US federal district court rules Corporate Transparency Act is unconstitutional

Tuesday, 12 March 2024
A US federal district court has ordered the US Department of the Treasury to stop enforcing the beneficial ownership reporting provisions of the Corporate Transparency Act against thousands of small businesses throughout the US.
Department of Treasury

The Act, which was enacted in 2020 but only came into force in January 2024, requires millions of entities operating in the country to report their beneficial owners to the treasury. However, it has encountered opposition from small businesses because of the administrative burdens it imposes.

In November 2022, the National Small Business Association (NSBA) and one of its members filed a suit in the Northern Alabama District Court challenging the constitutionality of the Act’s beneficial ownership information reporting rule. They argued that the rule would violate privacy protections by requiring law-abiding Americans to provide highly personal information to a government agency to be stored in a database for criminal enforcement purposes. Further, they claimed that the obligation is unduly burdensome on small companies and infringes on states' powers to govern business. The NSBA sought an immediate injunction against the treasury’s Financial Crimes Enforcement Network (FinCEN), which enforces the reporting rules.

On March 1, 2024, the court entered a final declaratory judgment enjoining FinCEN not to enforce the Act against the NSBA or any of its members. It found that the US Congress exceeded its constitutional powers in enacting it because the Act lacks a sufficient nexus to any enumerated congressional power to be a necessary and proper means of achieving its policy goals (National Small Business United v Yellen, No. 5:22-cv-01448).

The decision will ‘likely cause great consternation in the marketplace, as companies have been actively collecting information for anticipated filings or have already submitted filings since the start of the year’, says law firm Dickinson Wright.

FinCEN has issued a statement undertaking to comply with the injunction and agreeing that the parties concerned do not have to comply with its beneficial ownership rules for the moment.

However, it is not clear how far this exemption extends. The court's judgment is nominally limited to the plaintiffs themselves and no national injunction is in place. Law firm K&L Gates notes that for other affected entities the answer is not so straightforward. Companies formed before 2024 are not required to report their information to FinCEN until the end of 2024, so may prefer to ‘wait for a period of time to allow the courts to wrestle with the constitutionality of the [Act]’. Under the Act, companies formed in 2024 must report their beneficial owners within 90 days from the date of formation and should continue to comply with the Act until there is a definitive resolution. Holland & Knight echoes this: 'Nonparties are well advised to continue to timely, correctly and completely report the required information', it said.

The US government is likely to appeal the decision and that of the several similar cases being brought in other state courts. It will also ask for the injunction to be stayed pending appeal, according to Kocher and Feldman.

The district court's decision could have an impact on states currently contemplating adopting 'mini-CTAs', said Holland & Knight. California, Maryland and Massachusetts have proposed such Bills and other states may follow.

Law firm Berger Singerman considers that the CTA remains applicable and enforceable against corporations and other legal entities subject to CTA reporting, with the exception of the NSBA and its members. 'Therefore such corporations and other legal entities should continue to comply with FinCEN's final beneficial ownership information reporting regime at this time', it warned. The majority of US law firms appear to agree with this position.

Editor’s note: This is an updated news story, in light of the expert comment that has emerged since the International News Digest published on March 7, 2024.

Sources

The content displayed here is subject to our disclaimer. Read more