Proposed FinCEN Regulations on Disclosure of Beneficial Interests

Take-Away: On December 8, 2021, FinCEN published 114 pages of proposed Regulations to require certain entities, but not irrevocable trusts (so far), to file reports with FinCEN that identify two categories of individuals: (i) beneficial owners of an entity; and (ii) individuals who have filed the application with specified governmental authorities to form the entity or to register the entity to do business. These disclosure rules, if finalized, would apply to many partnerships and LLCs that are used in estate planning since those entities must be registered with the state. They may indirectly apply to irrevocable trusts that hold an interest in a reporting entity. Comments with regard to these proposed Regulations will be accepted by FinCEN until February 28, 2022.

Background: The Corporate Transparency Act [part of the National Defense Authorization Act for Fiscal Year 2021] (the Act) describes who must file a report, what information must be provided, and when that report is due. Requiring entities to submit beneficial ownership and entity applicant information to FinCEN is intended to help prevent and combat money laundering, terrorist financing, tax fraud and other illicit activities. The Background to these proposed Regulations states:

“Legal entities such as corporations, limited liability companies, partnerships, and trusts play an essential and legitimate role in the U.S. and global economies. They are used to engage in lawful business activity, raise capital, limit personal liability, generate investments, can be engines for innovation and economic growth among other activities. They can also be used to engage in illicit activity and launder its proceeds and enable those who threaten U.S. national security to access and transact in the U.S. economy. Because of the ease of setting up legal entities and the minimal amount of information required to do so in most U.S. states, combined with the investment opportunities the United States presents, the United States continues to be a popular jurisdiction for legal entity formation. The number of legal entities currently operating in the United States is difficult to estimate with certainty, but Congress found that more than two million corporations and limited liability companies are being formed under the laws of the states each year….The number of legal entities already in existence in the United States that may need to report information on themselves, their beneficial owners, and their formation or registration agents pursuant to the Act is very likely in the tens of millions.”

Impact on Estate Planning: As a practical matter, irrevocable estate planning trusts are exempt from these reporting requirements as such trusts do not file or register with the state upon their formation, nor are they required to annually register the trust with the sate. However, a trust could own or control a domestic reporting company, for which there are reporting obligations. The proposed Regulations provide that if an ownership interest is held by an exempt entity, e.g. an irrevocable trust that is not registered with the state, [defined in 31 C.F.R. 380(b)(3)]  which has or will have a direct or an indirect ownership interest in a reporting company, and an individual is a beneficial owner of the reporting company by virtue of such ownership interest, the report is to include the only name of the exemption entity and not other information that would otherwise be required to be reported under the Act. This limitation is intended to avoid ‘looking through’ the reporting entity to its owner, e.g. an irrevocable trust,  to force disclosure of what would otherwise have to be reported with respect to trust beneficiaries. [31 CFR 1010.380(c)(2).]  Additionally, these proposed Regulations will affect a large number of entities that do business in the U.S. including an LLC or partnership that is used in lieu of a trust, where the manager of the LLC or the general partner of a limited partnership acts as the equivalent of a trustee with regard to the management of the entity-owned assets or the control over the distributions from the entity to its member/limited partners.

Exempt Entities:  A long list of entities and individuals are described in the proposed Regulations as exempt, such as minors, inheritors of entity interests, deceased individual estates, and very large corporations, e.g. publicly traded,  or banks or other financial businesses with other public regulation and disclosure obligations.

Disclosures: Collecting the information and providing access to law enforcement and others, e.g. intelligence agencies, is intended to diminish the ability to obfuscate activities through the use of anonymous shell and front companies. As such, the Act and its proposed Regulations provide sweep disclosure rules that may creep into normal estate planning strategies even though a trust is probably an excluded entity, (so far, at least) from the disclosure requirements under the Act. Key terms under the proposed Regulations include:

