Update on Corporate Transparency Act: Federal Court in Alabama Holds CTA Unconstitutional

On March 1, 2024. a U.S. federal court in Alabama declared the Corporate Transparency Act (CTA) to be an unconstitutional exercise of congressional authority, and suspended its enforcement against the plaintiffs in that case.  National Small Business United v. Yellen, No. 5:22-cv-01448 (N.D. Ala.).  The CTA requires all companies to file a beneficial ownership information report (BOIR) by the end of 2024.  Companies formed in 2024 must file within 90 days of formation, unless an exemption applies.  Other court challenges to CTA requirements are emerging to raise questions of when or if a company is required to file. We expect the appeals process in these cases to stretch well toward the end of the year, or more likely into 2025.  Unless there is a nationwide order, companies remain required to file BOIRs for 2024 while cases make their way through the system.

The expectations of FinCEN itself are clear – companies will be required to comply with CTA.  FinCEN issued a release notifying companies that the reprieve granted in the NSBU case applies only to the NSBU plantiffs.  https://fincen.gov/news/news-releases/updated-notice-regarding-national-small-business-united-v-yellen-no-522-cv-01448  The NSBU case may be one of several cases that could cause companies to hesitate in their CTA processes.  Confusion caused by these court challenges may cause companies to delay analysis of their CTA obligations and/or collection of necessary information, making a filing on a timely basis difficult or impossible.  Meanwhile, the safest course is for companies to continue their BOIR filing processes, while the Government has appealed the NSBU decision.

The appeal will turn on the NSBU’s challenge to, among other things, the nexus between the regulated activity and interstate commerce.  Such Commerce Clause challenges have been considered long shots in the past, because settled law provides that the Commerce Clause doctrine supports federal regulation of “intrastate activities that substantially affect interstate commerce.”  Here, the stated purpose of the CTA is to “help prevent and combat money laundering, terrorist financing, corruption, tax fraud, and other illicit activity, while minimizing the burden on entities doing business in the United States.”  Legislative purposes far less connected to interstate commerce have survived judicial scrutiny, and money laundering activity is logically an activity that affects interstate commerce.  In the end, the NSBU court concluded that Congress lacked authority to enact the CTA because “[t]he proximity and degree of connection between the formation of an entity and its activities is too attenuated[.]”  Essentially, the argument is that merely forming a company does not suggest that it will operate in interstate commerce.  At the same time, the Court noted that Congress could have “easily” written the CTA to pass constitutional muster, raising the possibility that Congress may choose to modify the legislation.  Further, the NSBU court acknowledged that FinCEN’s 2016 Customer Due Diligence rule “provide[s] FinCEN with nearly identical information.”  As such, the NSBU court struck down the CTA while acknowledging a similar rule that provides nearly identical information is constitutionally acceptable.

The NSBU court also rejected other bases for Congressional power to enact the CTA legislation, including Congress’ broad powers to oversee foreign affairs and national security and impose taxes and related regulations.  The NSBU court concluded that the lack of constitutional authority to pass the act in question was “clearly demonstrated.”

In finding that Congress was not acting within the scope of its foreign affairs powers, the NSBU court reasoned that “[n]o principle of corporation law and practice is more firmly established than a State’s authority to regulate domestic corporations.”  It found that foreign affairs authority did not extend to purely internal affairs, such as formation of corporations under state law.  While the court conceded that the CTA is not a direct regulation of corporate formation, it decided that there was not adequate nexus between the purpose of the act and the foreign affairs power.  The NSBU court found objectionable that the CTA was a federal reporting requirement imposed on entities that voluntarily incorporate solely under state law, and that might operate exclusively within their state’s borders.

The NSBU court likewise rejected Government arguments that Congress was acting within its taxing power in enacting the CTA.  The Government argued that “the collection of beneficial ownership information is necessary and proper to ensure taxable income is appropriately reported.”  The law expressly allows the Department of the Treasury to access BOIRs for tax administration purposes.  The court concluded that providing access to the CTA’s database for tax administration purposes is not enough to establish a sufficiently close relationship to the Constitution’s grant of taxing power to Congress.

The Government is appealing the decision in NSBU, and some commentators have read the NSBU case as providing a roadmap for Congress to amend the CTA to more clearly invoke the Constitution’s grants of lawmaking authority.  This issue may ultimately be decided by the United States Supreme Court.  While there may be interest in challenging well-settled Commerce Clause jurisprudence, few justices have gone as far as Justice Thomas, who has argued that “post-1937 Commerce Clause jurisprudence is unfounded and un-originalist.”  While it may be possible to curtail Congress’s power to pass laws affecting interstate commerce, such efforts still face an uphill battle.  Meanwhile, companies need time to collect information and process filings, and do what they need to do to avoid FinCEN penalties.

We will continue to provide updates on this case and others that may emerge, as well as provide guidance on the application of the CTA.  Unless a more definitive nationwide decision is reported, FinCEN has stated that it intends to continue its enforcement of the CTA.

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