to discuss with your estate planning attorney such as a non-judicial modification or trust protector action. The key point is if you do not get the names of these people changed in the trust before January 1, 2024 it appears that even if you effectuate the changes in 2024 those people may have to file under the CTA as having been a “control person” over the entities involved for that stub period of time.

The above requires immediate action.

Likely most people will miss the above point entirely and as 2024 winds forward will realize the need for these people to report under the CTA. Those conversations could range from awful to antagonistic when people who though they were doing you a favor become entangled in the CTA reporting web.

Conclusion

The CTA is a massive reporting process that can be incredibly complex. The penalties and fines for failing to comply with the complex requirements are onerous. In at least the above three situations, and their may be others, it could be really beneficial for you to take action before the end of 2023. Don’t delay, find out if these points affect you and take action now.

Tags

US Corporate Transaparency Beneficial Ownership