The US government has focused significant efforts to combat the problems associated with tracking the financial resources used to fund terrorism or other illegal activities and the use of complicated corporate structures to facilitate tax fraud and money-laundering.
While these are important issues, laws and regulatory schemes put in place to address these issues can place burdens on legitimate businesses. A good example of this is the adoption of the Corporate Transparency Act (“CTA”), a law that creates new reporting requirements on US business entities, including your dealerships. This article will give you the background on the key requirements of the CTA as well as some practical tips to comply.
Reporting Requirements
The basic premise of the CTA is simple enough. Each business entity that is formed by filing with a state (e.g., corporation, limited partnership or LLC) must report basic information to the Department of Treasury’s Financial Crimes Enforcement Network (“FINCEN”). This information includes name, d/b/a, state of organization and EIN. While this sounds easy, the CTA goes one step further and also requires each entity to report information on its “Beneficial Owners”, including name, date of birth, home address, unique identification document number and a photocopy of the document (e.g., driver’s license or passport). Very few states require any reporting on owners of entities so this type of reporting represents a new level of detail and is more akin to the type of information you may have to provide to your bank under their “know your customer” rules.
Who are Beneficial Owners?
Before you can report information on your “Beneficial Owners”, you need to first determine who qualifies. Unfortunately, the definition is pretty broad and making this determination may not always be straightforward, especially with larger organizations. The CTA defines a “Beneficial Owner” as any individual who “directly or indirectly” either “(i) exercises substantial control over the entity; or (ii) owns or controls not less than 25% of the ownership interests of the entity”. “Substantial control” has been further defined to include any “senior officers” such as a CEO or COO, but this title is broad enough that it might also pick up a store manager in a single-store dealership. It is also possible that members of the Board of Directors might be covered. Finally, even the 25% ownership rule is not black and white since a person might be found to have “control” over ownership interests that are in a trust or that are voted through a voting agreement. The bottom line is that making a determination of who constitutes a “Beneficial Owner” will be fact-specific and may require consultation with your legal counsel.
When do Dealers Have to Report this Information?
If you have formed a new entity since January 1, 2024, you have already likely run into the CTA since the required information has to be reported within 90 days after the entity is formed. However, preexisting entities have until January 1, 2025 to file their initial report. The chart below lays out the timing requirement:
| Date of Formation | Reporting Deadline |
|
Before 1/1/2024 |
January 1, 2025 |
|
1/1/2024 – 12/31/2024 |
90 days |
|
After 1/1/2025 |
30 days |
In addition to the initial report, the CTA also require entities to report any changes to the initial information within 30 days of the change of information. It is this ongoing reporting obligation (and the need to also track changes with your “Beneficial Owners”) that will create the most challenges with the CTA. Please note that the willful failure to timely report information can also come with significant potential penalties, including a $500 daily fine for each entity, a fine of $10,000 and the potential for a prison sentence of up to 2 years.
Are there any Exemptions Available?
Some types of entities are exempt from the CTA. Of these exemptions, the one that may apply to equipment dealers is called the “Large Operating Company” exemption. To qualify for this exemption, the entity must have more than 20 employees on a full-time basis in the US, a location in the US and reported over $5,000,000 in gross sales on its US federal income tax return for the prior year. Since the financial test is based on revenue and not income, the good news is that we expect many dealerships to be able to qualify for this exemption for their operating entity. However, please note that there are a number of common situations that will still require some dealer entities to comply with the CTA despite this exemption:
Holding Companies
Many dealer organizations have established a holding company that owns the dealership operating company and perhaps other subsidiaries. Although revenues can be consolidated between affiliated entities to reach $5,000,000, entities cannot be consolidaed for purposes of calculating the number of employees. As a result, if you have a holding company structure but the holding company does not have over 20 employees, the CTA will still apply to your holding company (and its owners) even if the operating company is exempt.
Real Estate Companies
Many dealer organizations also own real estate in a separate entity. Since these entities normally do not have employees, it is also likely that these entities will be subject to compliance with the CTA.
Subsidiaries
One piece of good news is that if you have an operating company that qualifies for the Large Operating Company exemption, then all wholly-owned subsidiaries of that entity are also exempt through the “Subsidiary” exemption. Note, to qualify for this exemption, the subsidiary must be wholly (100%) owned by one or more exempt entities. If any non-exempt individual or entity owns an interest in the subsidiary, the entity will not qualify for the subsidiary exemption.
