Corporate Transparency Act Declared Unconstitutional In New Case

The Corporate Transparency Act, a burdensome new law that would require some 32 million closely held businesses to file invasive information with the Financial Crimes Enforcement Network, has just been declared unconstitutional in National Small Business United, d/b/a the National Small Business Association vs. Janet Yellen, in her official capacity as Secretary of the Treasury, 2024 Mar 1, 2024, U.S. District Court, N.D. of Alabama.

The Court concluded: “The Corporate Transparency Act is unconstitutional because it cannot be justified as an exercise of Congress’s enumerated powers.”

This case was just released, and the Government has not yet responded, so stay tuned!

What Is The CTA?

The CTA was enacted as part of the 2021 National Defense Authorization Act and became effective for newly formed entities (called “Reporting Companies”) on Jan. 1, 2024. Entities existing prior to 2024 would have had to complete their first filings by Jan. 1, 2025. The penalties for non-compliance are huge, $500/day plus potentially two years in jail. The information that has to be filed is complex and invasive and would include for each Beneficial Owner of every Reporting Company personal information such as home address, Social Security Number and a copy of a driver’s license or passport. Figuring out which entities are classified as Reporting Companies and which direct or indirect owners or persons holding substantial control over those entities is incredibly complicated.

What Does The New Case Mean To You Now?

So, this would seem to mean for now that the burdensome filings that so many people have been grappling with, and which professional advisers have been gearing up to help with, would seem to be at least on hold for now. But is that really the prudent response? Perhaps not fully, as explained below.

More important, the case may only apply to the plaintiffs. It may only provide relief to the named individual and the trade organization. It is not fully clear whether even the members of the trade group NSBA are all covered under the case. Considering the tremendous penalties for non-compliance it seems that realistically you might have two choices. The first which has been the CTA mantra discussed in prior articles, may remain true: “When in doubt file.” There seems to be little harm in filing and especially if your filing is simple there may be little or no cost.

So, if you are forming a new entity, consider filing within the required 90 days (and remember in 2025 that drops to 30 days) of formation. If you have entities formed prior to 2024 filings for them are not due until Jan. 1, 2025, so you have time to wait and see. But waiting is a mistake. Get your house in order while there is time as discussed below. The second option is to hire an attorney to parse through the opinion and give you specific guidance. But if you take that route you may not get certainty and likely the entire matter will continue to evolve.

If you have a contract in process or paid a service company or professional adviser money to evaluate CTA issues for you, perhaps you should put that on hold and request a refund of any payment. If you signed a contract, what does the contract provide regarding cancellation? But before reacting, you might consider waiting to see what the government will do. Also, consider the comments below as to how the CTA may be revised to perhaps pass a Constitutional challenge.

Some Questions

The Court found that the CTA doesn’t regulate the channels and instrumentalities of commerce or prevent their use for a specific purpose. That is why the court found that the CTA was invalid. Is that the correct conclusion? Might there be a different interpretation?

It would seem that FinCEN will appeal. Might an Appeals Court overturn the current decision? What will happen to the CTA in the interim while all that plays out?

Will the decision be limited to only the NSBA, i.e., the plaintiff in the lawsuit, or will it apply more broadly?

What Might The Government Do?

One line in the court’s opinion particularly stands out: “These cases also illustrate how easily Congress could have written the CTA to pass constitutional muster.” Is the Court perhaps suggesting that Congress merely revise some of the CTA to pass Constitutional muster under the analysis of the case? Before every does a happy dance and burns their CTA notes and files, consider this possibility. We may find out soon. The Court even gives Congress a suggestion for revision in stating that nothing would bar Congress from imposing the CTA’s disclosure requirements on State entities as soon as they engaged in commerce. Near the end of its opinion, the Court stated: “…maybe Congress’ omission of a jurisdictional hook from the CTA was just inartful drafting.” Perhaps that is what needs to be corrected.

The case just came out, so no reaction or announcements have yet been made by the FinCEN of the Treasury Department regarding what action it will take. With FinCEN’s massive undertaking to develop a complex website to gather filings, the issuance of extensive guidance on filings, and so much more, the CTA concept will not disappear. Further, the US is behind most other developed countries in terms of gathering information on entities that may be used in criminal activity, the support of terrorism, and other nefarious efforts. It just seems unlikely that the US government will walk away from these efforts.

Remember that the CTA was bipartisan, so a revision to pass constitutional muster might even be feasible in a divided Washington.

