Federal court finds small-business reporting rule unconstitutional

A federal court has ruled that the Corporate Transparency Act, which requires businesses to report personal information, is unconstitutional.

U.S. District Court Judge Liles C. Burke of the Northern District of Alabama court has found that the act violates the constitution. A lawsuit filed by the National Small Business Association successfully challenged the federal government’s collection of sensitive and personal information from “beneficial owners.”

Intended to combat financial crimes such as money laundering and financing terrorism, the Corporate Transparency Act requires most companies to submit what is called beneficial ownership information to the Treasury Department’s criminal enforcement arm. In a scathing opening to his 53-page opinion, Burke noted that the well-intentioned law is unconstitutional.

“The late Justice Antonin Scalia once remarked that federal judges should have a rubber stamp that says STUPID BUT CONSTITUTIONAL,” the opinion states. “The constitution, in other words, does not allow judges to strike down a law merely because it is burdensome, foolish or offensive. Yet the inverse is also true — the wisdom of a policy is no guarantee of its constitutionality. Indeed, even in the pursuit of sensible and praiseworthy ends, Congress sometimes enacts smart laws that violate the constitution. This case, which concerns the constitutionality of the Corporate Transparency Act, illustrates that principle.”

Corporate Transparency Act and beneficial ownership information

In an effort to prevent financial crimes often committed through shell companies, the Treasury Department issued a final rule in September 2022 implementing the Corporate Transparency Act.

The new rule established beneficial ownership information reporting requirements. Reporting companies include corporations, limited liability companies and “any other entities created by the filing of a document with a secretary of state or any similar office in the United States.” Exceptions are carved out for banks, insurance companies and companies with more than 20 employees and more than $5 million in gross revenue.

A “beneficial owner” is an individual who exercises substantial control over the entity or owns or controls at least 25% of the company’s ownership interests. The definition of “substantial control” is vague but includes senior officers, important decisionmakers and individuals with the authority to appoint or remove senior officers or a majority of the board of directors.

Beneficial owners must submit to the Financial Crimes Enforcement Network their full legal name, date of birth, current address and identification number from a driver’s license, ID card or passport. Changes to any of that information requires an update to the Treasury Department. The Financial Crimes Enforcement Network retains the information for at least five years after the company terminates.

Reporting of beneficial ownership information went into effect on Jan. 1 for newly formed companies. Existing companies are required to submit reports on Jan. 1, 2025. Failure to comply can result in a $500 per day penalty up to $10,000 and two years’ imprisonment.

Challenge to Corporate Transparency Act

Shortly after the final rule was published, the National Small Business Association filed a lawsuit against the Treasury Department.

The lawsuit argued that the Corporate Transparency Act’s beneficial ownership information reporting requirements exceed Congress’ authority under Article I of the constitution and violate the First, Fourth, Fifth, Ninth and 10th Amendments.

Article I Section 8 of the constitution establishes the enumerated powers of the federal government, including regulating commerce. The National Small Business Association argued that the Corporate Transparency Act does not regulate commerce. It called the filing of a company a “ministerial act,” not a commercial activity. The association pointed out that millions of entities are formed for purposes other than commerce or business.

Additionally, the association argued that by exceeding its powers granted under Article I, Congress also violates the Ninth and 10th Amendments, which protect unenumerated rights and delegate powers not expressed in Article I to the states, respectively.

The lawsuit claimed that forcing individuals to identify themselves to the federal government violates the First Amendment right to free speech and free association.

Regarding the Fourth Amendment, the Corporate Transparency Act compels the disclosure of personal information for law enforcement purposes and allows federal agencies to access that information without court authorization. Consequently, that enables “unreasonable search and seizures” with no prior suspicion of wrongdoing. This also violates the Fifth Amendment’s privilege against self-incrimination, the lawsuit said.

Court decision

The Alabama federal court concluded that the Corporate Transparency Act cannot be justified as an exercise of Congress’ enumerated powers.

The federal government first argued that the act is covered under Congress’ powers over foreign affairs. However, the federal district court found that incorporation is not only an internal affair but also a power delegated to the states.

Next, the government claimed the Commerce Clause protects the Corporate Transparency Act. Siding with the National Small Business Association, the court found that the act of incorporation is not an economic or commercial activity.

Lastly, the federal government argued that its taxing power justifies the new reporting rule since the database can be accessed for tax administration purposes. However, the district court determined that link to be weak. Burke pointed out that “all Congress would have to do to craft a constitutional law is simply impose a disclosure requirement and give tax officials access to the information.”

The federal court concluded that the Corporate Transparency Act is not justified by any of the enumerated powers given to Congress under Article I. Based on that conclusion, the court found it unnecessary to decide on violations of the First, Fourth and Fifth Amendments.

Beneficial ownership reporting still intact

Although the federal court found the Corporate Transparency Act is unconstitutional, the final judgment is narrow in scope.

This judgment prohibits the federal government from enforcing the Corporate Transparency Act against the plaintiffs. In other words, only current members of the National Small Business Association are off the hook from submitting a beneficial ownership report. In an official statement, the Financial Crimes Enforcement Network acknowledged that distinction.

“(The Financial Crimes Enforcement Network) 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,” the bureau said. “As a result, the government is not currently enforcing the Corporate Transparency Act against the plaintiffs in that action … Those individuals and entities are not required to report beneficial ownership information to FinCEN at this time.”

For everyone else, the beneficial ownership information report is due by Jan. 1, 2025. However, Barry Fowler of Taxation Solutions told Land Line Now that any owner-operators running a sole proprietorship under a “doing business as” or their own name do not have to submit a beneficial ownership report. Only businesses that have to file with the secretary of state are required to submit a report.

Fowler also pointed out that the reporting process is quick, simple and free. Business owners should be wary about any service offering to submit the report for a fee. Reporting can be completed at boiefiling.fincen.gov. Listen to the full interview with Fowler about beneficial ownership reporting below. LL

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