GrayRobinson Business Law Section: Analyzing the Corporate Transparency Act’s Impact on ESOPs

May 6, 2024

By: Brendan Hobbs and David Ottinger

The Corporate Transparency Act

The Corporate Transparency Act (CTA), enacted in 2020, is a landmark piece of legislation aimed at enhancing corporate transparency and combating illicit activities, such as money laundering, terrorism financing, and tax evasion. While its intentions are commendable, the CTA has ramifications that extend beyond its primary objectives, particularly concerning Employee Stock Ownership Plans (ESOPs). The CTA introduces new compliance requirements and potential challenges for ESOPs.

As referenced in the GR Insight,”The Corporate Transparency Act and the End of Hiding in the U.S.,” certain U.S. companies are required to report beneficial ownership information to the Financial Crimes Enforcement Network (FinCEN) starting January 1, 2024. Entities in existence prior to that date that are not otherwise exempt from the CTA’s reporting requirements have the entire calendar year 2024 to submit their initial Beneficial Ownership Information (BOI) report. However, entities created on or after January 1, 2024, (that are not otherwise exempt from reporting) only have 90 days from their creation date to file their initial BOI report. Despite ongoing legal challenges in federal courts across the country concerning the CTA’s constitutionality, FinCEN is still enforcing it.1 Because non-compliance with the CTA can potentially result in significant civil and even criminal penalties, all non-exempt entities must take steps to comply until further notice.

Understanding ESOPs

As highlighted in the GR Insight, “Why Business Owners and Employees Should Care About ESOPs,” ESOPs are a unique form of employee benefit plan wherein a company establishes a trust and contributes shares of its own stock or cash to buy shares from its owners. The trust holds these shares on behalf of the employees, who become beneficial owners of the company through their participation in the plan. ESOPs are often used as a succession planning tool for business owners looking to sell their companies while preserving jobs and promoting employee ownership.

Impact of the CTA on ESOPs

One of the key provisions of the CTA is the requirement for certain entities to disclose beneficial ownership information to FinCEN. This information includes the identities of individuals who directly or indirectly own or control 25% or more of the ownership interests in the entity, exercise substantial control over the entity, or receive substantial economic benefits from the entity’s assets. While ESOP trusts technically own the shares of the ESOP-owned company on behalf of the employees, the trust’s beneficiaries are the employees themselves, making it challenging to determine who should be considered the beneficial owners under the CTA.

Compliance Challenges

ESOP-owned companies may face significant compliance challenges in identifying and disclosing beneficial ownership information under the CTA. Determining the beneficial owners of the company becomes complex when considering the multiple layers of ownership inherent in ESOP structures. Moreover, ESOP-owned companies may also need to navigate privacy concerns related to disclosing the personal information of employee beneficiaries to FinCEN. Furthermore, filing inaccurate beneficial ownership reports or providing false or misleading information can lead to civil penalties against the individuals or entities responsible for filing the reports, possibly harming ESOP share value and potentially leading to additional liability on ESOP fiduciaries.

Potential Solutions

To address the compliance challenges posed by the CTA, ESOP-owned companies should implement robust internal processes for identifying and verifying beneficial ownership information. This may involve collaborating with trustees, legal advisors, and other relevant stakeholders to develop comprehensive compliance strategies. Moreover, some ESOP-owned companies may fall under one of the 23 categories of entities that are exempt from the CTA reporting requirements. In any case, working with knowledgeable counsel is vital to ensuring proper and timely compliance.

1 A declaratory judgment from the U.S. District Court for the Northern District of Alabama in NSBA v. Yellen held that the CTA is unconstitutional. However, the court narrowly tailored its ruling to apply only to the plaintiffs in that case. FinCEN has since released a notice stating that it is complying to the court’s order with respect to the plaintiffs, but that it will continue to implement the CTA as mandated by Congress against all others.

Contact GrayRobinson Attorneys Brendan Hobbs and David Ottinger, or a member of the Business Law Section.