Introduction

While drafting the Constitution, the Founders discussed giving the federal government the power to incorporate businesses but ultimately chose to leave the power to the states. The conflict between the powers of the federal and state governments was, and continues to be, one of the most contested political issues in the United States. Consequently, it is no surprise that Congress’ enactment of the Federal Corporate Transparency Act (“CTA”) has many critics.

The CTA requires nonexempt entities to file a report disclosing its beneficial owners by a certain date.  Beneficial owners include people who either (1) directly or indirectly exercise substantial control over the company or (2) own 25% or more of the equity in the company. The CTA applies to both existing and newly-formed entities, though the time to file differs.  The information reported under the CTA will be maintained in a database, and will not be publicly available.

The CTA May Be Unconstitutional

This past March, a Federal District Court in Alabama decided National Small Business United v. Yellen, a constitutional challenge to the CTA. Because the Federal government only has the power that the Constitution expressly grants to it, Congress must point to a specific enumerated power to justify any law it enacts.

In an attempt to justify the CTA in the National Small Business United case, the government pointed to its foreign affairs power, commerce power, and taxing power through the “necessary and proper” clause. The government argued that because the CTA was an attempt to prevent malicious foreign actors from concealing their ownership of United States entities, the CTA was a valid exercise of the Federal government’s foreign affairs powers. The court disagreed because such power does not extend to internal or domestic affairs, and entity formation is a domestic affair.

The court found that the CTA was not a valid exercise of the commerce power either because Congress can only regulate interstate or foreign commerce, or commerce with the Indian Tribes. The court found that entity formation itself was not a commercial activity, and that Congress could not regulate those entities simply because they might engage in interstate or foreign commerce in the future. Some may only engage in intrastate commerce.

Lastly, the government argued that the CTA was a valid exercise of its taxing power because the collection of beneficial ownership information is necessary and proper to ensure taxable income is appropriately reported. The court found this argument too attenuated and felt that it would give Congress virtually unrestrained power. Ultimately, the court held the CTA to be unconstitutional.

Reactions To The Court’s Decision

The United States Department of the Treasury’s Financial Crimes Enforcement Network (“FinCEN”) plans to enforce the CTA for all entities other than the specific plaintiffs in the Alabama case until the matter is resolved on appeal. Multiple United States Senators filed a brief in support of the government’s position. Non-profits, think tanks, and other organizations have filed briefs on both sides of the issue.  The Repealing Big Brother Overreach Act, which would repeal the CTA, was introduced in the Senate in May 2024, though it is not clear whether it will have the necessary support to become law. The Protect Small Businesses and Prevent Illicit Financial Activity Act, which would attempt to close loopholes for foreign shell companies to hide the identity of nefarious owners while extending reporting deadlines, passed the House by a wide margin in December. Court challenges were also filed in federal District Courts in Maine and Michigan following the Alabama decision.

State Law Considerations

This past December, New York passed the LLC Transparency Act (“LLCTA”), which mirrors the CTA, but only applies to non-exempt limited liability companies. California recently enacted its own version of the CTA, which goes even further than the CTA by making the reported beneficial ownership information public. It is possible that if the CTA is ultimately struck down, the focus will shift to the various state laws being put in place or proposed.  Because the Alabama court struck down the CTA on Congressional authority concerns, the state laws will not run into a similar issue. However, there are possible Fourth and Fifth Amendment concerns, which would apply to the states, that the CTA is an unconstitutional search and seizure and would require self-incrimination by effectively requiring business owners to confess to their participation in crimes.

Conclusion

It is not clear yet whether the CTA and its reporting requirements will stand. Nonetheless, because it usually takes a significant amount of time for appeals to be resolved and for legislation to pass, and as FinCEN is planning to continue enforcing the CTA, it is probably best for entities subject to the CTA to comply with the beneficial ownership reporting requirements, or at the very least to have their ownership records up to date and be ready to report in case the current deadlines remain in effect.