So, it may be that the CTA will have to be re-tooled to survive. If that is the case, then shouldn’t everyone affected just hit the pause button until we know more? That generally seems like a reasonable course of action, but there is a bit more to consider. The key point is to consider the advisable approach when planning to comply with the CTA. Before the NSBA case, the recommended perspective was to take a broad holistic approach to preparing. Those steps, regardless of the current status of the CTA, still make sense for many people.

A Quiz: Do You Need A Broad Holistic Approach To Your Entities And Trusts?

Answer the following questions:

When is the last time you updated governing documents for your entity (or entities)? That would mean revising a shareholders’ agreement for a corporation, partnership agreement for a partnership or an operating agreement for a limited liability company.

When is the last time you had minutes or a unanimous consent prepared and signed for your entity?

Do you know who the directors and officers are of your corporation? Do you know if you have managers, directors or officers in your LLC?

Have you created any irrevocable trusts that might own entities? Whatever the answer, was that a conscious decision that you explain in simpler terms today?

If you have an irrevocable trust (or trusts), do you know all the people named in the trust? Does each person named in your trust know that they have been named and what their role is?

If you’re like the vast majority of people who have set up entities and trusts, you may not have looked at the key legal documents in many years. In fact, many people have no idea where those documents even are.

That folks is why you need to consider a broad holistic approach to your entities and whether or not the CTA is on temporary hold pending revision, or whether the CTA has actually been permanently retired, you should follow up on your entities and trusts and get your legal house in order. The discussions below explain some of these steps and do so in a manner that reflects the options from the CTA: a temporary pause, a permanent retirement, or a revised version of the current law.

Review Entity Arrangements Now

Review all legal documents you do (or worse, may not) have for each entity. Independent of the CTA, you should be certain that you have the key legal documents in place, that they are current, and that you periodically create new documentation (e.g., minutes, consents) demonstrating your respect for and adherence to the formalities of the entity. Most entities were created for asset protection (to protect your home and other personal assets from a claim related to the entity’s activities and/or assets) and/or for tax planning reasons. If you don’t respect the formalities of the entity, the creditors and the IRS won’t do so either. That should all still be done.

When the CTA came on the scene, you had to review these documents to determine who may be Beneficial Owners, indirect owners, or substantial control persons. Can those people obtain FinCEN Identification Numbers to avoid having to file amendments when their Beneficial Owner Information changes? Can or should steps be taken to change those who might be Beneficial Owners? With the CTA on hold you might defer these issues, but if you have to update your entity documents anyhow it might be little extra work to consider these CTA points just in case the law is revised and reinstated. If you choose to defer these points, that is fine, but don’t defer getting your entity’s legal documents in order.

Review Trusts Now

Most trusts are created, just like entities, to protect assets and save income or estate taxes. Also, similar to the consequences to entities, if you and others involved (the trustee and other fiduciaries and persons involved) do not respect the formalities of a trust (e.g., adhering to the terms of the trust agreement that creates the trust), then the IRS and creditors may not be required to respect your trust either. Consider who are the people named in the trust and whether any changes are possible or warranted. Is the trust efficient from a state and federal income tax perspective? If not, it may be feasible to modify the trust document or move the trust to a different state. Are all assets the trusts owned properly documented as being owned by the trust? Is any insurance covering those trusts arranged properly? If not, protection might be lost. These are issues that should have been reviewed when you reviewed your trusts for possible CTA issues. But all these points, each independent of the CTA, are still worth investigating and fixing if warranted and possible.

If you have entities that may be Reporting Companies owned in whole or part by irrevocable trusts, review those trusts now. You should consider whether the people in that trust who might be characterized as Beneficial Owners (including “substantial control persons”) under FinCEN will cooperate in providing the Beneficial Owner Information to the Reporting Company. If not, evaluate removing or replacing them before the Reporting Company files its first FinCEN report. Anyone who might not have cooperated in your trusts to address the CTA is probably not someone you still want listed in your trust, even if the CTA has been deferred or eliminated.

Well, It’s Baaaaack

The movie “Poltergeist II” had this key haunting phrase and if you think the CTA is gone you might find yourself reminiscing about the evil spirits of the CTA. While you might hit the pause button and not file until it is clear what the status of the law will be, clean up your records. Reconsider who should be named in various positions in your entities and trusts. And when revising documents do so with the thought that the CTA may survive this court challenge so that you don’t have to revise them if it does.

