The Corporate Transparency Act (CTA), which became effective on January 1, 2024, was enacted to combat the use of shell companies by those seeking to evade anti-money laundering laws and economic sanctions. The CTA imposes an obligation on many U.S. entities (and foreign entities doing business in the United States), unless exempted, to report to the Financial Crimes Enforcement Network (FinCEN), a bureau of the U.S. Department of the Treasury, information of their beneficial owners and, for entities formed on or after January 1, 2024, information of “company applicants” who create or register them. The penalties for noncompliance range from civil fines to criminal penalties, including imprisonment.
However, on March 1, 2024, just 60 days after the CTA’s effective date, the U.S. District Court for the Northern District of Alabama ruled that the CTA is unconstitutional, in the case National Small Business United v. Yellen. This client alert summarizes the court’s decision, analyzes FinCEN’s response, and evaluates the future of the CTA and its state-level counterparts.
National Small Business United v. Yellen
The plaintiffs, National Small Business United (d/b/a National Small Business Association) (NSBA) and Isaac Winkles, an NSBA member and small business owner, filed suit in November 2022, alleging the CTA’s mandatory beneficial ownership disclosure requirements exceed Congress's authority under Article I of the Constitution and violate the First, Fourth, Fifth, Ninth, and Tenth Amendments.
The government offered three sources of constitutional authority for Congress's enactment of the CTA: Congress’s foreign affairs powers, its Commerce Clause authority, and its taxing power.
The government argued that its foreign affairs powers provide constitutional authority because the political branches have plenary power to conduct foreign affairs, and Congress's interest in limiting foreign money laundering and other negative foreign influences places the CTA under the purview of those powers. The government’s Commerce Clause argument reasoned that because many state-formed entities engage in activities that qualify as or affect "commerce," the act of corporate formation invokes Congress's Commerce Clause powers. Last, the government argued the CTA is a necessary and proper exercise of Congress's taxing power, because one purpose of the FinCEN database created by the CTA is to aid in efficient tax administration. The court was unpersuaded by all three arguments.
First, the court held that the CTA was not authorized by Congress’s foreign affairs powers because those powers do not extend to purely internal affairs, particularly in an area traditionally left to the states. Because corporate formation is a purely internal affair, which has always been a province of the states, Congress could not rely on its foreign affairs powers to justify the CTA.
Second, the court held that the CTA was not authorized by the Commerce Clause. Because the CTA does not actually regulate the channels and instrumentalities of commerce, the court reasoned, it cannot be justified as a valid regulation of those channels and instrumentalities, reasoning that the CTA merely imposes disclosure requirements upon entity formation, not once the entity is engaged in commerce; while most entities will engage in commerce, Congress cannot regulate an “entire class just because some members of the class use the channels and instrumentalities of commerce”; and the act of incorporation itself does not have a substantial effect on interstate commerce and is not sufficient to invoke the CTA. The court held that because the CTA does not contain a “jurisdictional hook” or serve as an essential part of a comprehensive regulatory scheme, it falls outside of Congress’s power to regulate non-commercial, intrastate activity.
Last, the court held that the CTA was not authorized by Congress’s taxing power because the collection of beneficial ownership information and tax administration are related only incidentally. Providing access to the CTA database for tax administration purposes is not enough to establish a sufficiently close relationship, and it would be a significant expansion of federal authority to allow Congress to justify any law under its taxing power simply because the law provided for the collection of data and provided tax-enforcement officials with access.
The court concluded that the CTA is unconstitutional because it cannot be justified by any of Congress’s enumerated powers. Accordingly, the court granted the plaintiffs’ summary judgment motion and permanently enjoined the defendants from enforcing the CTA against the plaintiffs.
FinCEN’s Response and Its Implications
In anticipation of concerns from the business community and other stakeholders about the scope of the court’s decision and ongoing compliance with the CTA, FinCEN released the following statement on March 4, 2024:
On March 1, 2024, in the case of National Small Business United v. Yellen, No. 5:22-cv-01448 (N.D. Ala.), a federal district court in the Northern District of Alabama, Northeastern Division, entered a final declaratory judgment, concluding that the Corporate Transparency Act exceeds the Constitution’s limits on Congress’s power and enjoining the Department of the Treasury and FinCEN from enforcing the Corporate Transparency Act against the plaintiffs. FinCEN is complying with the court’s order and will continue to comply with the court’s order for as long as it remains in effect. As a result, the government is not currently enforcing the Corporate Transparency Act against the plaintiffs in that action: Isaac Winkles, reporting companies for which Isaac Winkles is the beneficial owner or applicant, the National Small Business Association, and members of the National Small Business Association (as of March 1, 2024). Those individuals and entities are not required to report beneficial ownership information to FinCEN at this time.
