The Corporate Transparency Act, which went into effect in January 2024, imposes on entities created or registered in the United States by the filing of a document with the secretary of state (or similar office), a duty to report their beneficial owners to the Financial Crimes Enforcement Network (FinCEN). The Act defines a beneficial owner as an individual who either (i) exercises substantial control over a reporting company, directly or indirectly, or (ii) owns or controls at least 25% of a reporting company’s ownership interests.
Ownership Test
Determining beneficial ownership in simple entities is straightforward. However, complex legal structures may require more extensive analysis. This is because interests in reporting companies are often held through various intermediary entities forming pyramidal holding structures. The beneficial ownership of interests held by the intermediary entity must be attributed to the natural persons who ultimately own these interests at the time of filing. Thus, the reporting company must identify individuals who control the intermediary entity or whose ownership share of the intermediary entity is large enough to represent a 25% or more interest in the reporting entity. In multi-level ownership structures, this analysis must be repeated for each intermediary entity until all interests are attributed to individuals.
Each type of ownership, whether direct or indirect, must be accounted for on a fully diluted basis. For example, stock options or convertible securities must be treated as exercised, regardless of their vesting status. Companies that issue capital or profit interests, such as partnerships and LLCs treated as partnerships for federal income tax purposes, need to look at the total interest (whether capital and/or profit) held by an individual, calculated as a percentage of the total outstanding capital and profit interests of the entity. Corporations or entities treated as corporations for federal income tax purposes will consider either (i) the total combined voting power of all classes of ownership interests of the individual as a percentage of the total outstanding voting power of all classes of ownership interests entitled to vote, or (ii) the total combined value of the ownership interests of the individual as a percentage of the total outstanding value of all classes of ownership interests.
Interests held by a nominee, intermediary, custodian, or agent must be attributed to the beneficial owner on whose behalf such interests are held. In the case of a minor child, a parent or legal guardian should be identified as a beneficial owner. In the case of trusts, the ultimate beneficial owner could be the trustee (if they can dispose of trust assets), the grantor or settlor (if they can revoke the trust or withdraw assets), or the beneficiary (if they are the sole recipient of income and principal or can demand substantial asset distribution). In addition to minor children, nominees, intermediaries, custodians, or agents, beneficial owners do not include creditors, individuals who hold only a future interest in the entity through a right of inheritance, and employees who are not senior officers and whose substantial control over or economic benefits from the reporting company are derived solely from their employment status.
Substantial Control Test
Beneficial ownership can also be based on substantial control over the reporting company. An individual may be deemed to have substantial control if they:
• Serve as a senior officer (excluding ministerial officers like secretary or treasurer, unless the treasurer, in fact, acts as a chief financial officer with authority to manage financial or accounting matters of the reporting company);
• Have authority over appointing/removing senior officers or a majority of the board;
• Direct or influence significant decisions (including those relating to the reporting company’s business, legal structure, and finances) made by the reporting company; or
• Have any other substantial control over the company, whether direct or indirect, for example, through ownership or control of one or more intermediary entities such as investor entities described above.
Determining substantial control may require analyzing the reporting company’s organizational documents, such as incorporation certificates, bylaws, operating or partnership agreements. Other contracts that affect decision-making authority, such as employment agreements for senior officers, should also be subject to review. In some cases, individual investors may control the election or removal of the reporting company’s directors or officers via a side agreement. They may also have veto power or approval rights over major transactions such as reorganization, merger, or dissolution of the reporting entity or its business operations. As in the case of beneficial ownership, the determination of substantial control should focus on the actual powers of an individual rather than their formal title.
Due to difficulty in determining ownership or control in more complicated holding structures, some reporting entities may err on the side of over-reporting. While this approach makes sense in light of high penalties for failure to report, the reporting entities should be mindful of their continuing obligations to report changes to the submitted information within 30 days of the change. To avoid the possibility of future non-compliance, the reporting entities should develop strategies and procedures for prompt communication of any changes in the reported information by individual owners.