For example, one approach to minimize the burden on reporting entities with the CTA is to require all Beneficial Owners to obtain a FinCEN Identifier Number and give it to the Reporting Company. Requiring this in entity and trust documents can make compliance much easier and prevent Reporting Companies from being subjected to unreasonable requirements to update reports with FinCEN if, for example, a Beneficial Owner changes their home address. So, when amending documents to address this, merely provide that “If the CTA is applicable, then each Beneficial Owner shall provide the Reporting Company with a FinCEN Identifier Number.” In that way, whatever the eventual outcome of the CTAs constitutionality you won’t have to modify your documents again.

Review Of The Case

The Court said: “Congress sometimes enacts smart laws that violate the Constitution. This case, which concerns the constitutionality of the Corporate Transparency Act, illustrates that principle.” The mere fact that the CTA provides an important result did not support the Court’s finding it legitimate. More is required.

FinCEN argued that the CTA was constitutional based on the CTA falling within the ambit of the Commerce, Taxing, and Necessary and Proper Clauses, along with Congress’ foreign affairs and national security powers. The Constitution limits the government to those powers specifically granted or those that are necessary and proper to carry out the specifically granted ones. The Court concluded that the CTA is not authorized by the Constitution. The Court found that the CTA exceeds the Constitution’s limits on the legislative branch under Article I of the Constitution, and the CTA violates the First, Fourth, Fifth, Ninth, and Tenth Amendments. The CTA “lacks a sufficient nexus to any enumerated power to be a necessary or proper means of achieving Congress’ policy goals.”

CTA Penalties

The Court noted that the penalties for not complying with the CTA are consequential: punishable by a $500 per day civil penalty and up to $10,000 in fines and two years in federal prison. Those penalties, and especially how they can be applied, are nothing less than offensive, unfair, and outrageous. Those should be changed if Congress has to revisit the CTA to revise it to pass muster under the analysis of this case. There should at minimum be a good faith exception so that innocent small business owners who were unaware of the CTA or inadvertently did not comply precisely, are not harmed to such an extent.

Necessary And Proper Clause

The Court found that the Necessary and Proper Clause of the Constitution did not support the CTA because the foreign affairs powers of Congress do not extend to purely internal affairs, especially in an arena traditionally left to the States, namely entity formation.

The CTA’s civil penalties are not a tax, so the CTA cannot be made constitutional based on the government’s taxing powers.

The relationship between disclosure provisions and the taxing power is well recognized. However, the Court found that providing access to the CTA’s database for tax administration purposes is insufficient to establish a sufficiently close relationship to justify the CTA. Perhaps part of the “fix” would be for Congress to make the CTA filings a simple tax return appendage to entity tax returns to be filed by CPAs as part of the tax return preparation process. That would make a world of sense and could eliminate much of the cost and confusion the CTA created.

Commerce Clause

The Court next examined the validity of the CTA under the Commerce Clause and the Necessary and Proper Clause. It noted that the Constitution gives Congress the “Power . . . To regulate Commerce with foreign Nations and among the several States.” Under that power the Congress may regulate: (1) the channels of interstate and foreign commerce, (2) the instrumentalities of, and things and persons in, interstate and foreign commerce, and (3) activities that have a substantial effect on interstate and foreign commerce. The government’s argument was that entities constituting CTA reporting companies frequently utilize the channels of interstate commerce. These include the use of highways, railroads, navigable waters, and airspace, as well as telecommunications networks. It is hard to imagine any business entity of any size does not using telecommunications networks daily. But the Court observed that the word “commerce,” or references to any channel or instrumentality of commerce, are nowhere to be found in the CTA. The Court also noted in differentiating the CTA from a prior case that Congress cannot regulate an entire class (e.g., all entities under the CTA) whenever some sub-class engages in commerce. The Court reasoned that the Commerce Clause permits Congress to regulate interstate commerce to the extent of using such commerce, but no further. Might another Court view this differently? Might a simple amendment of the CTA resolve this constitutional issue?

The Court stated that Congress does not have authority under the Commerce Clause to regulate non-commercial, intrastate activity merely because certain entities, which have availed themselves of states’ incorporation laws, use the channels of commerce, and their anonymous operations substantially affect interstate and foreign commerce. The act of incorporation is not enough to invoke the Commerce power and the CTA does not regulate the economic activities, or require entities to engage in those activities to be regulated.

Conclusion

The CTA is a burdensome and invasive reporting requirement that subjects those failing to file to substantial penalties. This new case has found that the CTA was not Constitutional. With the substantial commitment the government has made to the CTA, and based on several provisions in the case discussed above, the government may both appeal and perhaps modify the law. It would be better for all involved, and much fairer, if the revisions turned the CTA into a simpler form to file as part of entity tax returns, and provide a good faith exception to the penalties. Anyone subject to the CTA should monitor developments to know what to do.