There are a few telling points in FinCEN’s statement.
First, it implies the government will appeal the decision to the federal Court of Appeals for the Eleventh Circuit, as many anticipate. Based on recent timelines for appeals to the Eleventh Circuit, it is possible that the appellate court will not resolve this case before January 1, 2025, which is the filing deadline for entities in existence prior to January 1, 2024.
Second, while FinCEN stated it will comply with the injunction not to enforce the CTA “for as long as it remains in effect[],” FinCEN was crystal clear that non-enforcement applies only to the plaintiffs in that case. This means only Isaac Winkles, reporting companies for which Isaac Winkles is the beneficial owner or applicant, the NSBA, and members of the NSBA (as of March 1, 2024). (We note that FinCEN included only NSBA members as of March 1, 2024, so an entity seeking to join the NSBA in hopes of shielding itself from CTA enforcement may not succeed.) By implication, all other entities must still comply with the CTA and are required to submit beneficial ownership and company applicant information to FinCEN.
Given this information, our recommendation to reporting companies regarding CTA compliance is the same as before the ruling was released—reporting companies should continue to comply with the CTA. FinCEN’s statement suggests strongly that it will continue to enforce the CTA against all entities other than those named in its press release. Until additional guidance is provided, ongoing compliance is the most prudent course of action.
Next Steps for the CTA and State Law Equivalents
The court’s opinion offers specific suggestions on how Congress could amend the CTA to pass constitutional muster. Although any such amendments could possibly be included in various appropriations bills, the 2025 National Defense Authorization Act (NDAA) could contain provisions designed to address the shortcomings in the CTA identified by the district court. Any legislative fix will require a bipartisan effort in an election year in which both parties likely have other pressing priorities. Complicating the legislative fix is the reality that the CTA has come under fire from a number of legislators since its enactment three years ago.
The court decision may push Congress to revisit the Establishing New Authorities for Businesses Laundering and Enabling Risks to Security (ENABLERS) Act, which was introduced originally by a group of bipartisan lawmakers as part of the 2022 NDAA, but which was removed ultimately by the Senate prior to passage. The ENABLERS Act intended to close existing loopholes by extending the anti-money laundering requirements in the Bank Secrecy Act to include professional service providers, such as accountants, lawyers, and third-party payment services. With the CTA’s status in question, Congress may reevaluate the ENABLERS Act, as its stated purpose is similar to that of the CTA.
In the meantime, states may be motivated to enact their own CTA equivalents because of the uncertainty surrounding the CTA. Such legislative initiatives at the state level could create double reporting requirements under both the CTA and a state’s equivalent requirements. One state, New York, has already approved a transparency statute modeled after the CTA, although the New York rule is specifically limited to limited liability companies. The New York LLC Transparency Act takes effect on December 21, 2024, and it incorporates many CTA provisions by reference. Other states may soon follow suit.
Maryland, for example, is considering its own transparency statute. The current bill would require entities formed in Maryland to file a report with the State Department of Assessments and Taxation (SDAT) that includes the names of the entity’s applicant and each beneficial owner. Currently, the Maryland bill contains only one exemption (for banking institutions). By contrast, the CTA contains 23 exemptions. Should the Maryland bill pass as currently drafted, it would take effect on October 1, 2024. However, the SDAT advised the legislature that the Maryland Business Express Service will have difficulty implementing the draft bill before December 2025. If nothing else, this illustrates to state legislators who are eager to pass transparency statutes that state agencies—at least in Maryland—may struggle with serious administrative limitations during implementation.
Practical limitations aside, the ruling in National Small Business United v. Yellen could spark renewed interest in state legislatures currently considering transparency statutes. Business entities and their beneficial owners should continue to monitor their state’s legislature for any movement on state-level CTA equivalents.
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As always, we and our colleagues are available at any time to discuss the implementation of the CTA, its application to your business, and other matters.