Practical Tips
We have two primary recommendations to help reduce risk to the dealerships with entities that are subject to the CTA. The first recommendation is to require each “Beneficial Owner” to register individually with FinCEN to obtain a personal FinCEN ID number. The process is relatively quick (10-15 minutes) and the benefit of this approach is that it eliminates the need for that individual to have to provide personal information to the dealership and the dealership can simply report the FinCEN ID number as part of its filing, which can help accelerate the ability to form a new entity. The other benefit of this approach is that the burden of reporting changes relating to the individual Beneficial Owners (and related penalties) falls on the individual. Beneficial Owners can obtain a FinCEN ID number by taking the following steps:
- Visit https://fincenid.fincen.gov/landing
- Sign-up for an account with Login.gov and then proceed to obtain a FinCEN ID following the instructions in the attached PDF.
- Each individual will need to provide current name, DOB, current residential address (generally, Company Applicants ONLY can use a business address), and a scan of a non-expired government issued ID document to submit through the FinCEN portal.
The second recommendation is that each entity subject to reporting adopt language as part of its corporate documents (e.g., bylaws or operating agreement) to include language obligating the owners and the company to file the appropriate updates with FinCEN. While this language can help provide protection to the dealership for the failure of a Beneficial Owner to timely report, the main benefit of this is to try to keep the obligation top of mind to limit chances that a Beneficial Owner will forget about the obligations. Along with this language, we also think it would be a good idea for the dealership entity to adopt a quarterly survey/certification that Beneficial Owners are required to complete to help identify potential issues and allow for an updated report to be filed as soon as possible. While this does not represent a “safe harbor” for avoiding liability, such a policy, if followed, should be helpful in establishing that any violation was not “willful” and therefore avoid fines.
Current Status of the Corporate Transparency Act
The CTA has been the subject of multiple legal challenges since it took effect this year. In March, the Northern District of Alabama sided with the National Small Business Association (“NSBA”), ruling that the CTA is unconstitutional as exceeding Congress’ enumerated powers. The court did not reach the other constitutional claims and the case is currently awaiting appeal in the 11th Circuit.
Importantly, while FinCEN announced it will honor the court’s ruling during the appeal process, the decision is limited to members of the NSBA at the time of the decision. Thus, any individuals or entities that were not members of the NSBA when the ruling was made remain subject to the CTA.
On the legislative front, members of both houses of Congress have introduced legislation to repeal the CTA (H.R. 8147, S. 4297). Both bills have been referred to Congressional committees for further review.
Until the courts reach a final determination on the constitutionality of the CTA, or Congress approves legislation repealing the CTA, the reporting requirements still apply. Accordingly, while there is general uncertainty surrounding the validity of the CTA, dealers should continue to take appropriate measures to comply with the law’s requirements.
Conclusion
With the upcoming deadline of January 1, 2025 for preexisting entities, it is important for dealers to begin the process of assessing whether they will be required to file reports with FinCEN and, if so, the Beneficial Owners that will also be required to report. We encourage you to contact your legal counsel to assist in this assessment and to help with any applicable policy language to assist with future compliance. In addition, please be aware that many professional firms are electing to NOT form entities for clients because the attorney or accountant forming the entity can also be personally liable if the correct information is not provided at the time the entity is formed. For those professional firms that are forming entities, including our firm, you should expect that those firms will require that you have provided all information needed to make the filings with FinCEN before the entity is formed as a way to reduce liability. The consequence of this is that you may not be able to form entities as quickly as before and therefore need to plan accordingly. This article is intended to provide general recommendations and is not intended to be legal advice. You should always consult your attorney for advice unique to you and your business.
LANCE FORMWALT is the leader of the Equipment Dealer Group at Seigfreid Bingham, P.C. The firm serves as legal counsel to the North American Equipment Dealers Association and many individual equipment dealers. Lance may be contacted at lancef@sb-kc.com or 816-265-4106. Also see www.sb-kc.com. This article is intended to provide general recommendations and is not intended to be legal advice. You should always consult your attorney for advice unique to you and your business.
