Corporate Transparency Act Deemed Unconstitutional
How Will This Impact Reporting Companies?
The Corporate Transparency Act (CTA), a United States federal anti-money laundering law, was enacted January 1, 2021, and came into effect on January 1, 2024. The CTA requires non-exempt reporting companies to report information about the reporting company and its beneficial owners to the Financial Crimes Enforcement Network (FinCEN). For a comprehensive overview of CTA compliance requirements, read our article.
On March 1, 2024, the U.S. District Court in the Northeastern District of Alabama ruled that the Corporate Transparency Act was unconstitutional (National Small Business United et al. v. Yellen et al.). The Court ultimately determined that the U.S. Constitution does not grant the government the authority to regulate entities as outlined in the law. This ruling complicates the path forward for many entities that have already begun to file or seek legal counsel.
Case Details
In defense of the Act, the Government contended that the CTA fell within the purview of several congressional powers, including the regulation of commerce, oversight of foreign affairs and national security, as well as the imposition of taxes and regulations. However, after an examination of each of these arguments, the Court determined that none provided a valid basis for the law’s enforcement.
Ultimately, the Court ruled that the CTA exceeded the constitutional boundaries of the legislative branch and that Congress failed to demonstrate a sufficient connection to any enumerated power to justify the CTA’s implementation as a necessary or proper means of achieving Congress’s policy objectives.
I. Foreign Affairs and National Security
The court began by examining whether constitutional authority for the CTA was within the well-known authority of Congress to regulate matters of foreign policy and national security. The Government argued that collecting beneficial ownership information is necessary to protect vital United States national security interests. However, the Court found that incorporation is an internal, rather than foreign affair, and that it has long been committed to state, and not federal regulation.
As such, the Court asked whether Congress’ Foreign Affairs powers justify the CTA’s regulation of “creatures of state law,” which are ordinarily within the purview of the States. The Court found that the answer was no because the CTA would convert traditionally local conduct into a matter for federal enforcement, which would substantially extend federal policing.
II. Commerce Clause
The Court then examined whether the constitutional authority for the CTA laid within congress’ authority to regulate interstate and foreign commerce. The court reiterated the three categories of activity that Congress may regulate under the commerce clause: 1) interstate commerce channels, 2) instrumentalities involved in interstate commerce, and 3) activities significantly impacting interstate commerce. The Court concluded that mandating the reporting of beneficial ownership information by most companies, not solely those engaged in commerce, did not fall within any of the categories.
The Court determined that the CTA exceeds the authority granted under the commerce clause because it regulates non-economic and non-commercial activity. This is because the CTA mandates the reporting of beneficial ownership information by most companies, including for example those that solely incorporated without engaging in further economic activities.
Additionally, the Court invoked a textualist argument, highlighting the absence of the word “commerce” or any reference to channels or instrumentalities of commerce within the CTA. The Court pointed out that Congress could have readily included such references if it had intended to, as it has done in numerous other legislations.
Lastly, the Court asserts that the CTA is “far from essential” in achieving Congress’ legitimate objective of reducing money laundering and terrorist financing, as evidenced by other constitutional efforts aimed at combating illicit activities.
III. Taxing Power
The Government contended that the collection of beneficial ownership information, coupled with its transmission to the Treasury Department, is necessary and proper to guarantee the accurate reporting of taxable income. However, the Court determined that, although the connection between disclosure provisions and the taxing authority is widely acknowledged (as evidenced in scenarios like an income tax return), the mere provision of access to the CTA’s database for tax administration purposes does not establish a close enough relationship in this instance. If that were the case, the Court said, “the Necessary and Proper Clause would sanction any law that provided for the collection of information useful for tax administration and provided tax officials with access” which would be a substantial expansion of federal authority.
What Does This Mean for U.S. Reporting Companies?
FinCEN released a notice on March 4th announcing that it is complying with the court’s order and will continue to do so for as long as it remains in effect. However, FinCEN’s statement implies that reporting companies not involved in the case are expected to follow through with their reporting obligations.
“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.”
In the long term, likely after a series of appeals, the constitutionality of the CTA will be determined. If deemed unconstitutional, the filings will not be required. If deemed constitutional, the filings will be required. It’s also important to note that if the Corporate Transparency Act is ultimately ruled by higher courts as unconstitutional, similar anti-money laundering and anti-fraud rules could develop to address present concerns.
Considering the uncertainty surrounding the constitutionality of the CTA and the significant consequences of non-compliance, it is advisable to encourage clients to fulfill the filing requirements stipulated by the CTA. Nevertheless, it’s important to acknowledge the potential scenario where compliance may not be essential in the end. Ultimately, individual companies must assess their own risk tolerance levels in making the decision to comply with the CTA at this time.
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