Corporate Transparency Act Update: Where are we now?

The Corporate Transparency Act (CTA) drew plenty of controversy before it passed and as it was enacted, so it should be no surprise that the debate continues even now that it’s in effect.

The CTA requires most entities incorporated under state law to disclose personal stakeholder information to the Treasury Department’s Financial Crimes Enforcement Network (FinCEN). The intent is to promote ownership transparency and reduce fraud. Companies want to make sure they get it right because the fines for non-compliance could run $500 a day.

Companies formed in 2024 are supposed to be complying now, providing extensive personal details about their owners. Older companies have until next year to do the reporting. However, several lawsuits have raised concerns leaving companies uncertain about what they should do. In this article, we’ll take a look at those lawsuits and their implications.

The top line is that nothing has change for the newly formed companies required to start reporting. Companies that existed prior to this year have the option of taking a wait-and-see approach considering that they don’t have to start sending information until next year.

Attempting to Reduce Fraud

Effective as of January 1, 2024, the CTA aims to combat financial crimes such as money laundering and tax evasion facilitated through shell corporations by requiring numerous entities including previously unregulated companies and smaller entities than had previously been subject to regulation (collectively, all “reporting companies”) to provide more information about their owners. FinCEN estimates that there will be 32.6 million reporting entities in 2024 and another 5 million created per year over the following decade.

 A Legal Challenge 

On March 1, 2024, in the case of National Small Business United v. Yellen, No. 5:22-cv-01448 (N.D. Ala.), a federal district court in the Northern District of Alabama entered a final declaratory judgment concluding the CTA exceeds the Constitution’s limits on Congress’s power. The plaintiffs had challenged the constitutionality of the CTA, arguing it exceeded Congress’s authority under Article I of the Constitution and violated multiple constitutional amendments. The court analyzed Congress’ authority to enact the CTA under (1) Congress’ powers over foreign affairs and national security; (2) the Commerce Clause; and (3) Congress’ taxing power, via the Necessary and Proper Clause before holding that none of these constitutional provisions justified Congress’ enactment of the CTA.

 On March 4, 2024, FinCEN released a notice acknowledging the National Small Business decision and stating that, “[a]s a result [of that decision], the government is not currently enforcing the Corporate Transparency Act against the plaintiffs in that action,” an exemption limited by the government to the individual named plaintiff, companies for which that individual is the beneficial owner or applicant, the National Small Business Association, and the members of that Association. The government explained that it would continue to require all covered entities not named as plaintiffs in the case to report their beneficial ownership information under the statute, effectively only granting relief to reporting companies who were members of the National Small Business Association as of March 1, 2024.

On March 11, 2024, the Department of Justice, on behalf of the Department of the Treasury, appealed the decision. The move was widely anticipated and should result in the case being heard by the Court of Appeals for the Eleventh Circuit prior to the end of the year.

 Analysis of Constitutional Issues and Decision:

The National Small Business United v. Yellen court examined the government’s contention that the CTA was a legitimate exercise of Congress’s power under the Commerce Clause and the Necessary and Proper Clause, which authorizes Congress to regulate activities that substantially affect interstate commerce. The government argued that the entities regulated by the CTA engage in or affect commerce, thus falling within this jurisdiction. However, the court highlighted a critical distinction: “Because the CTA doesn’t regulate the channels and instrumentalities of commerce or prevent their use for a specific purpose, it cannot be justified as a valid regulation of those channels and instrumentalities”. The court concluded that the act of incorporation itself, which the CTA regulates, does not constitute an economic activity that substantially affects interstate commerce, rendering the CTA’s reach too expansive under the Commerce Clause. Further, in connection to the Necessary and Property Clause, the court concluded that the CTA was not an essential part of a larger regulation of economic activity in which the regulatory scheme could be undercut unless the intrastate activity was regulated. Thus, failing to satisfy the burden necessary for protection under the Necessary and Proper Clause.

The government also argued that the CTA falls within Congress’s powers to regulate foreign affairs and national security, suggesting that the CTA is necessary to combat money laundering and terrorism financing, thereby protecting national interests. However, the court was not persuaded by this argument, concluding that Congress’ foreign affairs powers do not provide the requisite authorization for CTA’s attempted regulation of what are purely internal affairs particularly in an “arena traditionally left to the States”. The court underscored the principle that the regulation of corporate formation, a predominantly state-governed internal affair, does not extend to Congress’s foreign affairs powers.

Court’s Decision:

Ultimately, the court ruled that the CTA exceeded the constitutional bounds of Congress’s legislative power, lacking a sufficient nexus to any enumerated power to justify its provisions as necessary or proper means of achieving Congress’s policy goals. The opinion states, “The Government’s arguments are not supported by precedent. Because the CTA exceeds the Constitution’s limits on the legislative branch and lacks a sufficient nexus to any enumerated power to be a necessary or proper means of achieving Congress’ policy goals, the Plaintiffs are entitled to judgment as a matter of law”.

This ruling highlights the delicate balance between the need for legislative measures to combat financial crimes and the constitutional constraints on federal legislative authority. It underscores the court’s role in ensuring that the reach of Congressional power, even when aimed at laudable goals, does not extend beyond the limits set forth by the Constitution. The memorandum opinion serves as a detailed exploration of these constitutional boundaries and sets a significant precedent for the scope of federal regulation over corporate entities.

Additional Challenges to the CTA:

Ohio

On December 29, 2023, Robert Gargasz (a licensed attorney and his legal professional association) filed Gargasz v. Yellen, No. 23-cv-02468 (N.D. Ohio), in which the complaint seeks for a nationwide injunction against the enforcement of the Beneficial Ownership Information (BOI) Reporting Rule.

Maine

On March 15, 2024, William Boyle (a 90% owner of several Maine limited liability companies) in Boyle v. Yellen, No. 2:24-cv-00081 (Maine) filed a complaint in the United States District Court for the District of Maine arguing that the CTA is an “unconstitutional usurpation of the states’ power to regulate entity formations.”

Michigan

On March 26, 2024, another challenge was filed in Small Business Association of Michigan v. Yellen, No. 1:24-cv-00314 (W.D. Michigan) where the Small Business Association of Michigan (“SBA”) as well as several other parties filed suit asking the U.S. District Court for the Western District of Michigan to declare the CTA unconstitutional and to grant preliminary and permanent injunctive relief against its enforcement on the plaintiffs. The SBA argues that the CTA: (A) exceeds Congress’s enumerated constitutional powers since corporate formation is not a commercial act, (B) violates the Fourth Amendment and (C) is void for vagueness under the Fifth Amendment.

So Where are We Now?

Business groups are working together to encourage Congress to adopt a one-year delay in the filing deadline to give the courts time to fully consider the challenge and give the business community additional time to educate covered entities as to their reporting obligations under the new law.

Only limited relief has been granted by the courts and that has been limited to the plaintiffs in specific matters. The majority of reporting companies are still required to be in compliance with FinCEN’s reporting requirements.

• Reporting companies formed on or after January 1, 2024, are required to file their respective BOI Report(s) with FinCEN within 90 days after each entity’s formation. At this time, regardless of the uncertainty, all such companies formed on or after January 1, 2024 must still file in a timely manner in accordance with the CTA.
• With that said, reporting companies formed prior to January 1, 2024, are not required to file until January 1, 2025. Given the uncertainty surrounding CTA regulation, such companies formed prior to January 1, 2024, need not rush to submit filings to FinCEN.