• Domestic Reporting Company: The Act describes this as “any entity that is created by the filing of a document with a secretary of state or similar office of a jurisdiction within the United States.” This would cover LLCs and family limited partnerships. Presumably it would also include something as mundane as a purpose Trust, e.g. a pet trust, or the now in-vogue purpose trusts authorized by some of the ‘trust haven’ states like South Dakota, New Hampshire or Wyoming.
• Beneficial Owner: The Act describes this as “any individual who meets at least one of two criteria: (i) exercising control over the reporting company, g. an LLC Manager; or (ii) owning or controlling at least 25% of the ownership interest of the reporting company.”  Control is expansively defined to include “any individual who directly or indirectly, through any contract, arrangement, understanding, relationship or otherwise, exercises substantial control.” It will be curious to see how an ‘understanding’ constitutes indirect control that warrants a disclosure of information with respect to the person ‘in control.’
• Company Applicant: In the case of a domestic reporting company, a company applicant is the individual who files the document that forms the entity. This would seem to cover an attorney who files organizational documents on behalf of a client with the State of Michigan.  The proposed Regulations specify that a ‘company applicant’ includes anyone who either directs or controls the filing of the document by another.
• Filing Deadline: A required report would be due when the reporting company was created or registered with the state. Existing companies would have one year from the effective date of the final Regulations in order to file their initial report with FinCEN. For new entities that are formed after the Regulations become final, they would have 14 days from the date of their initial registration in which to file their initial report with FinCEN. Any changes to that information initially provided to FinCEN would then have to be updated within 30 calendar days with a updated report.
• Scope of Information: The proposed Regulations describe the information that a reporting company must submit to FinCEN. That information includes with regard to: (i) the reporting company and (ii) each beneficial owner and company applicant the following: the name, residential address, and date of birth of each ‘beneficial owner’ and each ‘company applicant.’ As an alternative to providing this specific information about an individual, either ‘beneficial owner’ or ‘company applicant’, the reporting company may provide a unique identifier issued by FinCEN- called a FinCEN identifier. The proposed Regulations also describe what they call “highly useful information” that reporting companies are encouraged, but not required, to provide to FinCEN.

Penalties: The Act provides that it is unlawful for any person to willfully provide, or attempt to provide, false or fraudulent beneficial ownership information to FinCEN, or to willfully fail to report complete or updated beneficial ownership information to FinCEN. The proposed Regulations describe persons that are subject to this provision and what acts, or failures to act, will trigger a violation of the Act. This is where all this form and information filing become eye-catching. The failure to file a report with FinCEN results in a $500.00 per day civil penalty. There is also a criminal penalty of $10,000 per violation, and the possibility of 2 years prison for a criminal violation of the reporting requirement.

Example:  An attorney creates a ‘shelf’ Limited Liability Company with filed LLC Articles of Organization that she keeps available in her office to be used when a client walks in the door and urgently needs to create and fund an LLC. Is the attorney a ‘company applicant’ for purposes of all the personal disclosures called for by the Act and the proposed Regulations? That LLC is then amended by the attorney to reflect the client’s choice of name for the ‘shelf’ LLC and the issuance of membership units to and in the name of the client. Does that amendment to the LLC’s Articles of Organization to reflect the name change, also filed with the State of Michigan, then trigger yet another disclosure obligation as a ‘reporting company?’ Does the client then file an updated ‘company report’ to disclosing herself as the ‘beneficial owner’ of the LLC? The client then funds the LLC with a closely held business interest. She promptly gifts the LLC units to her four children, each child receiving a 25% LLC membership interest. Are each of the 4 children ‘beneficial owners’ of the LLC subject to the proposed Regulations’ FinCEN reporting requirements? Instead, if the client sells her LLC units to an intentionally defective grantor trust (IDGT), will that IDGT have a reporting obligation under the Regulations, or will the ‘see through’ exception for exempt entities apply so that only the client’s personal information will have to be disclosed to FinCEN but not the IDGT beneficiaries? Any, or all, of these rhetorical questions could easily trigger one or more of the penalties that are described in the Act for the failure to provide the personal information contemplated by the Act.

Conclusion: While these are only proposed Regulations, it is pretty clear that very soon entities  will have new reporting requirements to FinCEN, enforced by pretty stringent penalties for the failure to fully comply with them. Hopefully a clear set of exempt entities will be described in the final Regulations, and in particular a clear set of disclosure rules when an irrevocable trust holds more than a 25% interest in a ‘domestic reporting company,’ so that the personal information of trust beneficiaries will not become a matter of public record.