Tax Notes published a good summary of the state of play regarding the Corporate Transparency Act in last week’s edition, including highlighting the multiple lawsuits filed against the law and the several bills introduced to either delay or repeal the onerous new reporting regime. That said, a couple of items in the article caught our eye that are worth clarifying.
Compliance Costs
The article notes:
According to FinCEN estimates, businesses with simple beneficial ownership structures will spend about 90 minutes on average to fill out their paperwork and about 40 minutes to update it. Companies with more complex ownership structures could spend about 650 minutes (just under 11 hours) to complete their initial filing and about 170 minutes (just under three hours) to update it.
This statistic recalls the old Hindu fable about the boy who drowned in a creek that “averaged” 6 inches deep. Yes, for single member LLCs with few employees, CTA compliance will be relatively simple, at the start. For more complicated businesses, however, compliance presents a very serious challenge, including:
Whose Information? The sales brochure claims the CTA will shine a bright light on shell companies by having them report the personal information their real beneficial owners (BOI) – the man behind the man, so to speak. But the CTA lost the beat somewhere along the line and defines “beneficial owner” to include anybody who makes any tactical or strategic business decisions – owners, executives, managers, consultants.
Take Sara who owns five hamburger franchises. At a minimum, she will need to report BOI for herself, her accountant, and the five people she has managing each of her locations. That much seems clear. But what about assistant managers? Are they covered? The CTA doesn’t allow for willful decisions not to report somebody, so Sara will have to err on the side of caution. Otherwise, it’s a felony. To work through all this, Sara will need to hire counsel and get advice on whose information is reported. She will also need to track down accurate information for each covered individual, including photocopies of their drivers’ licenses or passports. All those costs are a little deeper than just six inches, no?
Updated Reports: Another cost FinCEN glosses over is the difficult and ongoing task of keeping all this updated. Again, Sara’s small franchise operation will need to report the BOI of at least 12 people. Starting next year, any change in their status or information must be updated within 30 days, meaning something as mundane as a new passport number or home address will trigger a new reporting obligation. As only Sara and her accountant know whose information needs to be reported, she will have to stay on top of this through reminders and regular meetings. If a manager quits and she promotes somebody else, she has to file an update. Same if she hires a new accountant or buys another franchise. It’s not hard to imagine a simple operation like Sara’s requiring a dozen or more updates a year. All this takes time and attention, not to mention money. It also presents the legal risk that something will fall through the cracks and Sara will be out of compliance.
Entity Versus Business: The CTA is enforced at the entity level, including the thresholds for employees and revenues. Sara’s hamburger business collectively employs more than 20 people and collects more than $5 million a year in revenues, so she should qualify for the large company exemption. But the CTA’s revenue and employment tests are applied to each legal entity, not the consolidated business. Each of Sara’s franchise locations is a separate LLC – they are required to be by the franchiser – so Sara has five different entities to report.
This disconnect between the size of the business and how they are organized means some large businesses, with billions in revenues and thousands of employees, will be required to file under the CTA. For them, the compliance burden will be measured not in hours but in FTEs. They will literally need to hire somebody just to handle CTA compliance.
Taxing Authority
The second item raised by the Tax Notes piece is whether the CTA is justified under Congress’ taxing authority. Here, Tax Notes cites the NY University’s Tax Law Center and the arguments included in their amicus brief, including this one:
This [taxing authority] can be effective only if the IRS can identify who is responsible for paying tax on particular income (which, for business income, is often the individual owners, at their individual rates, rather than the entity itself). Tax evaders erect entities between themselves and their income for this very reason: to hide their tracks and thwart the law. The CTA counteracts this method of tax evasion. It gives the IRS the data it needs to assess and collect taxes at the correct rates and amounts, and from the correct taxpayer. It is constitutional.
Lots wrong here. First, the IRS already compels taxpayers to report who owns what as part of the process of collecting taxes. Second, as noted above, the CTA doesn’t limit its reporting to actual owners, so the information provided to FinCEN is unlikely to help the IRS narrow down who is supposed to pay taxes and by how much. Third, the collection of data is not the same as the collection of taxes. As the National Taxpayer Union makes clear in their amicus brief supporting the plaintiffs:
It is a bedrock principle that “Congress’s authority under the taxing power is limited to requiring an individual to pay money into the Federal Treasury, no more.” But mere data collection is not actually bringing in money to the federal fisc, and there is already an extensive system for the gathering of financial data for the purposes of collecting taxes: all of Title 26 of the United States Code. The District Court was therefore correct in holding that Congress could not “bring its taxing power to bear just by collecting ‘useful’ data and allowing tax enforcement officials access to that data.”
Finally, the CTA’s stated purpose is to help with the enforcement of money laundering laws. As such, many of the entities required to file under the CTA – homeowners associations, chapters of Alcoholics Anonymous, etc. – don’t pay taxes. It’s a bit of a stretch to suggest their information is being collected as part of some broad taxing authority.
That argument is further weakened by the fact that CTA amends the Bank Secrecy Act, not the Internal Revenue Code. The bill was referred to the congressional banking committees, not the tax writing committees. In fact, the IRS was given access to the CTA database only in the conference report, at the last minute, and after CTA bill had already passed the Senate.
Conclusion
Bottom line: It’s comical to suggest that a data collection program enacted to help with enforcement of our banking laws is really a taxing exercise designed to help the IRS. It is also a disservice for FinCEN to ignore the very real costs the CTA will impose on covered businesses.
The closer we get to this year’s reporting deadline, the more negative attention the CTA will garner. Millions of small business owners are going to be surprised and angry when they learn of these new reporting requirements. Congress needs to act now to delay the CTA implementation and give the courts time to review the new law, as well as time for covered small business owners to learn of their new reporting responsibilities. It’s the only reasonable thing to do, but as evidenced by the NTU submission, the CTA isn’t an exercise in being reasonable.